Congressmen Call for Hearings on Risks of Rental Securtizations

Private equity firms have been playing residential landlord for only a few years, but the impressive amount of capital they’ve deployed in this strategy means they’ve had significant impact in the markets they’ve targeted. And while PE investors might claim they’ve done communities a big favor by snapping up foreclosed and other distressed properties, playing a critical role in the housing recovery, some of these new landlords are already developing less than savory reputation. That should be no surprise, since PE firms in their traditional business play a numbers game, levering up and squeezing companies for more cashflow, leading to job losses and too often, bankruptcies. It’s not just that the math of portfolio returns allow for some failures; more important, as Josh Kosman documented in The Buyout of America, private equity fund managers pull so many fees out of their portfolio companies that they make money even when a business collapses. So there’s every reason to suspect them of structuring similar “heads I win, tails you lose” deals in the single family rental business.

Mark Takano, a Congressman who represents communities in California’s Inland Empire, one of the areas hit hardest by the housing bust, is concerned, and with good reason. He has noticed that prices for rentals have moves up smartly even as economic conditions in his district remain poor. He hypothesizes that the PE wall of money that washed in is a big, if not the, contributor. He’s also troubled by the idea that rental securitizations will only exacerbate the inherent problems of having big fund managers act as landlords: namely, that of not only being too big and removed to care much, but also having the securitization further insulated them from responsibility. He’s asked for hearings into rental securitizations.

There certainly is reason to be concerned about conditions in the communities he represents. Even though financial experts recommending spending at most 30% of income on housing expenses, almost 1/3 in two cities in his district, Riverside and Moreno, spend 50% or more. And in Riverside, while median income is $5,524 below its pre-crisis peak, median rental costs rose by $756 in the same period.

Yet at first blush, Takano’s charge sounds implausible: if private equity landlords have increased the supply of rental housing, how could that have led to more costly rentals? While stringent bank credit conditions play a big role, Takano believes that some renters would and even could be homeowners, were they not competing with all-cash buyers. His report explains:

When housing prices fell after the subprime mortgage crisis, investors had an extra incentive to buy properties cheap to rent and make a profit. The Inland Empire was particularly impacted because of its high rate of foreclosure. In an effort to help turn around distressed markets across the country, the Federal Housing Finance Agency sold hundreds of homes in bulk sales to large investors. In November 2012, Colony Capital purchased 970 properties in California, Arizona, and Nevada as part of an FHFA bulk sale. The Press Enterprise reported that in April of 2013, four out of every ten home purchases in Riverside County were by participants in an investment strategy, undoubtedly pushing out family buyers of modest means in the process.

Large investors can be more attractive to sellers, because they’re able to purchase homes with cash, rather than financing the purchase through a mortgage. Competition from large investors and a low vacancy level make it more challenging for individuals and families to purchase a home of their own. According to the Inland Valleys Association of Realtors, the percentage of home purchases in the Inland Empire that were purchased outright with cash has doubled since 2008, jumping from 17 percent to 34 percent in 2012.

In the abstract, there’s nothing wrong with renting, but whether it’s a good deal depends on price and terms. And not only is the price not so hot, but many of the PE landlords look a lot like slumlords. The biggest home buyer, Blackstone, is also reputed to be one of the worst property managers. And Takano is correct to be focusing his concerns on rental securitizations.

Personally, I’m stunned that any investor with an operating brain cell would sign up for the rental securitization launched last year by Blackstone’s rental operation, Invitation Homes, last year. However, it was a comparatively small deal ($479 million), Wall Street was eager to get it done (they hope more deals will follow, so it was likely made a priority for the salesmen), and for some investors, participating in a Blackstone deal is like buying IBM (computers, not the stock). In addition, Fitch refused to rate the deal, citing insufficient history.

Of course, using the Standard & Poor’s “we’d rate a deal structured by cows” threshold, it’s no wonder this deal passed muster. And in fairness, with a 40% cushion, the AAA investors do have a lot of protection. From a Bloomberg infographic (hat tip Lisa E):

Screen shot 2014-01-26 at 11.04.32 PM

But the real question is who will buy the riskier tranches, which account for 44% of the face value of the deal? The riskiest tranche presumably, like the equity tranche or RMBs, will get the upside if loss reserves in the deal aren’t used up, so they should attract buyers. But the old RMBS deals, which had much more certain-looking cash flows, found it difficult to sell the tranches that didn’t have possible upside, which were the BBB and often the A tranche. The remaining inventory got rolled into CDOs.

