The “Financialization” of Housing

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The goal was “to foam the runway” for the banks. – Timothy Geithner, former Treasury Secretary

During the frenzied run up in prices to the last market/economic/housing crash and credit crunch in ’08-’09, housing became not just a place of residence for people to live, but also a financial asset for “diversifying” one’s portfolio of assets. This was fueled through a variety of financial mechanisms, including extremely low interest rates set by Alan Greenspan at the Federal Reserve for an extended period of time, lax banking regulation and mortgage underwriting due diligence.  The main reason that this was possible was because mortgages became finanancialized or just another asset-backed security that could be easily packaged and sold to investors.

It was also aided and abetted by complex financial instruments or “products” like “credit debt obligations” (“CDO”), collateralized loan obligations (“CLO”), “credit default swaps” (“CDS”), and other complex opaque, UNREGULATED financial instruments that allowed for the packaging and selling of homeowner mortgages to investors.  The “CDS” even allowed (and still allows) investors to effectively short various pools or “tranches” of packaged mortgages by betting they would ultimately fail or default.  It was this instrument provided the rocket fuel for the crash itself.

When the housing market crashed, taking the economy and millions of Americans down with it, the government’s response was to  bail out the banking industry and NOT individual homeowners, who were left holding the bag.  The result was that millions of Americans lost their homes and had their lives upended for many years.  Although that was bad enough, that wasn’t even the worst part.  Since that time, the financial services industry, namely some in the private equity sector, have hit many of those same Americans again, by buying up millions of homes, some of them the very homes that homeowners lost because of the crash, to rent out as landlords in various key desirable areas of the country.

As a recent NY Times Magazine article, “A $60 Billion Housing Grab by Wall Street” documents, it has helped to “foam the runway” for the housing market over the past 8-9 years in general, and contributed to the housing affordability crisis in this country, among other highly negative effects for many Americans.  Here are some key excerpts from the article:

Strategic Acquisitions was but one of several companies in Los Angeles County, and one of dozens in the United States, that hit on the same idea after the financial crisis: load up on foreclosed properties at a discount of 30 to 50 percent and rent them out. Rather than protecting communities and making it easy for homeowners to restructure bad mortgages or repair their credit after succumbing to predatory loans, the government facilitated the transfer of wealth from people to private-equity firms. By 2016, 95 percent of the distressed mortgages on Fannie Mae and Freddie Mac’s books were auctioned off to Wall Street investors without any meaningful stipulations, and private-equity firms had acquired more than 200,000 homes in desirable cities and middle-class suburban neighborhoods, creating a tantalizing new asset class: the single-family-rental home. The companies would make money on rising home values while tenants covered the mortgages.

Wall Street’s latest real estate grab has ballooned to roughly $60 billion, representing hundreds of thousands of properties. In some communities, it has fundamentally altered housing ecosystems in ways we’re only now beginning to understand, fueling a housing recovery without a homeowner recovery. “That’s the big downside,” says Daniel Immergluck, a professor of urban studies at Georgia State University. “During one of the greatest recoveries of land value in the history of the country, from 2010 and 2011 at the bottom of the crisis to now, we’ve seen huge gains in property values, especially in suburbs, and instead of that accruing to many moderate-income and middle-income homeowners, many of whom were pushed out of the homeownership market during the crisis, that land value has accrued to these big companies and their shareholders.”

Before 2010, institutional landlords didn’t exist in the single-family-rental market; now there are 25 to 30 of them, according to Amherst Capital, a real estate investment firm. From 2007 to 2011, 4.7 million households lost homes to foreclosure, and a million more to short sale. Private-equity firms developed new ways to secure credit, enabling them to leverage their equity and acquire an astonishing number of homes. The housing crisis peaked in California first; inventory there promised to be some of the most lucrative. But the Sun Belt and Sand Belt were full of opportunities, too. Homes could be scooped up by the dozen in Phoenix, Atlanta, Las Vegas, Sacramento, Miami, Charlotte, Los Angeles, Denver — places with an abundance of cheap housing stock and high employment and rental demand. “Strike zones,” as Fred Tuomi, the chief executive of olony Starwood Homes, would later describe them.

For these companies, housing was again just another financial asset to monetize over time by often charging exorbitant rent prices, increases, various onerous fees, shoddy maintenance of the properties, and then packaged into financial “products” known as “REIT’s” or “Real Estate Investment Trusts”, funded by anonymous investors from all over the world:

“There’s no way of looking at the ownership of properties and understanding who owns them ultimately,” says Christopher Thornberg, a founding partner of the research firm Beacon Economics. While Invitation Homes and American Homes 4 Rent became publicly traded REITs, as far we know “the big money is still in private equity,” he says. (Progress Residential and Main Street Renewal are two such companies.) “They are completely subterranean. They’ve got multiple layers of corporations within corporations within holding companies.”

Landlords can be rapacious creatures, but this new breed of private-equity landlord has proved itself to be particularly so, many experts say. That’s partly because of the imperative for growth: Private-equity firms chase double-digit returns within 10 years. To get that, they need credit: The more borrowed, the higher the returns.

Our friends at Blackstone even created a new financial instrument called the “single family rental securitization”, a mix of residential mortgage-backed securities, collateralized by home values, and commercial real estate-backed securities, collateralized by expected rental income.  According to the article, here are some of the effects:

With the securitized homes, the rental income now needed to cover not only the mortgage but also the interest payments distributed to bondholders — creating an incentive to keep occupancy and rents as high as possible. In fact, Invitation Homes’ securitized bond model assumed a 94 percent paying-occupancy rate, putting pressure on the company to evict nonpaying tenants right away.

The growth imperative became even more urgent as the REITs began to go public. Since a rebound in the real estate market made acquiring new properties more expensive, companies looked for growth from their tenants: i.e., by raising rents, cutting down operating costs and maximizing efficiencies. In a 2016 fourth-quarter earnings call, Tuomi, the chief executive of Colony Starwood (formerly Colony American), declared that “not getting every charge that you are legitimately due under leases” — termination fees, damage fees and the like — is “revenue leakage.” In 2016, Colony made $14 million on fees and an additional $12 million on tenant clawbacks, like retaining security deposits, says Aaron Glantz, author of “Home­wreckers,” a book on the single-family-rental industry.

Maybe the worst part about all of this is these companies have found a way for the taxpayer to guarantee all of it:

Fannie Mae guaranteed a $1 billion 10-year fixed-rate loan to Invitation Homes in 2017, which was securitized by Wells Fargo. The loan is collateralized by 7,204 Invitation Homes rentals. It was the first single-family-rental loan guaranteed by a government-sponsored entity, and Freddie Mac followed suit. “Why is the taxpayer backing up loans so that they can get reduced interest rates?” said Eileen Appelbaum, co-director for the Center for Economic and Policy Research. “Why do we shift the risk to the U.S. taxpayer and create a huge windfall?” When I remarked that Fannie Mae said it wasn’t going to back any more loans, she laughed. “They won’t have to do it again! This is now an established industry.” If something goes wrong, Invitation Homes is on the hook for 5 percent of losses; the government is on the hook for the remaining 95 percent. So far, more than 10 S.F.R. companies have securitized rental debt, generating 70 securitizations totaling some $35.6 billion.

The personal stories told by some actual renters of some of these properties are also truly eye opening.  If you haven’t already done so, be sure to go read the whole article today.  My next blog post on housing with look at how monetary policy and anonymous foreign buyers have helped to juice what some believe is yet another housing bubble in the U.S.

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