Single-family rental property, one of the most talked-about new asset classes in structured finance, appears to be undergoing a reassessment.
The second-ever rental securitization may have gotten slightly higher marks from one credit rating agency, but investors judged Colony American Homes’ $513 million deal, which priced on April 3, more critically than they did the first such deal, which was completed by The Blackstone Group’s Invitation Homes in November 2013.
Moody’s Investors Service, Kroll Bond Rating Agency (KBRA) and Morningstar all gave the senior tranches of both deals a triple-A rating. However, KBRA rated most of the subordinated tranches of Colony American Home 2014-A half a notch to one notch higher than similar tranches of Invitation Homes 2013-SFR1.
And yet spreads on tranches of Colony America Homes 2014-1 were as much as 95 basis points wider than comparable tranches of the Invitation Homes deal.
This suggests that investors are becoming more discerning about the asset class as a whole, particularly as the pipeline of deals expands. Both American Residential Properties and American Homes 4 Rent have said they are working on rental securitizations. Deutsche Bank Securities estimates that approximately $5 billion in issuance is slated for 2014.
Colony American’s deal has slightly better credit metrics, notably a lower weighted average loan-to-value ratio, at 70% compared with 75% for Invitation Homes. “That is a meaningful difference because [at 75% LTV] this is the part of the leverage curve where risk starts to increase at a faster pace,” said Nitin Bhasin, a managing director in KBRA’s CMBS group.
The loan underlying the Colony American transaction also has a slightly higher debt service coverage ratio, at 1.76x compared with 1.68x for Invitation Homes deal.
Bhasin also pointed to the higher geographic concentration of rental properties in the Invitation Homes transaction, which has its highest exposure (34%) to the Phoenix housing market. By contrast Colony American’s largest geographical exposure (14.9%) is to Las Vegas. Also, the Invitation Homes deal had a higher advance rate of 53.2%, compared with 49% for Colony American Homes.
Nevertheless, Colony American Homes had to pay investors a 120 basis point spread over one-month Libor on its 4.9-year, triple-A rated tranche, five basis points wider than the spread on the senior tranche of Invitation Homes’ deal.
Colony American also priced its 5.1-year, Aa2’/’AA+’/’AA’ notes at 155 basis points over one-month Libor, 20 basis points wider than the. Aa2’/’AA’/ AA’, 5.1-year notes issued by Invitation Homes 2013-SFR1.
While some of that widening may be attributable to conditions in the broader financial markets, the spread differential between the two deals is even wider further down the capital structure.
Some investors, many of whom found the market’s inaugural deal expensive, may welcome the widening on second deal. Vincent Fiorillo, global sales manager at the DoubeLine Group, for example said that he found the pricing on the Invitation Homes deal too tight.
Another investor familiar with both deals said that pricing on the inaugural deal did not reflect the risks inherent in the asset class, nor did it reflect the fact that this is a new asset class.
Despite the broader geographic representation, for example, 30% of the properties backing Colony American Homes 2014-1 are located in the top two metropolitan areas, and 73% of the pool is concentrated in three states, California, Florida and Nevada.
This concentration reflects the sponsor’s focus on regions with the most attractive investment opportunities. “The need for local property knowledge and economies of scale in managing properties in a particular region can be viewed as positive aspects of concentrating on a few regions,” KBRA said in its presale report on the deal. “However, the risk of being significantly impacted by a local downturn in the economy and/or property markets is elevated.”
Also, Colony American Home’s debt service coverage, albeit higher than Blackstone’s, is still significantly lower than the typical debt service coverage of multi-family properties in KBRA-rated Freddie Mac K-series and other CMBS transactions in 2013, which have averaged at approximately 1.50x. Lower debt service coverage rations increase the probability of default during the loan term, particularly if cash flows come under stress.
Investors also cite as a concern the fact that properties backing rental securitizations are valued via broker price opinions (BPOs), which essentially represent the opinion of a real estate broker. Full appraisals performed by licensed appraisers are considered to be more reliable than BPOs, and are more typically used in commercial mortgage securitizations.
Bhasin said that KBRA gained some comfort after studying this less orthodox form of property valuation; nevertheless, “At the end of the day, we did take a 10% to 12% discount for BPO values as a starting point, and further stressed them up to 50% in our ratings determination process.”
Nevertheless, the investor who spoke on condition of anonymity said that “pricing hasn’t cheapened enough,” considering the risks of this new asset class.
Fitch Ratings has said it would cap its rating on the senior tranche of any rental securitization at the 'A' level, due to the lack of performance history for large portfolios of rental properties as well as concerns about the security of investors' interest in rental properties.
To be sure, pricing on both deals provided very attractive financing for their sponsors. Colony American Homes 2014-1 was over 5x oversubscribed, which speaks to strong demand. A source at one single family rental firm called securitization a "game changer." Prior to securitizaing single family homes, these firms rely on private equity and bank lines of credit, among other forms of financing.