Wall Street Landlords Splinter Along Funding Lines

Mounting financial constraints and rising real estate values are pushing rental home investors into sell mode.

The bid-ask spread to acquire other investors' rental home portfolios has narrowed meaningfully from a year ago, according to the chief executive of the country's largest publicly traded landlord, which has increased home purchases as other firms have stalled or slowed.

"There is a misconception that the supply of single-family properties has dried up," David Singelyn, CEO of American Homes 4 Rent, said in a phone interview after announcing last week it would buy 900 homes from Michael Vranos' hedge fund Ellington Management Group. Ellington is bowing out less than two years after it started buying homes.

The pickup in consolidations is the latest stage in the rental industry's maturation, which traditional lenders say has dampened demand for mortgages and affected housing prices.

There could be a wave of large transactions this year as real estate continues to appreciate as much as 9% in some states and just over 5.5% nationally year over year. Recent deals have included around 50 to 100 properties per transaction, but bigger deals, one including as many as 2,500 properties, are beginning to take place.

Only a handful of firms have the capital to make acquisitions that large.

American Homes has ratcheted up property acquisitions from $300 million to $500 million per quarter.

Invitation Homes will hit bids hard too, CEO John Bartling said in an interview. Invitation Homes, a subsidiary of Blackstone Group, has been buying a steady $35 million per week and now owns 46,000 properties, he said. Blackstone's global head of real estate, Jonathan Gray, hinted in recent weeks his interest in buying up public real estate investment trusts.

The roll-up strategy is preferable to acquisitions made on courthouse steps, and pricing conditions are improving for sellers, but the deals depend on the capital markets.

60% More Leverage

The industry's schism between growth firms and divesting firms has deepened, separating those with access to cheap and steady funding and those without.

Weak stock performance is slowing the ability of publicly traded landlords like Silver Bay Realty Trust and American Residential Properties to continue their purchase rates, researchers at J.P. Morgan Securities wrote in December. Purchases are not cheap. American Homes, for example, will pay a 26% premium to Ellington's costs.

Nearly all firms are expected to tap into more borrowed funds. Their leverage ratios are currently around half that of a typical apartment REIT, but that is likely to change this year, according to Nomura Securities International, which predicts the industry's debt-to-equity ratios will climb from 25% to upwards of 40% in order to finance new home purchases.

Securitization will have to be the lifeblood of the industry. Yet landlords big enough to package a deal are at risk of flooding the market with excess supply. Too much supply makes the deals harder and more expensive to sell, but too little supply hurts the asset class as a whole.

U.S. investors willing to buy into these deal s can only buy so much within a certain time. Last year, Blackstone began complying with the European Banking Authority's risk-retention rules. Underwriters designed that feature in order to bring in European investors for the first time. Executives at American Homes and at Blackstone Group's Invitation Homes declined to comment regarding their capital market activities.

Already, investors demand higher concessions to compensate for liquidity risk, spread volatility and lack of performance history. They are worried about refinancing of the two-year loans that back the securitizations and how that might play out. Some are concerned that even the largest firms may exit their investments and sell off their businesses.

American Homes 4 Rent is the only firm out of six to have completed these deals to structure longer dated 10-year notes. Longer notes give comfort to investors that the company is more likely to stick around for the duration. The five other firms are selling bonds that mature in two years.

Lobbying The GSEs

Housing experts for a time welcomed investors' buying and renovating distressed properties across the country. But their role has also invited criticism, even though rental housing inventory began last year to sag below historic averages for the first time since 2000.

Affordability advocates, supported by individual members of Congress, claim the cash purchases of Wall Street landlords have priced out potential first-time homebuyers and could be driving up property values in the regions hardest hit by the bubble. Mortgage bankers are all too aware of that correlation, as they continue to struggle with low volumes.

There could be more controversy on the way. Rental executives are lobbying Freddie Mac to expand their multifamily financing program in a way that benefits single family home investors.

"It wouldn't surprise me to see new [government-sponsored enterprise] activity in this space," Bartling said.

Smaller, more financially constrained competitors are even more vocal.

Sean Dobson, CEO of Amherst Securities, which owns a company called Main Street Renewal with 6,000 properties in portfolio, irked some policy officials gathered at the Urban Institute last month. Dobson, like many in the rental industry, have vocalized their critique that the government housing agencies will guarantee mortgages for a mom-and-pop house flipper, who does not have to abide by the fair housing standards, but they will not back larger operators, which abide by stricter guidelines. Larger rental investors lend using commercial underwriting criteria, they argue.

"Yes, we have a bias," Dobson said in a phone interview. "We would love to have a lower cost of capital. We definitely have a dog in the fight."

Freddie Mac has approached vendors to discuss potential multifamily funding, but it has made no new decision whether to help prop up the industry since Bush-appointee Ed DeMarco retired as acting director of the Federal Housing Finance Agency a year ago, according to experts consulting Freddie. Officials are said to be monitoring highly anticipated private market solutions that may appear in the next quarter via multiborrower securitizations. If those deals are successful at broadly financing the rental industry, Freddie may have less pressure to get involved. Any change may depend on current FHFA Director Mel Watt, a champion of affordable housing.