And there’s a lot more not to like from an investor perspective. It preserves the investor disenfranchisement of requiring 25% of the investors to participate for most types of suits to move forward. And NC contributor MBS Guy points out a real doozy:

In order to provide AAA ratings, the Kroll and Moody’s ratings both rely on the value of the underlying real estate, upon a sale of such properties. Neither rating report addresses what would trigger a sale.

The more detailed Kroll report addresses it a bit more: if performance, in the form of debt service coverage ratio, falls to a low level the loan to the trust (backed by the portfolio of properties) goes into default. If a workout can’t be arranged, then presumably the whole portfolio of loans would be individually foreclosed upon. This would be a mess: mass foreclosure of all of the properties. I can’t imagine how this would be managed in real life.

So if we are lucky, these rental securitizations won’t prove to be popular and the private equity barons will need to make use of other exit strategies. But investors in the US have the right to be stupid, so we can’t rely on such a happy outcome.

Needless to say, there’s even more reason to be alarmed from the standpoint of tenants and communities. The reports of private equity landlord neglect and misrepresentation are already legion. One staffer at a PE firm told us his firm believed they could shift most maintenance obligations onto the tenant. That is basically a notification that many, and likely most PE homeowners plan to take the concept of “absentee landlord” to a new level.

And even making the highly charitable assumption that PE landlords wanted to be decent property managers, a rental securitization makes it virtually impossible to happen. It uses the same servicing model that continues to be unable to meet legally mandated standards, like stopping dual tracking, even after umpteen settlements. Servicers are set up to be factories, with highly standardized processes. That proved to an abject failure for mortgages when defaults rose above their historically low levels. Servicers utterly lacked the infrastructure and processes to do anything on an individualized basis, when that’s precisely what is required with delinquent borrowers. Rental properties are even less well suited, by virtue of property management always being a high touch activity.

The PE overlords will loftily assure the public that these concerns are dated, that residential property management really does scale, and they’ve hired contractors on a regional basis to do the dirty work. Remember that servicers also hired contractors to perform much simpler tasks like securing property, and they failed abysmally.

So please, call your Representative and tell him or her that you are very concerned about all the stories you’ve heard about what bad landlords PE firms are turning out to be, and that if they can go ahead with more rental securitizations, it will be even harder to hold them accountable.

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  1. sd

    Wow. So all an enterprising individual would need to do is figure out which properties are owned by PE firms, embrace the capitalist spirit and open literally entire neighborhoods of grow houses and no one would notice. This will not end well….

    1. R Foreman

      > This will not end well

      That was obvious 6 years ago when they paid off all the bad debt, but no one seems to be able to stop this. It’s become like a creature that has a life of its own.

      Next thing you know the super-wealthy will be constructing a space station, physically separating themselves from the population, and beginning mass mineral extraction across the planet’s surface.

      1. NotTimothyGeithner

        What else do they know how to do? GE under Welch became a company which leveraged, acquired, consolidated, downsized, repeat. The company men who rise come from MBA programs where they almost immediately followed suit.

        The super wealthy won’t build a space station because they lack the know how and expect to be able to hire people for pennies to solve any future problems, but they also lack the ability to work together. While there are sheep to rob, they go about the robbing, but the worries about emerging markets are the MOTUs recognizing the next class of people they were going to rob as consumers first don’t exist despite neo-liberal predictions from the 90’s. Putin and the Chinese elite who aren’t fleeing don’t give a flying eff about American/Western corporatists, so they have no incentive to continue allowing western corporate imperialism. Its just like the breakdown of the colonial system in the 60’s. The system worked while local elites benefited directly from British rule, but when the little people started making noises the local elite fled or made a bid for the top job. Nehru had 4 million men under arms. Not all of them may have been soldier grade, but the British didn’t have allies who could counter 4 million men.

