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Single Family Homes Become an Asset Class

Tuesday, July 31st, 2012

It’s a sign of the times. Single-family homes, as distinct from mortgages, are an emerging asset class. For decades, investors have bought home mortgages in securitizations or as whole loans. Individual investors have built a cottage industry owning small numbers of rental homes. Institutions have been buying commercial real estate in various forms. Public and private REITs allow investment in various real estate asset classes in ways that improve liquidity, remove operational involvement and with more geographic and other risk diversification. What investors lack is a vehicle to own single-family homes that is analogous to single-family mortgages. And they’ve certainly not had the ease of a REIT structure through which to own those homes.

The Single-Family Challenge

Finance attracts a lot of clever people. So why haven’t structures been built to drive institutional ownership of homes? Until recently there have been good reasons (surely you would not think otherwise).

On the demand side, barring one year in the early 1990s, housing prices nationwide rose every year until 2007. Still, single-family homes did not score well as value in the investment sense. If anything at times they were a growth asset. And there were easier ways for investors to buy into growth than owning physical title. Homebuilder stocks, home improvement stocks or some of the late and unlamented mortgage companies were easier to trade and own. Times change and single-family homes are now arguably a value asset, even deeply undervalued depending on their location.

The Growth of the Rentals

Foreclosures and lower credit have made renters out of most former and many prospective homeowners. The renter culture has entered the single-family home market. What the small investor has known for years – that one can own a home and rent it out – has become much more economically viable. We need investor-owners for huge numbers of houses that owner-occupants are unable to buy. Even CoreLogic’s conservative estimates put the number of homes in shadow inventory at close to 2 million homes. Individual investors simply can’t absorb them all while we wait for the owner-occupant to come back. Institutions need to enter. We need to make investing in homes easy and very much in our society’s best interest.

Besides perceived value, institutions have not bought single-family homes because they are difficult to acquire at scale while controlling risk. Buying or selling a home is a byzantine process, reliant on hard copy forms, faxes and even a thumb-print identification to avoid fraud in some jurisdictions.  Buying a handful of houses is easy; buying hundreds, thousands or hundreds of thousands of houses is exceptionally hard because one has to combine the desire for bulk transactions with the reality of closings scheduled one home at a time. But that combo is needed today as homes incrementally transition from distressed ownership to rentals. One can always buy vacant homes in bulk but then the purchase price would reflect the quality of the asset and its rentability. Both seller and buyer would need quite a lot of information to have useful price discovery – that’s unlikely. Experiments out of Washington are helping with supply of homes but we are a long way from doing what’s best for the country and the housing market.

Another impediment to institutional homeownership is the operational complexity of managing residential real estate that is horizontally dispersed rather than vertically stacked (like apartments). Horizontal is harder in some ways than vertical but less risky in others. Besides, a nation that built the Google search algorithm can figure out how to manage homes.

Enter the REITs

As institutions look at single-family home rentals with asset value and cash flows, they want simplicity of ownership. The REIT structure makes a lot of sense. A REIT can own homes just as well as it can own other real estate. A broadening equity-market investor base wants the same: the economics of a rental home minus the operational involvement. The development of the REIT market tells us that REITs are a smart way to structure single-family home investment as those investments grow.

Public or private REITs can also help buyers obtain liquidity. Public REITs alone represent $525 billion in public market capitalization. Homes can be brought into a REIT; markets can be accessed for both equity and debt, with property management contracts attached. Capital can be allocated more efficiently. As a by-product we will see the creation of a new(-ish) industry that professionally manages homes at scale.

RMBS for Rental Homes?

The US financial industry being what it is, the “S” word – Securitization – is not far behind talk of a new asset class. To be fair, not all securitization is bad, the basic structure of mortgage backed securities was a fantastic innovation that institutionalized mortgage investing, reduced geographic and idiosyncratic risk etc. etc. It did not end well but the fundamental insight made mortgages affordable for a generation.

Could something similar happen in the single-family home asset class? Could rental homes be packaged into securities and sold off, maybe as REITs with financial and operational constraints but tax advantages or maybe through some other structure? I believe so. More importantly, to tackle the problem of homes with distressed mortgages, where new owner-occupant buyers are scarce, where investors need to step in to avoid the blight of a foreclosure, it better happen. Because the housing market needs all the help it can get.

Interestingly, such structures don’t need the government to do much, other than continue the tax advantage of REITs.

