A Unique Credit Instrument Fueling an Equally Unique Trend in Home Ownership

From the time of the real estate pricing peak 2006, the average price or residential real estate across the United States fell 35%. This price drop precipitated the start of a quiet trend among private equity firms, hedge funds, and real estate investment trusts. Companies such as Blackstone Group LP have entered into transactions to purchase almost 200,000 residences, paying upwards of $20 billion for the properties. Many of these properties are in some of the hardest hit housing markets in states such as Florida, Nevada, California, and Arizona. These companies are looking to take the landlord/tenant relationship to a new level. When purchasing distressed properties, in bulk, from lenders that foreclosed on their original mortgagees, these companies gain several significant advantages. First, they are able to negotiate a better price.  A commercial lender is in the business of lending money, not managing real estate.  When a company comes along and places an all cash offer on the table for a bulk number of properties, it becomes a win-win for both the commercial lender and the new commercial purchaser. Second, many of the companies purchasing properties in bulk are publically traded, so raising equity and obtaining debt financing is left difficult. Third, they have the management expertise to properly manage large real estate portfolio holding. The fourth advantage these companies possess, and possibly the most important, is the ability to issue highly rated corporate bonds, secured by the lease payments of the tenants from the dwellings.

By issuing fixed rate, long-term bonds now, companies such as Blackstone are able to lock in the current low interest rates offered to highly rated bonds. The companies are able to charge market rent for the properties, and adjust them annually or for each subsequent tenant. The revenue generated has the ability to keep pace with inflation, while the debt payments are fixed. As long as demand for housing remains constant or improves, and the home values remain constant or improve, future year cash flows associated with leasing of these properties should increase.  At the same time, future year cash outlays associated with financing should remain constant. The result should equate to an increasing annual positive cash flow.

However, like everything else, there are those who disagree with this new type of innovative financing. This argument appeals to the American dream, where one plank has always been home ownership. As companies purchase homes and become large-scale “landlords”, it translates to a lessor number of single-family owned residences. During the first half of 2013, the U.S. home ownership rate declined 65%, from its peak of 69.2% in 2004. Investment Firm Morgan Stanley expects the U.S. home ownership rate to stabilize at 63%, as more than 2 million households are added to the rental population. This argument is somewhat muted with the realization that owners who are underwater or have no equity in their property, may have no more incentive than renters. In the long run, everyone can agree that a residence that is lived in, whether by a renter or an owner, is better than a vacant home owned by a lender, and the side effects that are associated with an empty house.