        With anti-American sentiment, the anti-spying sentiment, and the EU’s problems, smaller governments which were expected to provide the next places to pillage would rather be pillaged by the Chinese and the Russians or even have the temerity to be partners.

    2. RepubAnon

      One wonders what happens to the securitized rental income bonds if the underlying property is seized by the government under the drug forfeiture laws, or contaminated by meth lab residue…

  2. j gibbs

    The real problem here is local: imposing legal obligations with teeth in them on these financialized landlords. Ideally, you need a landlord tenant court staffed with Marxist judges. New York City has had one for fifty years, and in my experience (up to 1990) the tenants got the best of it, even though the landlords were mostly the City’s richest scum household names.

    1. cripes

      “Staffed with marxist judges.” Really? We must have gone to a different housing court. The one i went to had no legal representation for tenents, 90 second “hearings” and a raft of retainer counsel for property owners battering tenants with endless petitions. My housing court was at 111 center st
      I suppose yours was 112 fairydust lane.
      Well, i guess perspective is everything, and tenants who won’t vacate their homes which happen to be your property can be irritating.

        1. cripes

          J gibbs:
          My reply was done in freezing Chicago while in transit. So disregard my comment assuming you were a property owner. I see you are advocating Marxist judges, I concur.

          However, my experience at 111 Centre St landlord-tenant court was perfunctory eviction hearings, overmatched tenants, sewer service (false attestations by landlords of serving papers to tenants to fraudulently obtain judgements). During maybe 55 hearings over three years in the 1980’s I learned that tenants must prevail every time and landlords need only prevail once. A bad situation. Basically, an eviction mill.

          1. alex morfesis

            you were able to keep your landlord from evicting you for more than three years and you dont think your judge was pro tenant ?

            would you have preferred some beluga from zabars delivered to your door by the judges assistant ?

            columbia tenants union no doubt…

            1. cripes


              your ass is showing. First, your assumption that a tenant should be evicted, or is somehow at fault, like nonpayment of rent, is asinine and totally wrong. This was a landlord that served me with eviction papers three days after my father died of cancer, telling the court I was a squatter. Fraudulent. And despicable. Like you.

              I was 19 years old and had lived there 10 years. I paid my rent for years, often into a segregated escrow account. The flood of eviction papers kept coming. Sewer service so frequent I took to making weekly trips to the court just to pore over the handwritten logs to see if a proceeding had been criminally filed against me without notice. And they were. Over and over. So, yeah, no penalties for criminal landlords, and the court did nothing to discourage this abuse.

              There are criminal landlords all over New York City and there are assholes. Maybe you are both.

              1. cripes

                Oh, one more thing I forgot, alex: I didn’t “have” a judge. The slumlord’s attorney’s played judicial roulette the entire time, trying for a sympathetic, compliant or lazy judge who would simply sign their fraudulent eviction petitions.

                How do we unpack generations of ignorant, classist arrogance contained in alex’s few sentences? The assumption that property rights should always prevail over human rights? That the moneyed should always be favored by the system, that lessor-income citizens should be rendered homeless or destitute at the whim of property when they feel like squeezing a little profit from your misfortune? And the insane, truly evil “belief” (isn’t there a more accurate word here?) that when their exploitation is frustrated or delayed, that somehow constitutes an abuse?

                Next alex will be telling us how hard it is to get good “help” and how hard it is to make it on 200K a year, what with private school fees for little tyler and all….

                It’s little turds like you that have ruined NYC.

            2. Yves Smith Post author

              You are assuming

              1. He was trying not to be evicted (you can go to housing court for tons of other reason, like your landlord hasn’t fixed a leak). He could be an attorney too.

              2. You ALSO assume that if we was a tenant trying to not to be evicted that he was a deadbeat and the landlord was right. Pray tell, why do you assume that? NYC landlords, if they have rent controlled or stabilized tenants, will try every trick in the book to get them out, including returning rent checks (they aren’t permitted to do that), trying to claim the tenant has a residence somewhere else, not providing heat, making physical threats, etc.

              1. cripes

                Thanks, Yves. you are correct in all that, except I am not a lawyer, although I did get a crash course at a young age in judicial procedure. And practice.