A number of groups have formed private REITs, rating agencies are talking about the unique issues in forming and rating single-family REITs. Nothing insurmountable, but rating agencies are going to need to evaluate the home acquisition, rental operations and property management processes of REITS seeking ratings.

Housing is a basic consumption good. It can be owned or rented. Home ownership is embedded deep within our national psyche. But the need for shelter is even deeper. People going through a foreclosure eviction need to live somewhere. Living with family or friends is not a long-term solution. These folks will need to rent as buying may be out of reach for financial or credit reasons, or may be (temporarily) unappealing.

REITs and simple securitizations can make homes much more attractive to institutional and individual investors. These homes would otherwise enter foreclosure, burden neighborhoods and signal the dysfunction at the heart of the current housing market. Securitization run amok hid the risks in our housing market. Within the cause of housing’s meltdown are the possible seeds of its rebirth. Securitization may yet save us.

Jafer Hasnain is co-Founder of Lifeline Assets, one of the first private equity firms in the country to invest exclusively in single-family homes. Information at

Foreclosure Crisis Requires Creative Thinking

Monday, October 25th, 2010

As of the end of September 2010 seven million mortgages were 30+ days late on payments. As I caught up on my New York Times reading over the weekend, I was struck by how consuming an issue this foreclosure legal mess has become.  It is on the front page, on the Op-Ed page and on the inside.  Well summarized in newspapers and well noted in the blogosphere.

This issue has progressed beyond the economic or financial and has become a political issue.  The fact that one of the most populist presidencies in recent memory has publicly stated their views on the mess (no need to halt foreclosures in a blanket fashion – which is sensible) and has been publicly opposed by all 50 states’ attorneys general is remarkable.  The group of state AGs includes people of all political stripes.  They have made it a political issue.  We read about it in the papers.  We hear confirmation of it in the market from our partners in the foreclosure industry.  In contrast to their thinking a few months back, banks today are desperately seeking a way to avoid foreclosure and a way to retain some homeowner dignity so they don’t turn around and make life miserable for banks.

This particular issue of robo-signing of foreclosure papers is one of those watershed events that historians refer to.  It changes the urgency of the debate.  The seemingly technical problem resonates with people in a way that other types of mortgage fraud do not and is evidence of the anti-foreclosure pushback out there.  This issue does not go away.

Yet no one wants a blanket “amnesty” on mortgages via a nationwide reduction in mortgage principal balance and a lowering of rates, as that rewards bad behavior, and the number reach to the many trillions.  We can’t reward bad behavior by accepting arguments to give all borrowers an amnesty with lower rates, principal forgiveness or both.  Some yes, all no.  But something must be done.  Punish, if you will, poor financial judgment on behalf of the lenders, the borrowers and the markets, but let us avoid bringing down the economy simply to “let the market clear”.  The market solution, a foreclosure, is often a dysfunctional outcome, especially today, when so many foreclosures are expected to occur.

The numbers are staggering.  As of the end of September 2010, according to Lender Processing Services, seven million mortgages were 30+ days late on payments, over two million had foreclosures that had commenced, and over four million were in default pre-foreclosure, with over two million of those 90+ days late.  Foreclose on a small number of homes, and the market and society can absorb the hit but when foreclosures become the norm in places, then the market seizes up and society cannot absorb the resulting economic and family displacement.

Think back to late 2008.  The expectation in the market was that housing would get worse but that the Fed would lower borrowing rates, that some combination of foreclosures and delaying recognition of lender losses would fix the problem.  What happened?  The lowering of rates and pumping in of liquidity has given rise to excess liquidity in parts of the housing market where it is not needed (note exceptionally low mortgage rates for those who qualify), and a complete rationing of credit where it is desperately needed (note how hard it is to actually get one of those mortgages).  Existing foreclosure and pre-foreclosure programs have not worked.  A number of us explicitly stated that serious, scalable and fair foreclosure alternatives had to be adopted that could solve the problem of people with job insecurity in homes with negative equity.  The solutions we saw in the marketplace gave us a sense that would prove insufficient and were poorly implemented.  We were right.  That annoys me.

This should be — and is — a time for some creative thinking.  This is the issue of today.  It is more immediate than deficits, trade and even the securities markets.  This hits us directly through an asset that is typically our largest “investment”.  Smart solutions, and there are a few out there, will strengthen the American Dream.  Conventional answers will not.  As concerned citizens, we should not accept intellectual inertia on this issue.

