Next Big Thing? Foreclosed Rental-Backed Securities

Monday, 23 Jul 2012 08:07 AM

By Nancy Stanley

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Banks and real-state investors are working on a new type of security that is tied to the housing market, The Wall Street Journal reported, but instead of having the securities backed by mortgages, the new securities will be backed by the rental payments of residents who live in previously foreclosed homes.

During the past several months, investors have been buying foreclosed properties alone and in bulk, with some even creating real estate investments trusts in order to raise capital to buy more properties, according to CNBC.

The firms, which are backed by investment banks and credit-rating firms, are seeking to package the rental payments into securities and sell them to other investors, known as securitization.

Instead of the cash flow to investors being provided by mortgage payments, as they are in mortgage-backed securities, the cash flow would be provided by monthly rents, CNBC reported.

Editor's Note: Economist Warns: ‘Money From Heaven a Path to Hell.’ See Evidence.

According to a new report from Lender Processing Services cited by CNBC, 5.57 million loans are either delinquent or in the foreclosure process, in addition to those already repossessed by lenders and the government.

Justin Chang, acting chief executive officer of Scottsdale, Ariz.-based Colony American Homes, told The Journal that he expects real-estate-owned (REO)-to-rental products in six to 12 months.

“I think securitization absolutely will become part of the REO-to-rental financing market,” Chang said. “We’re in lots of discussion with investment banks about just that.”

Colony American Homes was launched in January and is a division of private-equity firm Colony Capital LLC. It owns approximately 1,200 foreclosed homes and plans to own 5,000 by the end of the year.

However, some investors are cautious, as little data are available regarding the payment history of tenants of previously foreclosed homes, according to The Journal.

“If rating firms don’t have the data, they shouldn’t rate the deals,” David Jacob, who served as head of Standard & Poor’s Ratings Service’s structured-finance department from 2008 through 2011, told The Journal.

Even so, S&P has already been approached to rate these securities, and Moody’s Investors Service is getting questions from potential issuers.

“There is clearly an opportunity, lots of REO properties coming into the market over the next few years,” S&P’s Vandana Sharma told CNBC. “What is the best way to finance them? So the next thing is to say, how do you assemble a pool with some geographic diversity, how do you take homes from different markets, so how do you put that pool together?”

Other obstacles to the new securities are that there are few firms that have rented foreclosed homes for longer than several quarters and property management presents complications, since the costs of the property’s upkeep and management of tenants need to be factored in.

“There's also the cost of painting and re-leasing the homes, periodically setting the market rents, so there's a very active property management aspect to it and a capability, and then there's the question of what pays the investors back? Is it the lease payment from the rents they collect or is it the sale of these properties, so that's really the next phase of analysis for this opportunity,” Sharma noted.

Editor's Note: Economist Warns: ‘Money From Heaven a Path to Hell.’ See Evidence.

Several large investment banking firms, including Citigroup Inc., Wells Fargo & Co. and Jefferies Group Inc., are exploring the possibility of securitization.

In January, the Federal Reserve sent a paper to legislators on Congressional banking committees endorsing the conversion of foreclosed single-family homes into rentals; however, the report did not mention securitization.

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