                Even had any of his unwarranted assumptions been true, the tone of his comment reveals a truly horrible mindset that is all too common among the propertied and their retainers.

                I do not believe people like this can ever be made to see reason, decency or public interest. They are predators and predator’s servants. They can only be defeated, as Bill Black has pointed out.

                For ignorant noveau new yorkers like alex, there is the Voice’s annual Ten Worst Landlords
                although I’m sure he’ll screw his twisted view around the facts to suit his repugnant prejudices.

  3. PaulArt

    “…the Federal Housing Finance Agency sold hundreds of homes in bulk sales to large investors.”

    The FHFA sold houses en masse to these looters? How insane is this? The Government is enabling monopoly land lords?

    1. Carla

      The Government enables monopoly in everything else. Why not this?
      Payola works much more efficiently when a politician or “public” agency has to work with only a few big players.

      1. NotTimothyGeithner

        Two days ago, there was a post here about Obama’s new initiative to bring back Reagan era tax incentives for behaviors companies do anyway. Obama’s policy is simply giving the wealthy money for being rich. He will try to paint it as something else tomorrow night, but its just par for how our government operates. Nothing can be done without making the rich richer with the current culture. The idea of more and better Democrats was flawed because the party was ultimately too corrupt. Fortunately, many people will tune out of the SOTU as the Virginia Cavaliers will be on at the same time.

    2. Katniss Everdeen

      The “monopoly landlords” (along with the monopoly financiers, monopoly GMO food producers and monopoly “defense” contractors) ARE the government.

      Presidents, representatives, senators and “justices” are simply actors in the bi-annual “democracy” magic show, meant to make “voters” think they have pulled representative “government” out of a malignant corporate hat.

    3. usgrant

      I remember geting a chill when during the campaign Romney mentioned how investers were rescuing the housing sector by snapping up homes to rent. More vampire capitalism till there is no more lifes blood to suck.

  4. Jimbo

    The banks are going to control the rental market and run up prices. At the same time rental prices get driven up, retail businesses and small shops across middle america will continue to starve.

    Of course, nobody will really notice, because the media will not report on it. Of course the DOW and S&P500 are large juggernauts that sell globally and they will not reflect the pain much.

    ON top of that, safety nets will likely be shredded.

    The fix is in!

    1. NotTimothyGeithner

      They are close to noticing. Obama is announcing companies have pledged to no longer discriminate against the long termed unemployed. Wow, talk about the temerity of dope, but for 0 to even mention this is a direct fear that the Democrats are rapidly losing young voters.

  5. Tom Stone

    I managed SFR for 15 years and know quite a few people who still do. EVERY property manager I have spoken to about these securitizations has the same take. The “Investors” are going to get hosed, big time. And it will be a clusterfuck for the communities where these are concentrated. Even if these deals more or less hold together for 5 years the plan is to sell a bunch of thrashed rentals at the same time, for top dollar…

  6. McMike

    Nothing like a second go at raping the middle class over housing.

    I remember some modern lower tier Vietnam war movie (think Chuck Norris), the bomb expert guy was explaining how he set up the series of bombs: the first bomb goes off and everyone panics and runs over there, so he sets bomb number two over there, which sends everyone scurrying towards bomb number three…

    The part that particularly bugs me is that they use taxpayer money to finance the purchases, use tax breaks to make it extra profitable, public’s pension funds pay the fees and hold the bag in the end, and local taxpayers end up with blight, crime, and bulldozer quality inventory in the end when the PE inevitably pulls out after squeezing it to death.

    All of this to drive up rents, externalize costs renter, and then slink away in the night.

  7. PeonInChief

    Supply and demand has little to do with the cost of rental housing. The main driver is the cost of the alternative, and the PE firms drive up the prices, in essence, by paying cash for their properties. It appears that they’ve taken control in some areas to such an extent that they’ve overridden the second major driver, which is median income. But more important is the legal framework that subsidizes landlords and enables them to control the market. In fact, the ability to push off the cost of maintenance to tenants is only one example of this. In Georgia, one of the big PE markets, tenants who discover serious habitability problems can’t even break their leases and move. They’re stuck for the term of the lease.

    1. J.

      The renter may not have understood the law. They aren’t stuck for the term of the lease.

