As rental properties become more attractive to residents who may have been burned by the housing crisis, “institutional investors”—a new breed of landlord that can own up to 45,000 properties—are buying up many properties and using rental payments to service their loans. In this series, the Metropolitan Planning Council explores what these large-scale landlords’ implications are for the housing market.
Consider if a bundle of over 6,000 rental homes across a handful of communities were to suddenly be for sale; many residents would be forced to move and communities would experience increasing vacancy and decreasing property values. Recent trends in the housing market have made this a potential dilemma for American communities—Chicago included.
In a previous post, “Quality versus quantity in the single family rental market,” the Metropolitan Planning Council introduced a new breed of landlords—the institutional investor, who may own tens of thousands of single-family rental homes. Recent buzz in the housing realm has been about the ways that institutional investors are financing their investments and how these practices are reminiscent of behaviors right before the housing crisis of 2007.
There were a number of factors that led to the housing crisis. For instance, banks were approving mortgage loans with the promise of fast and easy refinancing to people that were not financially ready to become homeowners. Then, when market forces pushed interest rates up and housing prices down, new homeowners found themselves unable to refinance despite higher monthly payments they could not afford. Concurrently, an epidemic of job loss rendered those who were once stable homeowners unable to pay their mortgage. Selling was rarely an option because the decline in housing values left many mortgages underwater, meaning they owed more money than their homes were worth. At the same time, there was an abundance of vacant, newly constructed homes. Plus, the increase in interest rates on mortgage loans and lack of employment brought home buying to a halt.
What does this matter to our current housing market? The tie-in to today’s financing strategies is that many of these delinquent mortgages were backing securities. Mortgage-backed securities form when banks sell a bundle of mortgage loans they have issued to rid themselves of debt. They do this by selling the debt as bonds to investors. Bondholders get their money back when homeowners pay their monthly mortgage and the bondholders make profit off interest. However, when homeowners default on their mortgages, the bonds are not fulfilled. The rate at which people were defaulting on loans around the year 2007 exceeded anticipated risk and depleted every financial source involved. At this point, home buying was no longer at a halt, but sharply deflating. The financial institutions were unable to resuscitate a suffocating market.
Fast forward to 2012 through mid-2014, when institutional investors started purchasing single-family homes at an unprecedented rate. The housing crisis saturated the market with cheap, foreclosed homes that were easy for those with capital to scoop up at cash auctions. Partially through this buying spree, some of the larger institutions started securitizing their investments to give themselves immediate capital to make more purchases. What makes this particularly unique is that these institutional investors were converting single-family homes into rental properties. Under these circumstances, instead of securitizing mortgage payments, the institutions are securitizing rental payments. This means that they are selling anticipated rental payments in the form of bonds to outside investors. Similar to the mortgage-backed securities, as monthly rental payments are made, bondholders get their money back plus interest. Currently, these bonds have the highest possible ratings, which suggests a high degree of certainty that investors will receive the promised rate-of-return.
The high bond ratings offer some comfort; however, risk is still a factor. Some securities bundled over 6,000 homes across only a handful of communities. This tethers the performance of rental properties to each other, and subjects whole communities to each other’s weaknesses. This risk further escalates considering that some communities might be bundled into multiple securities. Should this buy-to-rent model falter, one has to question whether the bondholders’ payouts will be prioritized over the stability of these communities. If not, it’s easy to see how communities—many still struggling to recover from the last housing crisis—could be hit hard again by forces almost entirely out of their control. The best way to fulfill bonds and protect a community from a failing security is to sell the entire bundle to another large institutional investor. But, does this model have enough momentum to keep the interest of such investors?
As reflected by record highs in construction of rentals and record lows in construction of single-family homes, the rental market is having a moment. The housing crisis left people unwilling or unable to purchase a home, therefore driving up rental demand. Embracing the boom of rental demand through the buy-to-rent model of single-family homes improves the value of what would otherwise be vacant properties. This offers a reason to welcome investors, especially since the nature of the original purchasing directed institutional investors to communities hit hardest by the recession. Though the buying spree has slowed for some institutional investors, more are emulating the buy-to-rent model.
With massive portfolios at the institutional investor level, leasing and property management is typically outsourced to an agency. However, institutional investors need to ensure the selected agencies have the appropriate capacity and knowledge to occupy scattered properties with tenants and provide quality service to retain that occupancy. Additionally, policies and procedures need to be consistently enforced, such as proper approval prior to leasing or appropriate penalties for tenants who do not uphold financial obligations, to avoid delinquent rental payments and, ultimately, fulfill the bonds. The key to success in this model is going to be happy tenants and happy bondholders.
The buy-to-rent model for single family rental homes may be a viable way to right pre-recession wrongs, but considering the magnitude of past mistakes and the many parallels in past and present behavior, caution must be taken to protect investors, tenants and the communities caught in the middle.
Learn more about the issue in this series' other posts.