The financialization of rents.
In the Fed-engineered asset price inflation since the Financial Crisis, the value of the US housing stock has ballooned to $35 trillion, as large private equity firms have muscled into the single-family housing market, long the domain of mom-and-pop investors. They have acquired about 160,000 single-family houses out of foreclosure for least $32 billion. In the process, the homeownership rate has dropped to the lowest since 1965. And now comes the time to sell it to the public.
The largest player in the field, Blackstone’s Invitation Homes, which spent about $10 billion since the Financial Crisis, or about $150 million a week during the heyday, on about 50,000 homes in 14 metropolitan areas, has confidentially filed for an IPO, according to The Wall Street Journal. But it will face some, let’s say, challenges.
Other players in the buy-to-rent scheme include American Homes 4 Rent, which got started in 2012 and now owns about 48,000 rental houses in 22 states. It went public in August 2013 at $16 a share. It produced a net loss every year since, sports negative EPS of -25 cents and and a whopping negative PE ratio of -84. But its stock closed today at $21.09 a share.
Starwood Waypoint Residential Trust, spun off from Starwood Property Trust Inc., a commercial-property investment and finance REIT, started trading in February 2014. It has merged this year with the portfolio of houses owned by real estate mogul Thomas Barrack, changed its name to Colony Starwood Homes, and is now the third-largest landlord in the US. It too has lost money every year, has negative EPS of -47 cents and a negative PE ratio of -64. And its stock too is up and today closed at $30.02 a share.
Both of these companies, in this wondrous stock market of the modern era, have multi-billion dollar market capitalizations and trade near their 52-week highs. So Blackstone’s Invitation Homes would be in good company.
In Wall Street’s never-ending passion to financialize absolutely everything, they created a new asset class: rent-backed securities. Renters are notoriously fickle, but no problem. There are now about $16.7 billion of rent-backed securities outstanding, of which Blackstone created over $5 billion. That’s a big part of how this business levered up.
While mortgage lending may have become tighter over the past few years, making it tougher for people with less than perfect credit to obtain a mortgage, institutional borrowers, long favored by the Fed’s policies have no such issues. They’re highly leveraged at the institutional level. They can borrow cheaply from banks and in the overnight markets. They issue bonds and even rent-backed securities without breaking a sweat.
House prices are set at the margins, and this onslaught of institutional buying in the single-family home market changed the dynamics and helped create Housing Bubble 2 – now even more magnificent than the one that blew up with such fanfare. In some of the markets where Blackstone et al. were the most active, prices soared the most, according to the Wall Street Journal:
In Phoenix, where Blackstone bought its first house in 2012, prices have risen 57.5% since its homebuying binge began, according to Weiss Analytics. In Las Vegas, prices are up 60.3% since 2012.
But it isn’t easy to make these spread-out rental empires work profitably on a daily basis, according to the thick red ink oozing from the financial statements of those buy-to-rent companies that have gone public, including our two heroes above. They have to fix up, rent out, and manage tens of thousands of individual houses that are, though concentrated in certain cities, still far apart and have to be dealt with one by one.
And even though interest costs are still low for institutions, interest rates are rising, and interest expense, already a big item on the income statement, is bound to balloon.
So these companies need to grow their revenues. Alas, there are only two ways to grow revenues:
- Buy more homes, one by one, at the high prices now prevailing in Housing Bubble 2, now that foreclosure rates have fallen back to normal;
- Raise rents when many renters are already pushed to the limit after years of rent increases, and in competition with apartments, where rents in many big metros are already under pressure.
So acquisition costs are going to rise. And interest expenses are going to rise, not only because rates are rising, but also because debts are ballooning on higher acquisition costs. So a double whammy. And this whole thing must be managed with far-flung staff and contractors.
Many of their properties, acquired between 2011 and 2013, have appreciated substantially. So the hope is, when push comes to shove as operating and interest expenses are generating losses, that the properties could be sold at a profit to make up for the pain. But dumping these units on the market would create entirely new dynamics, with the reverse effect of what happened when these companies bought the properties.
Whatever the realities for those battling it out on the ground, and whatever the red ink for shareholders to admire, for Wall Street, there is a big sweetener: the fees to be made off the securitization of rents.
But the rental market is already sagging in San Francisco, New York, Boston, Chicago, Washington DC, and perhaps a city near you. Read… The Great Unwind Unravels Hottest Rental Markets in the US