In the wake of the housing bust, Wall Street funds set their sights on a new target – rentals. The foreclosure mess that resulted from their toxic securitization of bad mortgages had created a massive new inventory of cheap, vacant homes. If big funds could scoop them up at pennies on the dollar by the hundreds of thousands and collect a sizeable monthly payment on each, they might be able to create a model nearly as juicy as the mortgage fiasco. The only problem is, Wall Street’s boon may once again add to Main Street’s demise.
The basic premise is frighteningly similar to the one that kicked off the mortgage crisis. Big Wall Street banks securitize debt backed by single-family homes and then sell bonds to entities like insurance companies, pension funds, municipalities and other investors all around the world. The big difference is that they are financing landlords who are going to rent the houses, rather than people who are going to buy them.
In November, the Blackstone Group, a massive private-equity firm, was the first to jump into these products with both feet. They issued an enormous bond offering that found plenty of takers, but analysts quickly noted some red flags in terms of risk.
Relative to the value of the houses, the group borrowed more money than the collateral for bonds used in similar residential-mortgage securities. The gap between rents and interest payments was also smaller than in typical apartment complex bonds. That means that the room for tenants to miss rent payments or units to sit empty before a default crisis kicks in is much smaller.
Given those factors, as well as the normal volatility in the housing rental and overall real estate market, the large initial scope of this new scheme is pretty frightening (Blackstone’s offering alone amounted to $479 million of debt tied to the rent of 3,200 properties), especially when you remember that the inviability of the mortgage securitization scheme led to a global financial catastrophe and the worst recession in 80 years.
The rest of the usual suspects have since gotten involved – big hedge funds, private equity and investment banks – to finance a handful of big players in the institutional landlord game and it’s quickly emerging as Wall Street’s (and real estate’s) next big thing. Wall Street analysts put the overall market potential at about $1.5 trillion.
With all of its vacant homes and late-model, suburban foreclosures, Florida was an obvious target for their strategy and a Tampa Bay Times analysis showed over a billion dollars worth of such properties had been bought in the Tampa Bay region.
However, while buying the homes at discount prices was easy, putting the business model to the test has already proven difficult. Skeptics, like small-scale mom and pop investors, warned that these institutional players had no idea what they were in for. Financing a buy-fix-flip is one thing, but managing rentals is a completely different animal.
If you’re aggressive in getting anyone you can into a unit, the way you might be with a housing deal that you’re out of before the first mortgage payment is due, you’re likely to find yourself bogged down by a lot of deadbeat tenants, losing money on unpaid rent and eviction costs. If you’re more discriminating, units sit empty longer and higher market renters tend to demand higher levels of upkeep and service, upping management costs.
Then there’s the renters. A more recent Tampa Bay Times article details reports of corporate landlords aggressively upping rents and squeezing tenants who they are betting will reluctantly suffer the hikes, rather than endure the stress, as well as the financial and social costs of relocation – such as paying moving fees and trying to quickly find a new unit that is in their children’s school district or convenient to their place of employment.
A Wall Street ethos inevitably leads to as much rent as can possibly be yielded with as little spent on services as will be tolerated in order to maximize return to investors. The relationship between mom and pop landlords and their tenants might not always be perfect, but there’s a human element and face to face relationship that is absent in this scenario.
There’s also a symbiotic relationship on smaller scales that works for both parties. A local landlord with a few rentals can try to raise rents, but if a tenant balks and the unit sits empty even for a relatively-short two months while they make repairs and a new tenant prepares to move in, the lost rent will offset even a 15 percent increase – and that’s before you even consider the costs of marketing the rental or making cosmetic repairs that might not be necessary were the old tenant to remain.
An institutional landlord has more economy of scale to leverage (not unlike big apartment complexes) taking power away from renters. A community where renters are either forced to be increasingly transient or consistently getting squeezed for dollars that would otherwise be spent into the local economy is a less vital and stable one any way you look at it, especially when all of that money is leaving the local economy. From school districts plagued by relocation transfers to making the community less attractive to potential residential or commercial transplants, the costs add up.
Then there’s the impact on real estate markets. The huge Wall Street buy off has helped to push home prices upward, but if it’s an inflated premium, that only hurts traditional buyers, who are most important to the long-term health of the market. If the new scheme implodes, it could trigger a massive, fire sale sell-off, reflooding the market with homes, while driving down prices and putting most of the recent traditional homebuyers underwater on their mortgages.
Either way, this seems like a model that is good for a few mammoth Wall Street players and bad for the communities they are bleeding their profit from. Considering the fact that we are living in a dismal “new normal” courtesy of the their last big idea for turning the housing market into ATM machines, we should be leery of a new, unproven and risk-laden scheme getting this big, this fast.
Dennis Maley's column appears every Thursday and Sunday in The Bradenton Times. He can be reached at firstname.lastname@example.org. Click here to visit his column archive. Click here to go to his bio page. You can also follow Dennis on Facebook.
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