Bond investors are wresting higher yields from landlords in the fledgling business where rental homes are financed by credit markets.
As the supply of debt backed by mortgages on homes for rent overwhelms demand, yields on the riskiest portion of the deals climbed last week to 5.3 percentage points over benchmark rates, from 4 percentage points in early August, according to Bank of America Corp. The first of these securities were sold last November by Blackstone Group LP's Invitation Homes at a spread of 3.65 percentage points for the lowest-ranked piece.
Institutional landlords have issued more than $6.5 billion of securities in the last year backed by mortgages on about 46,000 rental homes, and more is in the pipeline, data compiled by Bloomberg show. Wider spreads come as lenders backed by Blackstone and Colony Capital LLC expect to begin marketing next year the first deals tied to loans to multiple landlords.
"There are a lot of people that got into the asset class, believed in the story and want to see how it goes," said John Kerschner, the Denver-based global head of securitized products at Janus Capital Group Inc., which has invested in the bonds. "But it's much harder to buy the third deal, fourth deal, fifth deal if you're already underwater on your first purchases."
Rental Demand
American Homes 4 Rent, the second-largest landlord,
Both the safest and riskiest of the securities pay a higher yield above the benchmark than its September deal, data compiled by Bloomberg show. The junior portion pays a 4 percentage point spread, compared with 3.6 percentage points two months ago.
Private-equity firms, hedge funds and other institutional investors have spent about $25 billion to buy more than 150,000 single-family homes since 2012, seeking to benefit from low property prices and rising demand for rentals, according to New York-based Keefe Bruyette & Woods Inc.
The market for bonds tied to rental homes has the potential to grow to as much as $65 billion, with about $30 billion of new issuance a year, as the industry expands and securities are refinanced, Keefe Bruyette analyst Jade Rahmani said in a report last month. That compares with about $550 billion for the commercial mortgage-backed securities market.
'New Market'
Supply of the rental-home bonds, particularly in the lower- ranking slices, has been rising too fast to match demand, said Jason Callan, who oversees about $21 billion as head of structured products at Columbia Management Investment Advisers LLC. The Boston-based firm has invested in past American Homes 4 Rent deals, its disclosures show.
"It's a new market and you just don't have that many people signed on to fully participate," Callan said.
Bond offerings stand to increase when firms such as Blackstone's B2R Finance LP, Colony Capital's Colony American Homes and Cerberus Capital Management LP's FirstKey Lending LLC bundle their loans to smaller landlords into bonds resembling multiborrower commercial mortgage-backed securities.
These deals will probably be fixed rate, in contrast with most of the initial transactions, according to John Beacham, president of B2R.
"In the U.S. market, the interest and demand for fixed- rate paper is significantly higher than it is for floating-rate paper," Beacham said. "That's a pretty significant difference and you are accessing a much bigger potential investor base."
Multiple Borrowers
Colony American Homes, which owns 18,500 homes, has a financial arm that closed $500 million in loans that could be securitized, according to a company presentation. FirstKey has also made more than $500 million rental-home loans and expects to do its first multiborrower deal next quarter, according to the company. B2R declined to provide its financing volume.
Offerings backed by multiple borrowers will likely face high hurdles, according to Janus's Kerschner. Landlords associated with the multiborrower deals will be smaller, lesser known operators.
"The whole leap of faith in these deals is the operator," he said. "If I can go out and buy the Invitation Homes or Colony or American Homes 4 Rent deal, why do I want to buy the multiborrower deal? It's taking a somewhat complicated unproven story and adding another layer of complexity on to it."
Falling Risk
Demand for rentals has increased with the U.S. home ownership rate falling to 64.4% in the third quarter, the least since March 1995, according to Census Bureau data. The number of owner-occupied residences fell by 657,000 in the 12 months through September, while the number of renter-occupied units climbed by 1.2 million.
Invitation Homes, which has issued four sets of bonds totaling $2.9 billion, says it hasn't struggled to find buyers.
"Invitation Homes securitizations are well received and continue to show strong demand among an ever widening investor base," Denise Dunckel, a spokeswoman for the Dallas-based firm, said in an e-mail.
Recent single-sponsor deals have been offered in longer, fixed-rate terms or were issued by firms that retained stakes, helping them appeal to a broader group of investors, including Europeans. The bonds sold on Nov. 20 by Agoura Hills, California- based American Homes 4 Rent included 10-year fixed-rate securities backed by mortgages on 4,503 rental homes, according to the company statement.
Appreciating Values
Rising home values lowered the risk of the bonds failing, according to an Oct. 23 Moody's Investors Service report analyzing the first five securities backed by rental homes.
In the first securitization by Invitation Homes, the 3,207 rental houses renewed 64% of expired leases, according to an October report by Kroll Bond Ratings Agency. Revenue growth outpaced higher-than-anticipated expenses such as repairs, maintenance and homeowner association dues, Morningstar Credit Ratings LLC said in a Nov. 3 report.
Some investors still aren't sold. Anup Agarwal, head of structured products for Western Asset Management Co., said he will refrain from buying the securities until the deals have a longer track record and it becomes easier to trade the debt.
"I understand why it's a good business model from the sponsor's perspective," said Agarwal, whose Pasadena, California-based company manages $472 billion. "But as a security holder, we don't see it as an attractive proposition."