      If the property is uninhabitable the landlord must allow the tenant to break the lease, or else repair the problem. The tenant can also pay for the repair and credit the cost towards the rent.

      (quoted from the link below)
      In all residential leases, the landlord has a responsibility to keep the rental property in
      good repair. The lease should not require the tenant to make repairs or waive the landlord’s
      responsibility for maintaining the property. Any lease provision, which makes the tenant
      responsible for repairs, is challengeable under Georgia law. The landlord is responsible for
      maintaining the building structure and keeping operational systems such as the electric, heating, and plumbing. The landlord is also responsible for repairing any appliances including heating and air conditioning included in the rental unit. A landlord is further responsible for meeting alllocal ordinances and minimum safety standards. The tenant should not be charged for repairs caused by ordinary wear and tear.

      Granted, it would suck to have to sue Blackstone for nonperformance.

      1. McMike

        I am just wondering when people start accidentally leaving the door unlocked and the appliances and copper starts disappearing.

      2. PeonInChief

        If you read the second-to-last paragraph here:

        you’ll find that a Georgia judge ruled that the tenants couldn’t be evicted, as they’d paid the rent, but they couldn’t force the landlord to fix the plumbing problems during the terms of the lease.

        And no tenant lawyer would tell a tenant to repair and deduct or withhold rent in most situations. If it goes to court, a tenant would likely lose the case and have to both pay the back rent and move. These are essentially rights without remedies in most states.

        1. Synoia

          One staffer at a PE firm told us his firm believed they could shift most maintenance obligations onto the tenant.

          In California, under the California Civil Code, a Tenant has a right to fix the home, spending up to one month’s rent per year, and deduct the repairs from the lease. In the Inland empire the tenants know the law.

  8. Pembquist

    Can somebody educate me on the value of these kind of investments. I just don’t understand who makes the decision to buy something that seems to have so little return for lending to such a dubious sounding scheme. I am only going by the coupon rates from the graphic, they seem pitiful to me, won’t the value of these things shrink as interest rates go up? Is there any participation by bondholders in the assumed increase in value of the properties?

    1. NotTimothyGeithner

      I think there are two answers to your questions:

      -Some (the dreaded “some”) sellers of these deals expect to cash out. Its basically a pyramid scheme and nothing more.

      -Greed can make people do crazy things. Judging from the behavior of the Gold Bugs, I suspect the Midas Story is more literal than I use to imagine, the symbolic message is still greed makes people do crazy things. Stories like the Golden Goose are honed and simple messages about greed and what it does. Just because someone is an MBA doesn’t confer on them wisdom, and since economics at least American schools of economics are largely junk pro-wealthy propaganda masquerading as science, the MBAs certainly don’t know anything.

  9. LillithMc

    In California’s inland valley the first round was massive overbuilding of new subdivisions that attracted commuters from the coast and created a large real estate marketplace. Massive numbers of junk loans were issued. Subdivisions quickly became 80% or more empty when owners could not afford the crazy changing payments; walked away from underwater values and preferred not to live in dead zones. The “mortgage insurance” paid by the home owners protected the banks. Once the money from the insurance was received, the banks dumped properties for low values to flippers, mass purchasers like Blackstone and cash investors. All “pride of ownership:” disappeared. The corruption that began with the big banks continued down to the property managers and real estate business. No ethics at any level. CA responded after the fact with a “Homeowner Bill of Rights” and other ways to stop what had already happened. Home values remain underwater trapping those who could afford to remain in their homes. Large numbers of renters are previous owners. who will rent from absentee securitized owners and “lack of ethics” property managers in instant slums. This has already happened. To late to change it. Forget concepts like community and “pride of ownership”.

    1. BrianH

      I live in the Inland Empire, own/self manage a 12 rental portfolio of Inland Empire homes purchased in the last 5 years and have purchased, repaired and resold 87 other homes here during the same time frame.

      5 years ago the hard hit areas like Perris and Moreno Valley were decimated, empty houses on just about every street. Now as I drive through these same neighborhoods they look substantially better. I’m certainly not a fan of the PE firms buying all the hundreds of houses in my immediate market but just wanted to point out that boots on the ground in my area reflect a huge improvement in the quality and appearance of these same neighborhoods.

