The Rush for Rentals by Investors Turns Into a Run for the Exit



This is the story of Dumb and Dumber…

The list of private-equity firms that over this past year have been rushing to get a stake in the supposedly red hot single-family home market include: Colony Capital LLC, Oaktree Capital Group LLC, KKR & Co., GTIS Partners and Waypoint Real Estate Group LLC, a real-estate investment firm in the single-family rental market that last year reported securing $245 million from Citigroup Inc., to expand its existing portfolio of over than 2,400 homes.

Last September, Waypoint’s managing director, Gary Beasley, talking about investors buying up homes said…

“We’re finally starting to see the private sector coming in and providing a solution. It was just equity and now it’s debt. We’re seeing meaningful price appreciation in a number of markets across the country.” 

Of course, reading Beasley’s comments bring two thoughts to mind.  One is that “meaningful price appreciation” ultimately means lowering expected returns for investors, and the other is that transforming equity into debt doesn’t sound all that good to me.  But who wants to worry about such things when there’s a gold rush in the works.

The numerous private-equity firms that have entered the single-family home space are ostensibly seeking a way to place a bet on the housing market’s recovery.  It began as a mom-and-pop type of investment, but it gained legitimacy among private equity firms when private equity giant Blackstone started buying tens of thousands of foreclosed homes.

Analysts chimed in… like the sycophants that are… saying that investor demand from these firms and others could help strengthen the housing recovery, and early in 2013, the Federal Reserve voiced its support for the strategy, desperate to find a way to deal with the backlog of foreclosures that continue to weigh down the housing market.

Warren Buffett showed up on the scene with an exorbitant bid for ResCap loans, thus offering proof that the Oracle remained bullish on the housing market as an investment opportunity, and without question, tens of billions has been raised by private equity firms from investors looking to take advantage of home prices that have fallen by at least a third and are perceived to be at or near bottom.

And what does all of that show?  That there’s plenty of dumb money in the world, that’s what.


Forget for a moment about price appreciation forecasts… let’s just talk about the whole buy-to-rent nonsense that’s been presumed to be a gold mine waiting to be mined, because it’s a lot like, if you remember that colossal failure from days.  It’s just a dumb idea. was the new technology play that always struck me as a very old idea… ancient even.  I mean, having one’s food delivered to one’s home has got to be an idea that been around since Cleopatra, right.  I don’t remember reading about Cleo doing her own shopping, do you?

There wasn’t anything new about having groceries delivered to your home, I don’t care whether your ordered them online or over the phone or fax… it just costs more, that’s all.  So, the idea that could do it and be anywhere near competitive with the supermarket was simply preposterous.

Buying up foreclosures with the idea of renting them out in order to make your fortune is another idea doomed to failure, and the private equity firms that tried to do just that this past year know it too, albeit a little late.

There are reasons that single-family homes for rent have always been the domain of the local mom-and-pop investor. 

For one thing, if the homes are spread out geographically, that means needing property management firms wherever you own a home you’re renting out, which is a very inefficient way of doing things.  You’re not exactly going to get any deals or realize many economies of scale advantages asking ABC Property Management in Des Moines to manage the one or two homes you happen to own in their area.  In fact, you’re going to pay top dollar for those services.


It’s very different when buying an apartment complex, where economies of scale do come into play, and the advertising can be done on one or two giant billboards.

The other problem has been that investors in this space have too often found themselves competing with moms-and-pops for foreclosed homes being sold at auction, and that has led to everyone involved paying higher and higher prices for the scarce inventory, to say nothing of the fact that one-by-one is no way to invest a $1 billion private equity fund.

The presumed to be frequent bulk sales of reposed homes has simply never materialized because… well, because banks aren’t stupid, that’s why.  Yes, I realize that to investors it only makes sense that banks should want to dump their REO inventories at 30¢ on the dollar, but somehow those bankers must be getting a hold of the same newspapers and magazines the investors are reading because they don’t seem to be in too much of a hurry to book exorbitant losses while property values appear to be rising.

Then there’s the fact that foreclosures aren’t exactly evenly distributed among all neighborhoods throughout the country… actually they have the tendency to congregate in pockets more than anything else.  And many of those pockets aren’t what you’d call high demand areas for rentals.

Fifteen minutes outside Las Vegas I’m sure you could pick up 5,000 empty homes on the cheap, but your chances of renting out even one would be, shall we say… remote?  Those homes shouldn’t have been built out there to begin with, and they sold because of easy credit that made it a no-brainer for anyone to qualify for a loan.

