Wall Street Explores Rental-Backed Securities

by Brian Endo ’16

Wall Street is exploiting a new product within the housing market once again. This time, however, the product is rental-backed securities. After the housing crisis beginning  in 2008, home prices severely dropped, leading to mortgage defaults and subsequent foreclosures. In the following years, large private equity firms such as the Blackstone Group have been looking to make a profit through these depressed house prices. These private equity firms have accumulated over 200,000 houses by taking over the auctions of these foreclosed homes by paying the total in cash.

The plethora of home purchases has artificially raised home prices and has indicated an increase in housing demand. Despite this, home ownership rates have remained stagnant. This trend has caused mixed reactions to the housing data being released and can signal distortion within the real estate market. Firms like Blackstone are not only looking to flip the houses at a higher price, but also trying to generate profits through the rental checks.

In November 2013, Blackstone gathered enough rental payments to create a rated bond backed by securitized rental payments. The bond consisted of over 3,200 rental payments on family homes and was valued at $479 million. The bond garnered a ton of interest from investors where there was six times more demand than supply. This new market is expected to reach heights of about $1.5 trillion and could solidify a position comparable to mortgage-backed securities. There have been a lot of criticisms from many economists, but Blackstone has touted the safety of these bonds by highlighting the lessons learned from the housing crash. Despite these claims, Blackstone has made some bold predictions such as a 95% occupancy rate of its homes and an average monthly rent of $1,300. The nature of these predictions seem a bit over confident and can lead to a speculative increase in prices of the securitized bonds.

An issue that came up with these home purchases was that the private equity firms were in charge of a lot of mortgages. When the firms did not generate enough profit from the housing sales, they squeezed the costs in the rental homes. The tenants end up getting the bulk of the loss when the investments turned sour. This translated to very bad living conditions where utilities were not maintained and no repairs or renovations were made on these homes. The firms are trying to give the least amount of effort for the highest level of rent they can obtain. The private equity firms push this boundary where it reaches the legal limits of these situations.

The creation of these rental-backed securities may cause a repeat of the housing crash. The problems start with the lack of care to the tenants of the rental homes where this continual negligence can drive away a lot of renters. This issue will lead to an unexpected decline in revenue from these investments, causing the firms to not have enough money to make interest payments. A lack of renters could lead to a potential default on these securities, causing another crisis with millions of dollars lost.

Sources:

http://www.salon.com/2014/04/09/%E2%80%9Cthey_don%E2%80%99t_care_if_we_freeze%E2%80%9D_the_shameful_new_way_wall_street_is_swindling_ordinary_americans_partner/

http://www.motherjones.com/politics/2014/01/blackstone-rental-homes-bundled-derivatives

http://dealbook.nytimes.com/2014/01/29/wall-streets-new-housing-bonanza/

 

 

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