History may repeat itself, but in few places are its cycles so maddeningly short as on Wall Street, where the recent advent of rent-backed securities has whipped financiers into another feeding frenzy. The innovators of this hot new financial product have found a way to slice, dice and repackage debt tied to thousands of real-estate-owned (REO) homes — a process that may sound awfully familiar.
That’s because it is: Rent-backed securities are the direct descendants of the mortgage-backed securities that crashed the economy in 2008. This time, however, investors’ income streams are coming not from monthly payments on frequently predatory mortgages but from the rent checks of thousands of ordinary tenants in single-family homes.
When rent-backed securities premiered on the market in October 2013, the $479 million offering from the private equity giant Blackstone Group generated more demand from investors than the private equity firm could accommodate. Since then, Blackstone and several other firms specializing in the rental of single-family homes have sold more than $3 billion of these bonds. REO-to-rental securitization has been hailed as an exciting new asset class, with financial analysts at Keefe, Bruyette & Woods estimating that it could swell into a nearly $1 trillion industry over the next six years.
The market reached a fever pitch this summer. In July and August alone, three firms have introduced three new REO-to-rental securitization deals, ranging from $310 million to $720 million in value. The companies issuing bonds backed by their single-family home rentals have assured investors that this strategy is a perfectly safe way to return some liquidity to the recovering housing market while providing a boost to the economy at large.
A new rental empire
Why is Wall Street playing landlord in the first place? Over the past two years, investors have acquired more than 200,000 homes — mostly foreclosures being sold off at bargain-basement prices — and refashioned them into a new single-family home rental empire servicing those struggling to find affordable housing. For Wall Street, rental securitization is the next logical step. The financial leverage it provides allows REO-to-rental firms to continue apace with purchases of new properties; meanwhile, bondholders are entitled to the cash flow from rental incomes, plus any gains that result from selling properties that have appreciated in value.
This scheme has helped halt the free fall of property prices, stabilizing the housing market and earning praise from some analysts. But is this really what a housing recovery looks like? New renters in single-family homes are frequently foreclosure victims, in some cases even renting back homes they previously owned. Would-be homebuyers, meanwhile, are squeezed out of the market by large institutional investors and have little choice but to continue renting. Hundreds of thousands of tenants have thereby found themselves the prostrate subjects of this new rental empire, leaving Wall Street landlords poised to benefit from rising rents catalyzed by historic levels of demand.
Lewis Ranieri, the man credited with pioneering rental-backed securities, has assured investors that while the last scheme may not have worked out so well, new rental-backed bonds carry no risk because renters provide a steady cash flow and rental homes can always be sold to compensate for any disruption to investors’ income stream. Others, however, aren’t so sure. In a letter (PDF) sent to federal housing and finance regulators in March, a coalition of 75 housing and consumer advocacy groups demanded more robust intervention, warning, “We are poised to experience another crisis if federal regulators fail to recognize and take corrective action to address red flags that are all too familiar.”
Among those red flags is the fact that REO-to-rental securitization deals have relied on projected occupancy rates that real estate professionals have called unrealistic at best — particularly given the wide geographic distribution of properties and firms’ inexperience in managing them. Blackstone’s first offering, for example, assumed a 94 percent occupancy rate and claimed that 100 percent of properties were occupied when the deal was launched. But within a few months, 8.3 percent of these properties were vacant or occupied by delinquent renters, causing rental income to fall by 7.6 percent. Reported vacancies have also been on the rise this summer after Blackstone offered a second, $1 billion bond in May and Colony Capital launched a $514 million deal in March.
In short, REO-to-rental securitization completes a cycle in which Wall Street firms and the banks backing them (the institutional owners of Blackstone include Morgan Stanley, Citibank and Bank of America) have reaped profits from the crisis they helped sow and in doing so planted the seeds for the next crash.
Costs to tenants
The transformation of rental homes into an asset class has tangible costs for tenants. Since investors-turned-landlords must meet obligations to bondholders, they’re likely to shake down their renters to make up for any shortfalls resulting from high vacancy or turnover rates.
The evidence so far suggests that this is creating a bevy of problems. Earlier this year, two colleagues and I broke the story at In These Times that Invitation Homes, the Blackstone Group subsidiary created to purchase and manage properties nationwide, may be using leases that violate local housing laws in order to maximize revenue. A lease we obtained from a Chicago tenant contained several provisions that housing attorneys say may be illegal. Among them, the lease attempts to shift responsibility for maintenance onto tenants by stipulating that they must rent the property “as is.”
A report (PDF) released in July by the Right to the City Alliance and Strategic Actions for a Just Economy concluded that such problems are widespread. Interviews with hundreds of Invitation Homes tenants in Atlanta, Los Angeles and Riverside, California, revealed unresolved plumbing and electrical problems when tenants moved in, exorbitant rent increases of 37 to 53 percent for lease renewals and aggressive rent collection techniques that have included delivery of eviction notices the same day rent was due. One Los Angeles couple is suing Invitation Homes, alleging that they were sickened and their belongings damaged by mold and persistent water leaks in their rental home and that the company demanded they continue to pay rent even after they were forced to move out of the property and stay with relatives.
Worst of all, housing advocates fear renters could face mass evictions even if they have never missed a payment, in the event that a bond blows up or Wall Street landlords decide to sell their homes to meet obligations to bondholders.
Cut Wall Street out?
Rep. Mark Takano, D-Calif., has joined the chorus of housing advocates calling on Congress to hold hearings on rental-backed securities. Groups such as the Right to the City Alliance, meanwhile, are advocating policy solutions such as a financial transaction fee on rental bonds and just-cause eviction laws that better protect tenants from being thrown out at the whim of the market. Such measures could help stem the tide of risky securitization and hold investor-landlords more accountable to tenants and communities.
But the shifts underway require a larger conversation about whether we should cut Wall Street out of the housing recovery altogether, thereby preventing investors from continuing to extract profit by betting on the fates of entire communities.
To this end, some communities are attempting to preserve affordable housing by taking it off the market entirely, managing it instead through nonprofit community land and housing trusts. While that is an important alternative strategy for rehabilitating vacant and foreclosed homes, such trusts are limited in number and are hard pressed to contend with investors ostensibly pursuing the same goals.
Without the enormous injection of capital that these investors continue to provide, the logic goes, the housing market would remain stagnant. But as fewer and fewer Americans are able to own homes, it’s time to rethink the idea that a housing recovery is synonymous with a rise in home prices and view it instead from the perspective of the growing numbers struggling to find affordable housing. From that vantage point, a real recovery could not be farther off.