It’s no secret that investors have been inhaling foreclosed properties at a breakneck pace, trying to cash in on an increasingly hot rental market. They have been buying properties alone and in bulk, and some are even creating REITs of these properties in order to raise capital to buy more. But enough is never enough, and with such a huge supply of distressed homes (5.57 million loans either delinquent or in the foreclosure process, according to a new report from Lender Processing Services and many more already repossessed by lenders and the government), it should come as no surprise the investors are getting ever more creative.
The latest proposal is for a new security backed by pools of previously foreclosed rental properties. It would be similar to the MBS model, but instead of mortgage payments providing the cash flow to investors, the monthly rents would. Standard and Poors has already been approached to rate these potential new securities.
“There is clearly an opportunity, lots of REO [bank-owned] properties coming into the market over the next few years,” explains S&P’s Vandana Sharma. “What is the best way to finance them? So the next thing is to say, how do you assemble a pool with some geographic diversity, how do you take homes from different markets, so how do you put that pool together?”
The properties could be owned by banks, investors, or even the federal government. But while the rental stream coming through these securities sounds simple enough, the fact that these are rental properties presents complications, specifically in property management. Unlike buying a security that pools mortgages, the owners of these securities would have to factor in the costs of the property’s upkeep and management of tenants.
“There's also the cost of painting and re-leasing the homes, periodically setting the market rents, so there's a very active property management aspect to it and a capability, and then there's the question of what pays the investors back? Is it the lease payment from the rents they collect or is it the sale of these properties, so that's really the next phase of analysis for this opportunity.” adds Sharma.
S&P is running some possible scenarios, one in which investors would first get rental income but then could also get a cut if the property were to be sold when the overall housing market recovers. Investors are already interested, especially given the fact that these days good yield is hard to find.
“We’re now in a world where yield means everything, and anything that throws off yield gets a look,” says Steve Duffy, Managing Director at Moss Adams Capital.