Now foreclosed, their prior owners are back in the rental market to be sure, unless they’ve moved back home with Mom & Dad, but they’re not going to be interested in renting a home in the middle of nowhere Mojave Desert.

And this brings up my overriding point about the hair-brained nature of the whole buy-to-rent scheme… even in areas in which people want to live, have you noticed or heard about any sort of shortage in the rental home market?  Have any of your friends or co-workers told you how they’ve been unable to find a home to rent?  I haven’t heard or read about anything like that being the case, so where’s the shortage that these private equity investors are hoping to alleviate?


Then there’s the question of price appreciation or stabilization, as in, has there been any?  I don’t think there has, really.  What I do think happened last year is that with 60 percent of home sales coming from investors, instead of the historical 10 percent, they managed to bid up the bottom of the market, causing everyone to pay more than they should for the properties… creating a mini-bubble, if you will.

And now that investor demand has chilled appreciably, they’re realizing that their capital… or someone else’s, if they can unload what they’ve bought on even dumber money… is about to be destroyed.  It won’t be easy for many to dump their inventory, however, because they can’t sell the homes to people who will live in them… the demand just isn’t there and never was… so they’ll have to find another fund who hasn’t yet realized the flaws in the group-think that’s been going on.

The first sign that the gig was up came when Blackstone announced its first-ever home rental bond, a securitization structured by Deutsche Bank (who also provided $3.6 billion in loans, by the way) and known as the “Invitation Homes 2013-SFR1” offering, which was pitched by JPMorgan and Credit Suisse as co-leads.  (Securitizing these homes-to-be-rented is a way out for Blackstone, although they’d never admit it.)

When I first heard about it all I could think to say was: “Lord, if I could only figure out how to short this thing…”

Ratings agency, Fitch declined to rate this newfangled monstrosity triple A, and surprise, surprise, wasn’t chosen to rate the offering, but not to worry, those practicing the oldest profession in the world over at Moody’s showed their true colors by giving the deal at least one triple A.  The consensus had been that under no circumstances would such a deal deserve anything higher than a single ‘A’ rating, but how soon we forget on Wall Street, don’t you know.

The reception, which seemed to me only slightly better than Facebook’s IPO last year, had investors balking about Blackstone not having enough skin in the ill-conceived game, and about the ratings agencies giving too much credence to the future home price appreciation baked into the numbers… both reasonable concerns, especially when you consider that Blackstone only bought the distressed properties within the last year.

If it were me, I would have said it more clearly.  The fact is… every single statement and assumption in this securitization is AT BEST… nothing more than SWAG.  (That’s “Scientific Wild Ass Guess,” for those who don’t know.)  None of it is proven, none of it is based on anything that’s ever happened before… it’s anything but triple A material… in fact, I’d say it should be hard-pressed to remain investment grade (which is BBB or above).

According to the Financial Times… “The agency analysis utilized recently updated so-called “broker price opinions” or BPOs, reflecting estimated current home values that some investors said were too high in some regions. Even the rating agencies acknowledged in their respective pre-sale reports that the BPOs were too high in several areas; so high, in fact, that they looked at national home-price indices and in some cases applied a cap to the amount of HPA they would give credit for.”


The other problem with the deal was that while the stated LTV (Loan-to-Value) ratio was a judicious 75%, the loan-to-cost ratio was roughly 88 percent.  That means that if Blackstone bought a home for $80,000 and renovated it for $20,000, the total cost would be $100,000 and $88,000 of that amount would have been borrowed funds…. and only $12,000 in that example would be Blackstone’s equity.

If you showed that math to Blackstone, however, they would have argued that they had 25 percent equity in the deal, based on the 75 percent LTV, but that’s just because they’re… well… liars.

According to Kroll, another of the ratings agencies that rated the deal, Blackstone has only 5-10 percent equity in the deal, which is the sort of 100% swing (from 5 to 10) that makes me insane.  I mean, what would you say if you heard someone describe a suspect as being 6-12 feet tall, weighing 200-400 pounds?

Oh yeah… sign me up for some of that.  I’m not sure I’d want a piece of this deal at 14 percent, let alone at triple A rates… I think I’d feel safer holding bonds from Portugal at par.


