Can rental securitisation revive US housing?

Political concern and misunderstandings could threaten the budding US rental securitisation industry before it has a chance to take off.

Since the first deal in October 2013, rental securitisation has been viewed as a second life for the housing market. The real-estate owned (REO) to rental securitisation deals have focused on single family homes concentred in areas hardest hit by the housing crisis. The purchase of these properties by larger investors instead of individuals is seen as responsible for the spike in real-estate prices in depressed areas.

Some believe it could become a trillion dollar-plus industry. But politicians and major rating agencies, including S&P and Fitch, stress that there is not enough precedent behind the product to make a solid judgement about its viability.

Transactions have so far been private placements. But the industry continues to attract investors, and it may not be long before a Securities and Exchange Commission (SEC) registered issuance is completed which would force the regulators to weigh-in.

"I am concerned that before this takes off and grows into an industry that some estimate might be worth $1.5 trillion, we should try to understand these products now and have more oversight now, so that we understand the pitfalls and what the future consequences might be," Congressman Mark Takano told IFLR.

"It's premature to call for regulation," he added. "I'm calling for more oversight. I want the Financial Services Committee to use its staffing to perform an analysis so these instruments can be better understood."

Congressman Tekano represents the 41st district of California, south east of Los Angeles. The area was hit hard by the housing market crash and subsequent recession. Like other areas of the US sunbelt including parts of Florida, Arizona, Georgia and Nevada, it has now become a popular area for investors looking to buy single family homes to rent.

The REO to rental scheme was originally presented by the Federal Housing Finance Agency (FHFA) as a way for individuals whose homes had been foreclosed to remain in the property as renters.

The eventual securitisation of these is unsurprising, but the collateral is not the same as traditional mortgage back securitisations (MBS). The transactions that have been completed so far have been based off of a single loan.

"It’s premature to call for regulation. I’m calling for more oversight" US Congressman Mark Takano

This loan is granted to a special purpose borrower, which uses the capital to purchase the properties. The lender then sells the loan to a deposit entity, which then sells it to a common law trust. The trusts have, so far, elected to be classified as real-estate mortgage investment conduits (REMIC) to avoid double taxation. This structure closely resembles that of MBS, as it is based off a single loan and must be repaid regardless of whether the properties produce rents.

"In the past, some individual borrowers were offered loans that they did not have the means to repay," said Seth Messner, partner at Katten Muchin Rosenman. "In this case, the borrowers are sophisticated financial institutions that have an incentive to keep their properties leased."

It is anticipated that as the market grows, new multi-loan securitisations will also be issued based on the same basic structure. Again, while the rent would be used to facilitate the loan payments, each of the repayment bundles must be made regardless of whether rent was collected.

Vacancies are a major risk factor for the product.

When the first securitisation was issued in October, Moody's and smaller agency Morningstar rated it triple A. Since then the vacancy rate in those properties has risen to eight percent, two points higher than the estimates.

It is in property owners' best interest to keep their properties occupied and maintain a low turnover rate. This minimises costs and ensures they have cash flow from the rents to service the original loan.

"Even in securitisation where the collateral is the mortgage, the debt service on the bonds is paid by the cash stream coming off the rent," said Aimee Cummo partner at Alston & Bird. "Short of securitisation, institutions are providing financing for residential rental properties on a bridge loan basis and those loans are either secured by mortgages or by the rental stream directly."

Politicians, who are looking to increase home ownership among ordinary Americans, will therefore need to take a look at the wider housing market and not just the impact of this single product. The restructuring of the government sponsored enterprises, Fannie Mae and Freddie Mac, is intended to help bolster the market, but a final plan has yet to be passed.

Greater understanding of the rental securitisation product could help it gain legitimacy and prevent politicians from pushing for heavy-handed regulation. It should also help the investors, especially given many areas that were ideal for REO and eventual securitisation were those hardest hit by the recession and still struggle to come back.

"If I was an investor I would be concerned about the speed of the economic recovery in these areas," said Congressman Takano. "There is a reason why the bottom fell out of these markets so dramatically."