      1. LillithMc

        At one point in the Sacramento suburbs were I live and sold real estate for 20 years we had over 60% home-ownership. What disturbs me is that our market was corrupted and turned into a rental market that I believe will not be good for our community. I received 14 “straw man” offers in one day in 2006 that were obviously fraud, but would be funded generating about $30k cash for the “real estate sales and loan agents” within two weeks. A few in the Russian community have gone to jail for “straw man” deals (they faked the buyers), but that was just a token. Those who funded them were the real criminals in my opinion. Several homes I sold that much later due to refinancing became short sales have previous home-owners probably going to rent from Blackstone. We remain at least 20% under value from 2006. One home with top value of $700K was sold by bank for $300K and flipped for $400K last year. Too ugly for me.

  10. Lune

    One other possible future problem is a wag-the-dog effect.

    Since landlords are typically local and relatively small, local rental laws by communities, states, etc. are fairly easy to pass and enforce since landlords are too small and scattered to form an effective lobbying force.

    Now enter Blackstone et al. How easy do you think a it will be for a local community whose housing stock is dominated by a PE firm to pass tenant protection laws? Or not rollback current protections.

    Similarly, when all these investments inevitably go bust, you will hear cries from the PE firms to “streamline” rental regulations in order to “protect” Main Street America from the foreclosures that will be necessary if PE firms have to honor every little town’s arcane tenant protections. Spending a million dollars on lobbying Congress is easily justified when you have thousands of houses for rent, something that currently most landlords don’t have. And so, just like ERISA gutted local health insurance regulations and the Supreme Court gutted local usury laws regulating credit cards, I fully expect before this cycle is complete, the Federal govt will gut local tenant regulations with “streamlined” federal regulations that are coincidentally much more pro-landlord than anything any community currently has. All in the name, of course, of preserving Main Street America…

    1. Nathanael

      The local community will happily pass the laws, because Blackstone et al are *absentee* landlords from *out of town*, and as such they have no votes. They could attempt to spend money to bribe the local government, but they won’t be able to fight every one of them. Therefore you’re right, what Blackstone et al will do is to attempt to override local laws with federal law.

      I don’t think that’s going to stick. People are already angry about the other ways the federal government has gutted local laws.

  11. vlade

    Re MBS guys comments – what does he mean by “foreclosed upon”? It’s a rental property, cash paid. So is the security the actual property which is supposed to generate rent? Or is it pure rent securitization?

    I.e. instead of the mortgage secured by the property what’s being sold is a rent contract secured by the property? I don’t have time to go through the contracts, but if this is the case I’d say that even 40% subordination may not be enough, as there are no principal payments, and defaulting on rent (or stopping the contract) is much much easier than refinancing the mortgage. I’d say you have to assume at most 85-90% of occupancy at any given time, and it could easily be much less. If properties were bulk-purchased, that indicated high correlation (as the properties were in foreclosure at the same time likely for similar reasons, and likely get rented out to similar profile renters). Maintianing a good, diversified, well seasoned etc. rent portfolio would be much harder than the same for RMBS. Running/servicing the protfolio would be also massively more expensive than RMBS one.
    Also, RMBS can be stable even in downturn, as people tend be loath to sell their house – but have no problem whatsoever with jumping the ship of a rental property to move somewhere else.

    Lastly, what happens when a maturity comes and you can’t refinance (assuming that the security is the rental property)? Do you foreclose?

    Socially speaking, it’s more than bad, as if MBS Guys reading is right, loss of income on the properties (i.e. low occupancy rates), or inability to refinance at maturity could mean massive foreclosure (and assumed evictions) even for renters who pay!

    The hunt for yield is about the only reason why anyone with two braincells would purchase anything like this, as it has so many potential structural problems.

    BTW, this is about umpteenth time that I posted and the comment went missing in the last few weeks….

  12. Nathanael

    In addition, Fitch refused to rate the deal, citing insufficient history.

    Of course, using the Standard & Poor’s “we’d rate a deal structured by cows” threshold, it’s no wonder this deal passed muster.

    Thanks for this marvellous line. I’ve got to remember “we’d rate a deal structured by cows”. :-) Mooo.

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