‘Rental Bonds’ Not a Fit for Retirement Portfolios

by Marc Bastow | July 31, 2013 1:51 pm

Investors are always looking to find just a touch more yield from their investments, and Wall Street is always trying to find ways to accommodate those desires … so sure enough, here comes another Wall Street-engineered income idea …

Bonds backed by home-rental payments.

Blackstone Group (BX[1]) — which according to the Wall Street Journal has spent more than $5.5 billion[2] to purchase around 32,000 single-family homes around the country — is in talks with Deutsche Bank (DB[3]) to bundle up rental payments on between 1,500 to 1,700 of those homes to create a rental bond deal of between $240 million and $275 million.

The “securitization” vehicles would be backed by equity and property worth between $300 million to $350 million, sliced into “tranches” representing different layers of risk — and price — with each slice conceivably rated by one of the major ratings agencies.

In short, we’re talking about oodles of rental payments bundled together to form a pool of assets, all reviewed and rated by uncompromised ratings agencies, which will certainly be priced to yield enough to grab your attention.

Hey, what could go wrong?[4]

How about a whole bunch.

Let’s start with the rental market itself and the structure of these instruments. Securitized vehicles are rated based on the stability of the underlying payment stream. Part of the housing crisis and subsequent financial debacle stemmed from the increasing delinquency rate on mortgage payments; over time, larger portions of homeowners’ paychecks were going to make those mortgage payments, and lots of folks weren’t able to keep up. As that payment stability cratered, so did the mortgage-backed market.

We could be seeing a similar problem in the rental market, as the U.S. Census Bureau found[5] that in 2011 (the latest period studied), nearly 45% of renters were paying more than 35% of household income on rent. That 35% represents “high rental income,” according to the bureau, and is used as a measure of affordability. Unless each rental income stream is checked as part of the due diligence effort to rate those rental bonds, it’s a crap shoot as to which ones, or how many, might be at risk.

Again, sounds familiar.

A second difficulty is management and ownership of the real estate itself. Blackstone manages more than $64 billion in real estate assets, and it founded and funded a nationwide, institutionally managed single-family rental platform[6] called Invitation Homes. So yes, BX has some expertise in the market, but that market remains fickle and subject to the winds of overall market conditions.

“Distressed inventory” — which is what Blackstone calls its properties — might come back to stronger valuations, or they might not, and while Blackstone might love its tenants, it probably would be quick to hand the keys back to any lenders (or bondholders) if “distressed” turned into “hopelessly underwater.”

If those foreclosures start to occur, renters will be on their own to deal with whomever takes over the properties; at best, those renters will be status quo on payments, and at worst tossed out. The repercussions to the portfolios counting on those steady payments is a loss of value — just what you’re trying to avoid in retirement.

The bottom line here? I’m all for finding ways to improve the housing market, and buying up surplus short-sale or defaulted inventory is a nice step. But I’m not particularly jazzed about jumping into a product potentially bundling rents from previously foreclosed houses for the sake of a few extra basis points.

Marc Bastow is an Assistant Editor at InvestorPlace.com. As of this writing, he did not hold a position in any of the aforementioned securities.

  1. BX: http://studio-5.financialcontent.com/investplace/quote?Symbol=BX
  2. has spent more than $5.5 billion: http://online.wsj.com/article/SB10001424127887324170004578638093802889384.html?mod=wsj_share_tweet
  3. DB: http://studio-5.financialcontent.com/investplace/quote?Symbol=DB
  4. Hey, what could go wrong?: https://investorplace.com/2013/06/reckless-endangerment-reveals-the-roots-of-the-financial-crisis-summer-reading/
  5. U.S. Census Bureau found: http://www.census.gov/newsroom/releases/archives/american_community_survey_acs/cb13-70.html
  6. single-family rental platform: http://www.blackstone.com/our-businesses/aam/real-estate

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