Wall Street engineering is back in the housing market. Its newest product is one heck of a contraption, a synthetic structured security of the type that helped blow up the financial system back in 2008. It’s like those triple-A rated mortgage-backed securities that became toxic waste in your “money-market-equivalent” bond fund or elsewhere in your 401(k) or in the portfolio of a town in Norway – only worse.
To get that deal done, private-equity giant Blackstone Group is conniving with too-big-to-jail Deutsche Bank, which is already buried under an avalanche of legal problems, scandals, and write-offs in Germany.
Blackstone has been on the forefront in the housing market, gobbling up 32,000 single-family homes for $5.5 billion, helter-skelter, at foreclosure auctions on courthouse steps scattered around the country, hoping for capital appreciation and rental income. Deutsche Bank has been on the forefront funding this binge and leading the issuance of $3.6 billion in loans.
There were other players. American Homes 4 Rent bought 19,000 single-family homes, Colony American Homes nearly 18,000, Silber Bay Realty Trust 5,370, Waypoint Homes 4,620, American Residential Properties 2,530…. In total, private-equity firms, rental REITs, and hedge-funds have raised over $17 billion to buy over 100,000 vacant, foreclosed single-family homes since 2011.
Countless smaller companies, mom-and-pop operations, and individual investors have jumped into the fray, buying out of foreclosure whatever they can get their hands on. Frenzied radio ads once again promise untold wealth in real estate. Flipping is in vogue again. All the insanity that had been flushed out of the system during the crash is back, but this time, big firms with access to the Fed’s free money are the prime players.
They’re all chasing after foreclosed homes. Every time they buy one, it is moved from the highly scrutinized inventory-for-sale list to the mercifully ignored inventory-for-rent list. And now home prices are spiking in the double digits year-over-year just like in 2006 – at the cusp of the crash.
But the second phase of this magnificent buy-to-rent strategy – renting out the house – has experienced a hiccup. Overall, rental vacancy rates fell to 8.2% in the second quarter, the lowest since 2001. But that report is dominated by apartments. Single-family homes that had been bought out of foreclosure, often as stripped-down wrecks, are in an entirely different space. As of June 30, only 48% of the properties of American Homes 4 Rent were leased, according to a regulatory filing, Bloomberg reported. A similar debacle was staring other firms in the face.
“The headline occupancy numbers for this space, roughly 50%, is not yet enough to give evidence that this business model works,” said Jade Rahmani, an analyst with Keefe Bruyette & Woods Inc.
So how do you extract some moolah while you still can? Sell the homes into a market where first-time buyers have become rare – 29% in June, down from the 40% of a healthy market – just when higher mortgage rates are beginning to slam into bubbly home prices? Not a good idea. Instead, let’s dump some paper. In that spirit, Blackstone is planning to bundle monthly rental payments of about 1,500 to 1,700 of its homes into structured synthetic products to be hawked by Deutsche Bank to its hapless clients, “people familiar with the matter” told the Wall Street Journal.
This being a new phenomenon, there is no data on how well these tenants pay or how long they stay in those homes before they move out, leaving them vacant once again. Blackstone, normally a PE firm, has become a landlord with 32,000 properties scattered around the country. Now it has to fix heaters and roofs and plumbing, and collect late rent payments. If renters are upset with the maintenance, or if they run out of money, they stop paying rent, and others will move out without apparent reasons. Renters are a lot more fickle than homeowners.
But yield-hungry investors have been driven to the edge of exasperation, and they’re willing to take risks, practically any risk, to get some yield, and apparently they’re willing to hold their nose and pick up some of this stuff, and this would be the first deal of its kind, so the yield might be a tad higher. An irresistible siren call. Odysseus, when he was in a similar quandary, put wax into his ears and had his crew tie him to the mast of his ship.
According to “people familiar with the matter,” the starter deal isn’t huge, maybe $275 million. The top tranche could be rated as high as single-A by the very credit rating agencies that slapped tipple-A ratings on toxic mortgage-backed securities even as the housing market was crashing. The paper might be backed by up to $350 million in equity and properties – at current bubble valuations. Mortgage-backed securities were also backed by properties.
Housing Bubble II is upon us. With a twist. This time it is the big money that jumped into it, drove up prices, and moved affordability out of reach for first-time buyers. Now that the risks are piling up, driven by vacancy rates in that space of 50%, while interest rates are rising globally, the big money is starting to get antsy. Time to shift risk to someone else. It’s the kind of impeccably timed Fed-induced Wall Street engineering that we have seen so many times before. It will work out for a while, and then someone else will end up holding the bag.
One of the Fed’s other big beneficiaries, Amazon, shifted its promotion machine into high gear to tout President Obama’s visit to one of its warehouses where he unveiled his “better bargain” for “middle class jobs.” The visit was artfully synced with Amazon’s announcement that it would create 7,000 jobs. Out of nothing. One of the ongoing lies in America’s jobs crisis. Read…. The American Jobs Curse At Amazon (And Obama Stepped Right Into It)