Stakes are rising in the saga of the $479 million sale of the nation’s first securities backed by more than 3200 rental homes. Though neither pricing details nor hard numbers on the response from investors have leaked, it’s clear that Blackstone is making serious headway in its struggle to turn leases into cash and pave the way for an asset class and a whole new way of thinking about housing.
Blackstone’s deal, officially titled Invitation Homes 2013-SFR1, faces serious obstacles. Rating agencies, have treated the offering conservatively. For more than a year have been wary and withheld top ratings despite Blackstone’s creative structuring of the deal to reduce investor risk. Facing resistance over the idea of basing securities on rental leases, Blackstone instead found a creative way to secure the deal by individual mortgage liens on each underlying property rather than an equity pledge, allowing for the creation of a so-called real estate mortgage investment conduit, or Remic, structure, according to sources close to the deal.
Related: Blackstone and the “Raters” Duke it Out
The newness of the assets, the difficulties raters have assessing the risks that investors will incur and the lack of a track record managing rentals profitably were reportedly reasons that would keep raters from giving the offering a AAA blessing, though it did garner ratings from a handful of agencies, with the exception of Fitch, which held off and let it be known it would rate the bonds a very low BBB, if it had to rate them at all.
Blackstone Beats the Raters, 4-1
But Blackstone did much, much better than that. Moody’s, Kroll and Morningstar gave the $278.7m top slice of the securitization a triple A rating, or 1.15 percentage points, surprising many market participants who had speculated that the deal would be lucky to get a single A rating, if any rating at all. Moody’s said it had decided to give the top part of the bonds its highest available rating after judging that Blackstone would be able to sell its properties if tenants stopped paying their rent.
A $41.5 million portion rated BB by Kroll priced at 365 basis points, down from about 400. The raters said in reports last week that the planned rankings are appropriate based on how the classes carry greater loss protection than similarly rated assets. However, Fitch Ratings stuck its guns and warned that it may be difficult for issuers of such bonds to liquidate their portfolios.
After accounting for the borrower’s equity in the properties, the Blackstone AAA securities could get paid off if the homes get sold for just 43 percent of their current values, making Kroll’s rating “sufficiently conservative,” a Kroll’s analyst at the firm, said in a telephone interview.
The breakdown of rental properties in the deal includes 34 percent from the Phoenix area, 17 percent from the Riverside-San Bernardino-Ontario region in southern California and the rest from other parts of the state, as well as Florida, Georgia and Illinois. Invitation Homes, Blackstone’s subsidiary, bought the houses for $444.7 million, and with repairs and refurbishments spent $542.8 million, compared with the collateral’s $638.8 million valuation. The average home included in the security is more than 25 years old, with three or more bedrooms and a pre-rehabilitation price of $149,000, ratings reports show.
The highest average loan-to-value ratio for home loans serving as collateral for bonds without government backing since the crisis was the 69.7 percent in PennyMac Mortgage Investment Trust (PMT)’s September sale, according to Kroll.
So after months of Sturm und Drang, the raters ended up being a big help in marketing the bonds. The 42 percent for the AAA portions in the Blackstone deal compares with about 30 percent for new commercial-mortgage bonds and 6 percent to 9 percent typically for prime home-loan deals since the crisis.
Playing a Liquid Market
Reactions from investors reflected how the way Blackstone structured the deal reduced risk and made the offering as attractive as similar real estate securitizations
Axonic Capital LLC, a $2 billion structured-credit asset manager based in New York, was considering buying the riskiest class offering the highest yields, said Chief Investment Officer Clayton DeGiacinto. He said the rental-home industry can be successful and the bonds offer enough protection for investors.
“We also operate a portfolio of single family homes and understand the risks and rewards of the business well,” DeGiacinto said. “We are in the midst of a paradigm shift in the way that this country finances housing and this deal is part of that change.”
The Blackstone deal heralds the latest use of securitization, an investment-banking strategy pioneered in the 1980s and later blamed for fueling the shoddy lending that contributed to more than $2 trillion in losses at the world’s largest financial institutions. Bonds can be created out of everything from mortgages and auto loans to resort timeshare interests, television-broadcast rights and drug sales.
Should Blackstone succeed, the market for rental-home securities may grow as large as $900 billion, assuming 15 percent of annual home purchases are conducted by investors and 35 percent of those and existing rental-home owners turn to the market for financing, according to Keefe Bruyette & Woods Inc. Banks have been the main source of financing for new property landlords such as Colony Capital LLC and Blackstone, which has spent $7.5 billion on about 40,000 houses.
As Deutsche Bank, Credit Suisse and JPMorgan took the Blackstone bonds on the road for sales meetings with investors last week, the most surprising addition to Blackstone’s corps of cheerleaders, one of America’s newest Nobel Laureates for Economics, Robert Shiller, kept the headlines flowing.
Having heard of the Blackstone deal, Shiller tweeted this could “mark a revolution,” according to Business Insider.
“My first thought is that this securitization might develop the markets further and that the two markets might support each other,” Shiller said.
“On a deeper level, regardless of its impact on the futures market, if the REO to rental securities take hold, and become liquid, it may increase the efficiency of the market for single family homes,” he added. “That market has been extraordinarily inefficient, as [Karl] Case and I showed in an American Economic Review article 25 years ago. Momentum persists for years. That would all change if professionals could really play a liquid market, and did so on a large scale.”