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The New Single-Family REO Rental Asset Class

JAN 8, 2013 3:00pm ET
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Institutional investors of all sizes are reportedly amassing billions of dollars in capital they plan to invest in renting unsold real estate owned inventory, which according to analysts, is building up demand for larger-scale investments.

By some accounts, according to Keefe, Bruyette & Woods analyst Jade Rahmani, roughly $6 billion to $9 billion “has been raised or committed” by investors suggesting potential acquisitions of anywhere from 40,000 to 90,000 properties.

Nonetheless, this inventory amounts to only around 15% of the nation’s REO inventory.

In other words, Rahmani argues, more financial leverage is necessary.

Furthermore, since the single-family rental market “has historically been fragmented, funded with capital from retail or smaller institutional investors,” he notes, the current marketplace has opened up new investment opportunity for untraditional investors.

Another market shift is on the horizon: Investments in single-family REO rentals imply long-term investor engagement.

Key findings include the expectation to see “robust growth over the next 12-24 months” in the REO-to-rental market, which has the potential to emerge as an institutional asset class.

“Investor interest has increased meaningfully as the large foreclosure inventory combined with a secular shift towards renting has created the possibility of larger-scale investments in the space,” Rahmani wrote in the second edition of his report, “KBW Mortgage Matters; Single-Family REO: An Emerging Asset Class,” that focuses on distressed inventory.

The main factors contributing to that conclusion are old and factual.

For example, despite recent housing market improvements, “restrictive mortgage credit, negative equity, continued deleveraging of borrowers and lenders, and the overhang of delinquencies” will continue to favor renting, he wrote.

The math also indicates REO rentals make sense to investors even though “leverage is currently limited.”

Rahmani lists as “potential financing” options: secured credit lines, lending syndicates, high-yield debt, government-sponsored-enterprise-provided financing and securitization.

KBW analysts estimate cash returns on investments in REOs are in the 5%-7% range, while total returns could reach 15%-20%.

In other words, opportunity could be meaningful. " We expect more public companies to enter the space over time," the report concludes.

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