American Homes’s Long Bonds Delay Risk: Corporate FinanceJody Shenn
American Homes 4 Rent, one of a new breed of Wall Street-backed landlord, won over investors with bonds that let it use their money to boost its profits for twice as long as the rest of the industry.
The company, which owns dwellings in at least 22 states from Arizona and California to Indiana and North Carolina, sold $488 million of notes this week that are backed by some of its 29,000 houses. The 10-year term compares with a maximum of five on eight similar deals since November.
The longer due date helps postpone what Fitch Ratings warns is a heightened refinancing risk facing the new type of securities, and a 1 percent annual paydown on the principal may make it easier to roll over. The bonds from Agoura Hills, California-based American Homes represent a “win” for the industry and possible template for future borrowings, Arlington, Va.-based investment bank FBR & Co. said.
“It’s different than prior transactions and clearly better,” Dan Chambers, an analyst at Fitch, which hasn’t graded any of the offerings, said in a Sept. 10 telephone interview. While the firm still wouldn’t have given the notes the rankings offered by competitors, which went as high as AAA, the transaction “mucks with our argument a little bit.”
American Homes Chief Financial Officer Diana Laing didn’t respond to phone calls seeking comment. The company’s shares have climbed 9.5 percent this year to $17.74 as of 10:40 a.m. in New York, returning 10.5 percent with reinvested dividends.
As the worst U.S. housing slump since the 1930s wound down, private-equity firms, hedge funds and real-estate investment trusts began scooping up properties to rent out, creating landlords led by Blackstone Group LP’s Invitation Homes and American Homes, which was founded by self-storage billionaire B. Wayne Hughes and went public last year.
Renting out single-family homes was a mom-and-pop business, with large landlords limited to apartment buildings, which are easier to manage. American Homes offers dwellings including an $850-a-month rental in Sahuarita, Arizona, and a Vero Beach, Florida, home at $3,125.
By bundling loans on such properties into bonds of varying risks -- a process known as securitization -- the institutional landlords are recouping much of the cash they put up buying and improving homes, and getting a chance to earn higher returns on the capital still invested. The deals, whose defaults wouldn’t push the operators into bankruptcy, total $4.9 billion.
American Homes spent $701 million on the almost 4,500 houses valued by brokers at $750 million that backed its offering, according to Kroll Bond Rating Agency, which graded the notes as high as AAA. The bonds pay 4.4 percent on average.
The debt helps push up the landlord’s annual returns on the properties to 10.5 percent at current rents and projected expenses, Keefe Bruyette & Woods Inc. analyst Jade J. Rahmani said in a report, calling the deal “a significant milestone.” That’s up from about 6.5 percent without the leverage.
The deal, the first to include a fixed-cost loan, will minimize interest-rate risk, FBR analyst Steve Stelmach wrote in a note to clients. Earlier floating deals included derivatives to avoid runaway borrowing costs over their terms.
American Homes first used the securitization market with a $481 million transaction in May. That deal came due in two years, with three one-year extension options. Other offerings used that structure or three-year terms with two extensions.
Moody’s Investors Service and Kroll have said they are comfortable assigning top grades to large portions of the deals because in a default, the value of the underlying properties would be more than enough to repay the notes. The classes repaid first in the American Homes deal represent 42 percent of the stated value.
If issuers can’t repay the bonds when due, a replacement manager takes over and may sell properties in bulk or one-by-one. Final legal maturities, the focus of credit ratings, are usually 12 years after the point at which that process would start, according to Navneet Agarwal, an analyst at Moody’s.
“They don’t have to conduct a fire sale,” he said in a telephone interview. “It’s a pretty long period to realize the value. People under appreciate that fact.”
Kathleen Kennedy, a spokeswoman for Kroll, declined to comment.
Fitch differs with Moody’s and Kroll on repayment depending on foreclosures, Chambers said. Issuers will probably find refinancing difficult because of the large amount of debt relative to the cash generated by the property pools, he said.
“Would you make a loan that you knew couldn’t be refinanced, and as a rating agency, would you rate it?” he said. “Highly rated investment-grade bonds shouldn’t be predicated on a repayment limited to foreclosure. There should be a plan A.”
A measure known as the debt yield for the American Homes deal is about 6.6 percent after adjustments, and it would be about 7.4 percent after 10 years, he said. While better than the 4 percent on the last Invitation Homes offering, that’s below the ratios in apartment-building deals such as about 9 percent on recent Freddie Mac offerings, he said.
The metric -- net cash flow divided by total debt -- reflects the maximum interest rate on borrowing that could be serviced without any cushion for a lender or principal payments required. Fitch estimated in a statement this month that the Invitation Homes deal could only bear a rate of 0.02 point if lenders demand those latter items.
Only three of the earlier transactions required principal amortization, according to Kroll.
Any increase in borrowing costs fueled by inflation is likely to come with rising rents, Agarwal at Moody’s said. At the same time, longer terms bring new risks as well as benefits. They create more time for unexpected jumps in expenses or economic slumps to leave properties producing too little cash to cover regular payments, he said. On the other hand, there’s a chance to “ride out” troubled periods before maturity.
“In the highly unlikely event of default, particularly given the current economic outlook, loans would be extended and reworked,” Denise Dunckel, a spokeswoman for Invitation Homes, said in an e-mail. The replacement managers “would be highly inclined to avoid fire sales of the assets and instead keep the homes operating as is to maintain the income.”
(An earlier version of this story was corrected because it misstated the state in which one of the rental properties was located.)
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