And then there’s the issue of who was selected as the servicer for the deal… Blackstone chose Situs Holdings, which is a commercial loan servicer that has roughly zero experience with residential real estate, and the property manager on board, it turns out, is a subsidiary of Blackstone.  Yes, you heard that right… Blackstone owns the property manager for the 3,000 plus homes that are supposed to find themselves renters.

Can you imagine what will happen when… not if, but when… the equity slice blows up and Blackstone shuts down the property manager?  I wonder how the investors will go about finding a company (read: companies) to handle the administration involved in collecting 3,000 plus checks from all over the country each month.  Piece of cake, right?

And then there’s the question of how any sort of liquidation would be handled in the event things really went badly.  I mean, Situs is used to selling an office building in a pinch, but that’s nothing like trying to unload 3,000 homes in neighborhoods in and around Phoenix, Arizona; Riverside, Los Angeles and Sacramento, California; Atlanta, Georgia; and Tampa, Florida… which is where 90 percent of the homes in this deal are located.

(Remember when I said earlier that foreclosures tend to congregate in pockets?  Well, that’s what I meant.  If half of these homes get rented, I’ll eat my socks.)


Exit… Stage Left.

Last April, Leon Black, CEO of Apollo Global Management, another private equity mega-firm, said his firm was selling “everything that wasn’t nailed down,” and you would think that sort of statement would send more of a message, but as I’ve said before… optimism is a hard thing of which to let go.  Dumb money is always the last to know that the party has ended.

But, it’s late enough in the game that the word is now out.

At the end of September, Reuters reported that Oaktree Capital Group is looking to dump its accumulated portfolio consisting of 500 single-family homes bought out of foreclosure.  They tried to convert their portfolio into a rental-REIT, so as to unload it on the public, but they just didn’t screw us in time… this time… and they were forced to pull the plug on the perverse plan.

Gosh, I wonder why that would be, I mean, with prices going up and all, I can’t imagine why Oaktree would want to bail out on all those “low priced” bargains.  It would seem that they want out of what was only recently considered the red-hot buy-to-rent bonanza.

Oh, and by the way… Reuters was unable to find out the price Oaktree’s asking for the 500 home portfolio, which is another way of saying… “It’s been reduced.”  Unfortunately, American Homes-4-Rent and Silver Bay Realty Trust, have managed to convert their portfolios into publicly traded REITs, which are being shoveled into mutual funds that will find their way into unsuspecting retirement accounts

They are unlikely to be alone as far as looking for an exit goes.   In total, private equity firms, REITs, and hedge funds raised in excess of $17 billion since 2011, in order to buy over 100,000 vacant, foreclosed single-family homes… you can guess where.

In addition, spurned on by the Fed’s QE and zero-interest-rate policy, Lord knows how many smaller companies and individual investors also jumped on the bandwagon, and as it has the tendency to do, the insanity drove up home prices at double-digit rates thus “fixing” the problems we’ve had with the housing market for the last 6-7 years.  Anyone care to take a guess at what happens next?  Anyone?  Anyone?

American Homes-4-Rent picked up 19,000 single-family homes, Colony American Homes nearly 18,000, Silver Bay Realty Trust threw down for 5,370, Waypoint Homes gobbled up 4,620, and American Residential Properties brought up the rear with 2,530 homes bought.


These homes, that last year were found on the for sale sheets that investors have been reading with the focused attention of an 11 year-old boy reading Playboy, now appear on the lists of homes, “FOR RENT.”  The problem is… they’re not renting.

It’s the strangest thing, but even though vacancy rates for apartments have fallen to 8.2 percent, which is their lowest level since 2001, single –family homes bought after foreclosure have VACANCY RATES OF 50 PERCENT and higher… according to Bloomberg this past July.

And can you guess what the 50 percent vacancy rates are doing to rents?  Here’s a clue… it’s not increasing them.

It’s finally become clear, at least to some, that the business model of buy-to-rent isn’t workable and that the dumb money that dove into the shallow end of the pool thinking it was an ocean, is about to get its head smashed when it hits bottom.

Yes, my friends… the homeowners and other professionals who read Mandelman Matters… I wrote this as a gift to you.  Wall Street and Father Fed have managed to transform single-family homes into something akin to a commodities futures market, where prices jump without demand, and crash at any moment without warning… they’ve done it this time… not homeowners, but those darn irresponsible investors.

The only question now is whether what used to be the smart money, but now realizes it’s the dumb money, will be able to find even dumber money… it’s called the Wall Street shuffle… or at least it should be.


Mandelman out.

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