Sunday, February 23, 2014

Why Blackstone’s Bet on Single-Family Home Rentals Will Probably Turn Out Badly

From Bloomberg:
Rents collected on the collateral for the first U.S. rental-home securities declined by 7.6 percent from October to January, according to Morningstar Inc.

There’s a lot of cash sloshing around the economy’s gas tank right now, even though we’re not moving anywhere very fast. Blackstone deployed some of their low interest-rate funds to snap up single-family homes in certain areas, to rent out (sometimes to the freshly homeless who got caught up in the last housing bubble). The private-equity firm then bundled a bunch of the rental streams into a securitization.

Overall, this is a win for banks trying to offload foreclosed inventory or for short sellers who want to dump a home Blackstone wants to buy. But it’s a lose in many other ways.

Why is turning former middle-class neighborhoods of homeowners into FOR RENT zones not such a good thing? Let us count the ways.

1. Renters tend to be more transient. Anyone buying a house will prefer to live in a stable, well-anchored neighborhood of homeowners and will likely discount the value of a home in any of these FOR RENT areas.

2. Renters naturally won’t care about the property the same way as an owner does. They may be less likely to repaint the exterior when it needs it. Or they may not be as attentive about maintenance issues. Or they may not care about picking up that junk on the front lawn.

Not that renters are pigs (I’m one myself, in the city). But there’s a difference between how you take care of something you own and something you rent. From a management standpoint, the impact will be a magnitude bigger than with apartments, which are smallish, contained boxes sharing a common roof and exterior walls. An apartment building of 50 units is simpler to take care of than 50 houses flung over half a town.

3. In the suburbs, renters tend to be poorer people, sometimes living hand-to-mouth. When a neighborhood turns into largely FOR RENT units, it will drag down property values, because, all things being equal, people will display a bias toward living in more stable, well-to-do areas (that they will associate with better schools, better people, etc.). NOTE: I’m not saying this is a fair bias, just that it exists.

Why is this a lose for the investors in such companies?

1. This is a novel strategy. As the Bloomberg story suggests, this idea may prove to be a flop. Why has no one ever tried doing it before on such a broad scale? If your response includes the phrase “a lack of securitization vehicles,” then you might want to go back to Financial Crisis 101 and ask yourself if that’s a good thing that securitization is helping make this trend possible. Remember those CDOs of 2008?

2. What’s the exit strategy? Getting out from underneath 10,000 homes isn’t quite the same as selling your unsuccessful tire-making business to a competitor and walking away. Anything resembling dumping homes on the market will seriously depress values in these places -- creating a lot of local enmity as well as severely eroding the value of these investments.

3. The ironic Catch 22: To operate with the most efficiency, Blackstone (and others trying to capitalize on the Homes for Rent trend) will want to buy up clusters of homes. But in doing so, as Yves Smith notes at Naked Capitalism, the firms will depress rents in those areas. This inherent conflict suggests scalability of these operations is a problem.

4. Are these houses that private equity outfits are buying such a great deal anyway? Once interest rates rise, prices could stiffen, even fall, in the housing market. Personally, I think the underlying economy is a lot weaker than the numbers, pumped up by years of Fed easing, would indicate. And even with all the Fed QE, median incomes are stagnating. This can’t be a good thing if we want a vibrant, healthy economy.

5. Bad PR. We’ve already seen how that works with Magnetar’s housing play in Huber Heights, Ohio. A big Wall Street landlord will galvanize a pissed-off citizenry (and attract tons of media) like nothing else, hampering a company like Magnetar’s effectiveness at arguing for things like (perhaps rightly deserved) property tax reductions.

If the misery index ever does spike again in the housing market, the last place I’d want to be in is that of a Blackstone, sitting on an inventory of thousands of homes, niggling with towns over their property tax burden, just as the public starts looking for people to hang from the lamp posts.