Housing slowdown puts damper on rent-backed bonds

Published Sun, Sep 11, 2022 · 08:30 AM

SALES of bonds backed by debt associated with single-family rental housing has soared over the last 2 years, as rents climbed across the country. Now, with the housing market contracting, issuance is set to cool from record levels.

BofA Securities predicts that single-family rental (SFR) securitisations – which repackage a single loan tied to multiple properties – will fall to just US$2 billion for the rest of 2022 as Federal Reserve rate hikes send shivers across the industry.

SFRs were first launched in 2013 and issuance had been slow to pick up until last year’s credit boom, which saw a record US$18.4 billion in sales according to Kroll Bond Rating Agency (KBRA). Issuance this year seems to be following a similar trajectory, having reached US$12 billion as of Aug 22 compared to $9.1 billion at the same point last year, a KBRA report shows.

But the ratings agency sees darker times ahead for this corner of the credit market.

“The sentiment has started to change from the last 2 years, as home price growth is slowing down, and some areas are even experiencing price declines,” said Akshay Maheshwari, senior director in commercial mortgage-backed securities at KBRA, in an interview. “We expect issuance to continue, but it may be slower than the first half of the year.”

The SFR securitisation market has been around for almost a decade, having launched soon after the 2008 financial crisis, when institutional and private equity firms bought up distressed homes in areas where prices were most impacted due to the downturn, write Maheshwari and Nitin Bhasin, KBRA’s co-head of commercial mortgage-backed securities, in their Sep 6 report.

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However, sales did not really pick up until 2021, when demand for housing soared and with it home prices. As a result, issuers started attaching additional houses to their portfolios and bundling them to seek financing in the structured markets, with the help of low interest rates and thus low cost of financing. Those portfolios tend to be highly leased when the bonds are printed, according to KBRA, which estimates 96 per cent on average is leased.

Avid money managers, optimistic about the sector, scooped up the securities. Meanwhile, high housing costs, rising mortgage rates and a lack of housing supply also helped the sector as many consumers turned to rentals instead. 

“The sector has benefited from a fundamental housing supply and affordability constraints, in the backdrop of strong economic growth with increasing rents and home prices,” write Bhasin and Maheshwari. “The Covid-related disruptions did not put any downward pressure on values or rents. The sector’s stable performance during the downturn attracted more issuers and investors, which led to a rapid rise in and sustenance of higher issuance volume.”

But the tide is turning fast. In July, home prices recorded their first monthly decline in almost 3 years, and it was also the largest single-month drop since 2011, according to mortgage data provider Black Knight In August, home prices in San Francisco – one of the most expensive US housing markets – took a tumble as interest rates remained high and tech employees continued to work remotely and exit the city.

“Headwinds have been gathering with rising financing costs, uncharted inflation, elevated geopolitical risks, and increasing concerns about a general economic recession,” write the KBRA analysts.

At the same time, mortgage rates have jumped, with the average for a 30-year loan increasing to 5.89 per cent this week. It’s also costlier now to tap the structured markets for SFR transactions. A roughly US$1 billion FirstKey Homes deal issued in June paid a coupon of 4.25 per cent on the largest tranche, while the equivalent slice of a similarly sized deal from the same issuer a year ago paid 1.538 per cent.

The hot housing market has made many issuers rethink their expansion plans, said market participants. For instance, Home Partners of America, the single-family landlord owned by Blackstone, recently announced it would stop buying houses in 38 US cities, including Boise, Fresno and Memphis. Those markets represent less than 5 per cent of Blackstone’s recent activity, according to the firm. 

“We and Home Partners remain fully committed to expanding access to homeownership and continue to actively purchase homes on behalf of our residents in more than 20 of the highest growth markets in the US,” said the firm’s spokesperson in an emailed statement.

Others, such as American Homes 4 Rent and Invitation Homes, are signalling a slowdown in their purchasing pace as well, according to an Aug 26 BofA Securities note.

Money managers are also being more wary when it comes to buying up the debt.

“Everybody is being more cautious because we are at an inflection point,” explained John Kerschner, head of US securitised products at Janus Henderson Group, in a phone interview. “Home price appreciation is going to be weaker, but that doesn’t mean the market is going to implode. It just means it will slow down.”

To be sure, the SFR sector still has some upsides as the rental market – on which its cashflows rely – remains strong. Rent growth has increased at around 3-5 per cent annually over the last several years and accelerated post-Covid, notes KBRA. And it’s 12.3 per cent higher over July of last year, according to real estate listing site Realtor.com. Still, growth has started to decelerate, with median rent across the 50 largest metropolitan areas in the US going up by only US$3 from June to July, reaching US$1,879, according to Realtor.com data.

“We are watching rent trends closely, but we are constructive on the sector as people can’t afford buying a single-family house now,” said Kerschner. BLOOMBERG

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