A new financial innovation in the housing market
Financial innovation in the housing market is back.
The last year saw the creation of something called “REO-to-rental securities” or “rental-backed securities.” It’s enough to give you subprime crisis flashbacks. But in fact, it’s a very different species of financial instrument.
It does start with a house, much like that of Jess Joslin. “It’s a two-story brick house with a two garage,” she says.
Joslin rents from American Homes 4 Rent, one of the largest players in the emerging market of single family rentals owned by big investors. “From what I understand, almost all their houses look like this,” Joslin says. “They’re really nice.”
The largest investors have purchased nearly 200,000 houses in the last several years. The purchasing peaked in 2012, and has focused on places where the subprime mortgage crisis hit hardest.
“You’re seeing it in Phoenix, in Las Vegas, in Atlanta,” says Laurie Goodman, director of the Housing Finance Policy Center at the Urban Institute.
In many of these markets, housing prices fell by more than a third, and the plan was to buy low with cash from investors, and then reap the profits from high rents. But in many of these markets, housing prices have appreciated, while rents have remained more stagnant. “Rents haven’t gone up all that much,” says Goodman. “And they haven’t gone up nearly as much as home prices.”
This change has meant that the buy-to-rent strategy generates less return for every dollar. To make up for it, in the last year, these investors have looked for ways to put other people’s dollars to work.
Enter securitization.
Do we call them rental-backed securities?
“They’re viewed as a hybrid,” says Doug Bendt, director of research for mortgage-backed securities at Deutsche Bank.
His bank pioneered this new financial instrument as a way of giving investors more leverage. “‘Necessity is the mother of invention,’ as the saying goes,” he says.
Think of it as a really big loan to a really big landlord, chopped into little pieces and sold to bondholders. The landlord—like American Homes 4 Rent—gets some cash for the rising home prices, and lower borrowing costs going forward. “Just kinda like a homeowner refinancing,” says Bendt.
The bondholders get a check every month, thanks to thousands of rental payments from people like Jess Joslin.
And if some of the thousands of Joslins stop paying their rent? The landlord can kick them out of their homes and find new tenants, or sell the whole house. That, and a much smaller scale and more conservative approach, are why analysts like Goodman and Bendt see the rental-backed security as far more benign than the infamous toxic assets that led to the last housing crisis.
“I think people think, ‘Oh this is a repeat of the excesses of the past!’ But in reality, it’s very, very different than the past,” says Goodman. “It’s sort of a begin to creep back to normalcy.”
A normalcy where more people are renting, and more of their landlords are multi-billion-dollar companies.
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