February 26th, 2014
Law360, New York (February 20, 2014, 9:26 PM ET) — The Blackstone Group LP’s recent groundbreaking move to sell bonds secured by single-family rental homes may have created the next securitization blockbuster, but attorneys say the product could attract the same type of litigation that has plagued the commercial and residential mortgage-backed securities markets.
Blackstone is among a growing group of entities that amassed large numbers of foreclosed homes after the crisis and are turning them into profitable rentals. Now some are hoping to take that profitability one step further, extending loans secured by these single-family homes and securitizing them.
This process offers benefits both to players like Blackstone and to smaller landlords that own groups of single-family rentals and can’t get traditional lenders to lend against their assets. Blackstone’s debut product — sold to a syndicate led by Deutsche Bank AG — has been very well- received, but attorneys caution that many questions remain unanswered, and REO-to-rental- backed bonds could pose litigation risks.
“If there is a loss caused by these securitizations, someone is going to be looking to Deutsche Bank and Blackstone, or whoever is providing the bond, for recoupment,” said Scott Gizer of Early Sullivan Wright Gizer & McRae LLP.
Blackstone’s $480 million deal, in which it pooled 3,200 homes owned by its portfolio company Invitation Homes and used them to secured a single loan that it then securitized, made waves as the first of its kind.
Several other opportunistic real estate investment companies, including American Homes 4 Rent and Colony Capital LLC, are expected to follow suit, but they are treading lightly as the new product is assessed by the market and investors.
Blackstone and its partners have not been targeted by any litigation related to the deal, announced in October. But Gizer, who represents large and small companies in disputes involving distressed assets and foreclosures, said that going forward, REO-to-rental-backed bonds may face some of the same litigation issues as CMBS and RMBS did after the crash.
Potential litigation would likely center on questions about representations and warranties regarding the creditworthiness of the renters and the value of the homes.
Renters are not necessarily the best long-term prospects, Gizer said, and a standard will have to be set for which properties — and therefore which renters — to include in securitized pools.
The value of rental income can be volatile as well. On Wednesday, Morningstar Inc. released data showing that collected rents fell 7.6 percent during the last quarter of 2013, though it noted there were more lease renewals than expected.
Those looking to follow Blackstone’s lead will have to take these things into account and be particularly careful when vetting investments.
“I would expect, or hope, that if they’re going to go forward and this becomes a popular type of investment, that the due diligence provided is going to be more thorough and the types of rental contracts that get thrown into these pools are going to be lower-risk,” Gizer said.
The homes themselves may also be subject to condemnation or landlord-tenant litigation that could encumber the overall loan indirectly by affecting the value of the collateral, according to David Reiss, a real estate finance professor at Brooklyn Law School.
Before the recession, single-family homes were considered too expensive to be managed by a large institution like Blackstone or American Homes 4 Rent because of their geographic diversity and because it was hard to control property management on so many different homes, according to Reiss.
The financial crisis made distressed single-family homes cheaper and more attractive to opportunistic investors, and the low price may compensate for the other issues, he said.
“This is a new asset class, and it is not yet clear whether Blackstone has properly evaluated its risks,” Reiss said. “Time will tell whether these bonds will become a significant new category of asset-backed securities or whether the financial crisis presented a one-time financial opportunity for some firms.”
So far the results have been positive, though the ratings agencies have yet to comment on the decline in rental revenues in the third quarter. Morningstar, Kroll Bond Ratings and Moody’s Corp. all surprised the market last year when they upgraded Blackstone’s deal to Triple A from the expected A-. Analysts said this upgrade was thanks to the conservative nature of the deal’s structure, which focused on legal protections for individual homeowners.
Some lawmakers and regulators have called for measures to ensure that future deals are equally protective.
Rep. Mark Takano, D-Calif., recently asked the House Financial Services Committee to hold hearings to determine how single-family rental bonds might harm or benefit the housing market. And some experts have called for a review of the covered bonds guidelines issued in 2008 by the Treasury and the Federal Deposit Insurance Corp., as well.
The guidelines’ definition of an “eligible” property may need to be updated, and issues may arise with regard to the need for revolving rather than static pools in order to address REO-to-rental- backed bonds, according to Susan E.D. Neuberg of Edwards Wildman Palmer LLP.
These changes could further encourage the creation of these bonds, which Neuberg emphasized are not the no-income-verification, 95 percent loan-to-value, variable interest rate mortgages of the pre-crash era.
“These are not your grandmother’s RMBS bonds,” she said. “Inherently, the risk lies with the quality of the underwriting.”
–Editing by Kat Laskowski and Philip Shea.
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