Housing Slowdown Puts Damper on Rent-Backed Bonds
Sales of bonds backed by debt associated with single-family rental housing has soared over the last two years, as rents climbed across the country. Now, with the housing market contracting, issuance is set to cool from record levels.
BofA Securities Inc. predicts that single-family rental (SFR) securitizations -- which repackage a single loan tied to multiple properties -- will fall to just $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 $18.4 billion in sales according to Kroll Bond Rating Agency. Issuance this year seems to be following a similar trajectory, having reached $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 two 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 securitization 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 Sept. 6 report.
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% 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 three years, and it was also the largest single-month drop since 2011, according to mortgage data provider Black Knight Inc. 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% this week. It’s also costlier now to tap the structured markets for SFR transactions. A roughly $1 billion FirstKey Homes deal issued in June paid a coupon of 4.25% on the largest tranche, while the equivalent slice of a similarly sized deal from the same issuer a year ago paid 1.538%.
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 Inc., recently announced it would stop buying houses in 38 US cities, including Boise, Fresno and Memphis. Others, such as American Homes 4 Rent and Invitation Homes, are signaling 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 securitized 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% annually over the last several years and accelerated post-COVID, notes KBRA. And it’s 12.3% 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 $3 from June to July, reaching $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.
Relative Value: AAAs
- Tracy Chen, portfolio manager at Brandywine Global Investment Management, recommends looking at the AAA tranche across structured products, such as collateralized loan obligations, non-qualified mortgage bonds and asset-backeds. They are looking cheaper than lower-rated investment-grade corporate bonds, she said
- Chen likes subprime auto ABS over non-QM bonds, as auto loans tend to have higher priority of payment than mortgages
“Demand is very, very strong still in the labor market. We’re still printing new payroll job numbers at a high level, wages are running at elevated levels,” said Federal Reserve Chair Jerome Powell in remarks at the Cato Institute’s monetary policy conference in Washington. “By our policy interventions, what we hope to achieve is a period of growth below trend, which will cause the labor market to get back into better balance, and that will bring wages back down to levels that are more consistent with 2% inflation.”
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