It’s a sign of the times. Single-family homes, as distinct from mortgages, are an emerging asset class. For decades, investors have bought home mortgages in securitizations or as whole loans. Individual investors have built a cottage industry owning small numbers of rental homes. Institutions have been buying commercial real estate in various forms. Public and private REITs allow investment in various real estate asset classes in ways that improve liquidity, remove operational involvement and with more geographic and other risk diversification. What investors lack is a vehicle to own single-family homes that is analogous to single-family mortgages. And they’ve certainly not had the ease of a REIT structure through which to own those homes.
The Single-Family Challenge
Finance attracts a lot of clever people. So why haven’t structures been built to drive institutional ownership of homes? Until recently there have been good reasons (surely you would not think otherwise).
On the demand side, barring one year in the early 1990s, housing prices nationwide rose every year until 2007. Still, single-family homes did not score well as value in the investment sense. If anything at times they were a growth asset. And there were easier ways for investors to buy into growth than owning physical title. Homebuilder stocks, home improvement stocks or some of the late and unlamented mortgage companies were easier to trade and own. Times change and single-family homes are now arguably a value asset, even deeply undervalued depending on their location.
The Growth of the Rentals
Foreclosures and lower credit have made renters out of most former and many prospective homeowners. The renter culture has entered the single-family home market. What the small investor has known for years – that one can own a home and rent it out – has become much more economically viable. We need investor-owners for huge numbers of houses that owner-occupants are unable to buy. Even CoreLogic’s conservative estimates put the number of homes in shadow inventory at close to 2 million homes. Individual investors simply can’t absorb them all while we wait for the owner-occupant to come back. Institutions need to enter. We need to make investing in homes easy and very much in our society’s best interest.
Besides perceived value, institutions have not bought single-family homes because they are difficult to acquire at scale while controlling risk. Buying or selling a home is a byzantine process, reliant on hard copy forms, faxes and even a thumb-print identification to avoid fraud in some jurisdictions. Buying a handful of houses is easy; buying hundreds, thousands or hundreds of thousands of houses is exceptionally hard because one has to combine the desire for bulk transactions with the reality of closings scheduled one home at a time. But that combo is needed today as homes incrementally transition from distressed ownership to rentals. One can always buy vacant homes in bulk but then the purchase price would reflect the quality of the asset and its rentability. Both seller and buyer would need quite a lot of information to have useful price discovery – that’s unlikely. Experiments out of Washington are helping with supply of homes but we are a long way from doing what’s best for the country and the housing market.
Another impediment to institutional homeownership is the operational complexity of managing residential real estate that is horizontally dispersed rather than vertically stacked (like apartments). Horizontal is harder in some ways than vertical but less risky in others. Besides, a nation that built the Google search algorithm can figure out how to manage homes.
Enter the REITs
As institutions look at single-family home rentals with asset value and cash flows, they want simplicity of ownership. The REIT structure makes a lot of sense. A REIT can own homes just as well as it can own other real estate. A broadening equity-market investor base wants the same: the economics of a rental home minus the operational involvement. The development of the REIT market tells us that REITs are a smart way to structure single-family home investment as those investments grow.
Public or private REITs can also help buyers obtain liquidity. Public REITs alone represent $525 billion in public market capitalization. Homes can be brought into a REIT; markets can be accessed for both equity and debt, with property management contracts attached. Capital can be allocated more efficiently. As a by-product we will see the creation of a new(-ish) industry that professionally manages homes at scale.
RMBS for Rental Homes?
The US financial industry being what it is, the “S” word – Securitization – is not far behind talk of a new asset class. To be fair, not all securitization is bad, the basic structure of mortgage backed securities was a fantastic innovation that institutionalized mortgage investing, reduced geographic and idiosyncratic risk etc. etc. It did not end well but the fundamental insight made mortgages affordable for a generation.
Could something similar happen in the single-family home asset class? Could rental homes be packaged into securities and sold off, maybe as REITs with financial and operational constraints but tax advantages or maybe through some other structure? I believe so. More importantly, to tackle the problem of homes with distressed mortgages, where new owner-occupant buyers are scarce, where investors need to step in to avoid the blight of a foreclosure, it better happen. Because the housing market needs all the help it can get.
Interestingly, such structures don’t need the government to do much, other than continue the tax advantage of REITs.
A number of groups have formed private REITs, rating agencies are talking about the unique issues in forming and rating single-family REITs. Nothing insurmountable, but rating agencies are going to need to evaluate the home acquisition, rental operations and property management processes of REITS seeking ratings.
Housing is a basic consumption good. It can be owned or rented. Home ownership is embedded deep within our national psyche. But the need for shelter is even deeper. People going through a foreclosure eviction need to live somewhere. Living with family or friends is not a long-term solution. These folks will need to rent as buying may be out of reach for financial or credit reasons, or may be (temporarily) unappealing.
REITs and simple securitizations can make homes much more attractive to institutional and individual investors. These homes would otherwise enter foreclosure, burden neighborhoods and signal the dysfunction at the heart of the current housing market. Securitization run amok hid the risks in our housing market. Within the cause of housing’s meltdown are the possible seeds of its rebirth. Securitization may yet save us.
Jafer Hasnain is co-Founder of Lifeline Assets, one of the first private equity firms in the country to invest exclusively in single-family homes. Information at www.lifelineassets.com.