Issuers of securities tied to U.S. rental homes will struggle to obtain ratings above the lowest investment-grade tier from Moody’s Investors Service unless they choose structures with higher expenses, a potential setback to property buyers led by Blackstone Group LP.
The bonds would be safest if backed by mortgages on each individual property, rather than secured by a trust that owns a pool of homes, the New York-based ratings firm said in a report. That’s partly because the trust may be ensnared in a bankruptcy filing by the company that created it, potentially exposing bondholders’ collateral to claims by other creditors.
The bankruptcy scenario creates a “low-probability, but high-severity risk” for those structures, which some potential issuers have approached Moody’s about using, Yehudah Forster, a senior credit officer, said yesterday in a telephone interview.
Blackstone, Colony Capital LLC and Pine River Capital Management LP’s Silver Bay Realty Trust Corp. were among firms accelerating their purchases of homes to offer as rentals in 2012, helping halt a five-year slump in values. Transactions involving investors jumped 75 percent in November from a year earlier in 25 metropolitan areas tracked by Radar Logic Inc. as total sales rose 7.6 percent, the analytics firm said this week.
The use of securitizations to boost returns with borrowed money and extract cash may aid the transformation of a market once dominated by small buyers into a new institutional asset class that, according to JPMorgan Chase & Co., may reach $1.5 trillion. Blackstone, which has spent more than $2.5 billion on 16,000 homes, is already using other financing, a credit line from Deutsche Bank AG opened last year.
Ratings companies began commenting last year on how they would approach assessing potential securities backed by rental homes, a market fueled by the foreclosure crisis they helped create by granting inflated grades to mortgage bonds.
Moody’s said in August that items including a dearth of historical data on the business could make it difficult for issuers to obtain the grades they seek.
In its report today, Moody’s said it wouldn’t offer its “highest ratings” to deals backed by “equity” structures, rather than individual mortgages, also because they would offer less protection against “unauthorized sales” of homes and new liens.
Adding mortgages on individual properties carries costs to create and register the loans, Moody’s said. In New York City, for instance, the tax associated with a $500,000 mortgage is more than $10,000, the firm said.
Bonds from low- or unrated sponsors seeking to avoid those expenses will need to allow for “significant third-party oversight” to achieve ratings in its lowest investment-grade tier of Baa, Moody’s said. “Highly rated sponsors have the ability to achieve higher ratings even with an equity structure because of the reduced risk of a sponsor bankruptcy.”
While issuers may choose to not to tap Moody’s for grades, Fitch Ratings said in August that it’s unlikely to grant ratings in its top AAA or AA categories to deals tied to rental homes.
It cited the “limited performance data for the sector and individual property management firms” as well as for “market rents, rent roll histories, vacancy rates, and supply and demand.” The “ambitious growth strategies by regional operators looking to expand their portfolios rapidly over the near term” is another concern, New York-based Fitch said.
Individual mortgages aren’t the only way to protect securitization investors from a sponsor’s bankruptcy, said Steve Blevit, an attorney at Sidley Austin LLP who represented Deutsche Bank as it extended a $600 million credit line to Blackstone in October.
“The Moody’s analysis is good as far as it goes,” Blevit,
who’s also working on rental-home securitization plans, said in a telephone interview from Los Angeles. “But it fails to take into account additional legal structuring that leading players in the industry are planning for these types of transactions.”