Large single-family rental companies are expected to grow significantly over the next 12 to 24 months, Rahmani notes in a recent report, while smaller players will have a chance to take advantage of “leverage and consolidation.”
Growing investor interest in single-family rentals in general and REO-to-rent assets in particular indicate “the sector has the potential to emerge as a long-term institutional asset class,” he wrote.
Data are encouraging despite lower annual growth of distressed purchases compared to the overall purchase market, which indicate that while investor purchases helped catalyze the recovery, “strong resales, low inventory and declining delinquencies” have become more significant factors.
The REO-to-rent segment of the housing market is going through fundamental changes that support these conclusions.
Historically smaller investors funded the single-family rental market, which has always been fragmented, according to Rahmani.
Today, “the large foreclosure inventory combined with a secular shift toward renting” has created unprecedented opportunity for larger-scale institutional investors who have raised or invested an estimated $20 billion to acquire approximately 150,000 REO properties. But this seemingly significant amount of capital only equals less than 15% of distressed sales over the past 12 months and 4% of seriously delinquent loans and foreclosures.
Demand will remain strong since regardless of improvements the still-high number of serious delinquencies currently estimated at 2.7 million will “continue to increase the percentage of renters,” improved occupancy and lead “to positive operating income.”
KBW analysts estimate unlevered cash returns in the 5% to 7% range, while levered internal rates of return, including home price appreciation, could exceed 15%. If so far leverage has been limited to secured credit facilities, they wrote, “Future financing options could include expanded facilities, lending syndicates, convertible or high-yield debt, and securitization.”
At least three successful securitizations of nonperforming loans were reported in 2012 paved the way for more NPL securitizations.
In April 2012 Rialto Capital completed Rialto Capital, 2012-LT1, its first NPL securitization with assets that were performing at 22%. In June a joint venture between Blackstone and Square Mile Capital made possible the issuance of another security, S2 Hospitality, 2012-LV1, consisting of assets that were 75% performing. Lastly, in September 2012 Oaktree completed Oaktree Real Estate Investment/Sabal, 2012-LV1, another NPL securitization that included assets that were 80% performing.
Rahmani argues they could serve “as a potential template for initial single-family REO securitizations,” despite concerns that lack of current yield from NPLs “would result in a greater need for subordination” on those securities because all returns for bondholders would depend on the resolution of the distressed mortgage loans or sales of REOs.
Nonetheless, the REO-to-rent asset class is here to stay. Ratings agencies, including Fitch and Moody’s Investors Service, are now working on the details of security risks and methodologies for analyzing these transactions.
“Opportunity could be meaningful,” analysts wrote, as more investors are entering the market and some REITs focused solely on single-family rentals have gone public.
Analysts expect to see “more public companies in the space over time” and more major banks lending to investors.
Prospects for leverage in the REO-to-rental market “have slowly begun to appear primarily in the form of secured credit facilities,” offered by a number of banks including Citigroup, Bank of America, Wells Fargo, J.P. Morgan and Deutsche Bank, Rahmani notes.
Colony American Homes is among the examples in the KBW list of public single-family rental REITs with access to lines of credit from a major bank. Earlier in September Colony reported that it secured a $500 million credit facility from J.P. Morgan, analysts wrote, “with a potential to upsize the facility to $1 billion.”
At the top is Blackstone, which has already expanded its initial $600 million credit facility to $3.6 billion.