The New Real Estate Train Wreck Coming Your Way: Securitized Rentals
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No matter how bad things get, it turns out they can always get worse. Wall Street is about to foist a new “innovation” on investors that even the ratings agencies won’t touch.
Greedy, reckless, and just plain lazy mortgage originators, servicers, and trustees took what was actually a not unreasonable idea, that of mortgage securitizations, and turned it into a loss-bomb. Remember, that movie did not have to end badly. First, participants in the private label mortgage securitization market did for the most part comply with the requirements of their contracts for the first decade plus of that product’s existence. It was their wanton disregard for their own products which have led to the chain of title mess and difficulties in foreclosing that still plagues that market. Second, securitization markets that developed later than the US market (most notably, in of all places Russia and Eastern Europe) and featured some improvements on the US template have not seen the abuses of borrowers and investors suffered here and got through the global downturn reasonably well. However, the sell side has completely refused to implement the sort of reforms necessary to make the product safe for investors. So the US mortgage is and is likely to remain on government life support for the next decade.
So what have the “innovators” decided to do? Foist an even worse product on hapless investors. Remember, mortgage securitizations in concept are a decent idea and with proper protections, fees, and incentives, can be a useful and attractive product. Securitizing rental income streams for a large number of single family homes is a completely different proposition. The concept is clearly still being fleshed out, since a story on it in Reuters was unclear as to whether the “bonds” would also be entitled to the proceeds of the eventual sale of the house. I imagine that the private equity investors who are targeting this market are pushing for that, since fobbing off the problem of the home sale to the securitized vehicle is tantamount to a full cashout. They’d get initial tenants in, no matter how good or bad, and effectively flip the house to the securitization.
The newly-found convervatism of the ratings agencies may (stress only may) put a damper on this market. The ratings agencies are not willing to rate the initial deals, and want to see some history before they hazard a rating. Even then, some regard this product as sufficiently risky so as not to merit high ratings even if it were to become established. From Reuters:
Over the past three months, Fitch, S&P, DBRS and Morningstar have each published initial assessments of the potential risks of the new asset class. But no agency has yet published official criteria for the product.
Fitch said that such transactions are unlikely to merit a rating above Single A — and even that would require sufficient historical rental-payment data or a solid record from the property’s operator/manager.
Moody’s issued its first report on the subject on Thursday, but said that since it had not seen a formal proposal yet, it was too early to tell exactly what rating it would assign a transaction. However, it noted that even extra credit enhancement would not mitigate a lack of historical rental-payment data, and therefore some transactions might not merit top grades.
“We would like to see the specific underwriting criteria that the operator is using to choose these tenants,” Kruti Muni, a Moody’s analyst, told IFR.
“Obviously the operators would rely on income information, the existence of security deposits, history of utility payments, etc. The diversity of the geography of the pools of homes is significant as well.”