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Rent-Backed Securities [Finance
Posted on October 20, 2014 @ 05:11:00 PM by Paul Meagher

Mark Dotzour from the Texas A & M Real Estate Centre wrote a blog called Wall Street Landlords in which he discusses how Wall Street investment firms are buying large numbers of distressed single family homes that are in various stages of foreclosure. Mark published a useful table that lists the investment firms owning the largest number of such single family homes:

What many of these firms are doing with these properties is fixing them up and renting them out for income. Some may sell them when the housing market appreciates again but many of them are happy with the combination of a discounted purchase price and higher than average rental fees so will likely remain landlords for the foreseeable future.

The biggest player by quite a margin is the Blackstone Group, a huge NY-based investment firm with $248 billion in assets under management. The Blackstone Group is leading the way in devising a new financial product, rent-backed securities, based upon the rental income from these properties.

According to Brian Lynch, "Under this business model, the equity present in rental agreements will be aggregated into tranches based on confidence in the financial ability of the tenants pay their rent. The collateralized security instruments from these tranches will have various rates of return based on risk factors from the underlying leases. Should these rent-backed securities default, the security owners may even have an ownership stake in the properties to fall back on". The reason Blackstone is offering these rent-backed securities to investors is to "allow them to free up equity in these properties to purchase even more distressed homes". Investors apparently are quite excited to buy them so other large investment firms in this market are considering similar offerings.

These rent-backed securities setup an obvious positive feedback loop that will lead to Blackstone becoming an even bigger player in the single family home rental market. While institutional investors and pension funds are apparently quite happy to invest in such securities, Occupy Our Homes Atlanta is not so thrilled. They reported that:

  • Tenants wishing to stay in their homes can face automatic rent increases as much as 20% annually.
  • Survey participants living in Invitation Homes [Blackstone's brand for single family home rental properties] pay nearly $300 more in rent than the Metro Atlanta median.
  • 45% of survey participants pay more than 30% of their income on rent, by definition making the rent unaffordable.
  • Tenants face high fees, including a $200 late fee for rental payments.
  • 78% of the surveyed tenants do not have consistent or reliable access to the landlord or property manager.

It will be interesting to see how the rent-backed securities market plays out. Will the relentless profit-maximization of the Blackstone Group lead to ever more complex leveraging of the rental income and home collateral they own (e.g., rental default swaps)? Will blow back from main street put limits on the positive feedback loop that firms offering rent-backed securities can enjoy? Could there be a market failure involving large losses in rental income and investors wanting their money back - or would they end up owning all or part of the distressed homes backing these securities?

I don't have any answers but I expect that the Blackstone Group will be the company to watch in this evolving market for rent-backed securities.

I also wrote this blog in part because I'm interested in learning more about the Blackstone Group holdings in order to understand why they are the largest alternative investment firm in the world. I seem to be running into their name more frequently as a result of the many companies they have acquired or have a controlling interest in.

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