S. Jafer Hasnain is a Managing Partner of Lifeline Assets, a Chicago-based real-estate private equity firm which he co-founded in 2008.  Mr. Hasnain was previously a portfolio manager and analyst at AllianceBernstein for 14 years, with stints at Merrill Lynch, Citibank and Goldman Sachs prior to that.

Lou Dobbs Is Wrong: America’s Melting Pot a Job Creation Engine

Tuesday, December 29th, 2009

Job-creation research proves that Lou Dobbs is wrong about immigrants’ impact on the United States economy.  Lou Dobbs’ resignation from CNN after 27 years  has led to speculation about his future plans — whether in politics or a possible move to Fox News.  Dobbs, known for his controversial opinions on immigration, went so far as to question the validity of Barack Obama’s Hawaiian birth certificate and suggested that the president was actually born in Kenya.

Countering Dobbs’ divisive opinions, recent research has found that thousands of immigrants who come to America looking for work end up starting entrepreneurial businesses, some of which employ thousands.  Consider these statistics from a study by the U.S. Small Business Administration:

  • Approximately 1.5 million immigrants own their own business, generating $67 billion in annual revenue.
  • In Illinois, 14.5 percent of all businesses are immigrant-owned; approximately 28 percent of the state’s engineering and technology companies were started by immigrants, according to a Latino Technology Alliance study.
  • Immigrants are 30 percent more likely to start business than native-born Americans, according to the SBA study cited above.
  • Businesses owned by immigrants are more likely to have paid employees.

One example is Jai Shekhawat, who left India to pursue a corporate career in America.  After stints at Burroughs Corp., Syntel, Inc., and McKinsey & Co., Shekhawat started Quinnox, Inc., a Naperville-based IT outsourcing company.  Later, he started Fieldglass, Inc., a Chicago business that has yearly revenues of $30 million and employs 150, primarily in the metropolitan area.  In addition to India, entrepreneurs who have started successful Chicago-area businesses include immigrants from Ukraine, Greece, Ireland, Poland, Nigeria and Ethiopia.

S. Jafer Hasnain is a Managing Partner of Lifeline Assets, a Chicago-based real-estate private equity firm which he co-founded in 2008. Mr. Hasnain was previously a portfolio manager and analyst at Alliance Bernstein for 14 years with stints at Merrill Lynch, Citibank and Goldman Sachs prior to that.

Fannie Mae Program Seeks to Keep Families in Their Homes Rather than Foreclose

Monday, November 30th, 2009

03how1_583Homeowners facing foreclosure will soon be able to rent their homes from the government controlled Fannie Mae. Called Deed to LeaseTMthe program lets homeowners transfer ownership of their home to Fannie Mae. They then sign a one-year lease, with the option of month-to-month extensions available.  Fannie Mae will try to sell the homes during the year-long rental period.

In the first half of 2009 Fannie Mae took about 57,000 homes into foreclosures which became REO. In the same period they did about 1200 deed-in-lieu of foreclosures but those borrowers didn’t rent the homes back. It is likely that a significant percentage of potential foreclosures which cannot enter loan modification will be eligible for the D4L program as the requirements on credit quality are quite lenient.

According to Jay Ryan, Fannie Mae vice president, “The Deed to Lease Program provides an additional option for qualifying homeowners who are facing foreclosure and are not eligible for modifications.  This new program helps eliminate some of the uncertainty of foreclosure, keeps families and tenants in their homes during a transitional period, and helps to stabilize neighborhoods and communities.”

Deed to Lease serves borrowers who are unable to qualify for a loan modification, but still want to remain in their homes.  To qualify for the program, the owners must live in the home and offer proof that they can afford the market rent, which is determined by a third-party company hired to manage the properties.  The rent must be less than 31 percent of the resident’s pretax income.

This program is a major step towards acceptance of rentals as a solution to the overhang of potential foreclosures in US single family residences. It recognizes that keeping families in homes that they had chosen to live in and own in the recent past is healthy for the family, the neighborhood and the house itself.

A few things about D4L are worth noting:

  • D4L is offered for mortgages that are part of securitized pools not whole loans unless serviced by Fannie Mae so it is likely that many banks with whole loans will not be able to use the program. However, it provides banks a positive signal about a business model that turns homeowners into renters if loan modifications cannot be done. Banks should thus be more amenable to creative solutions to the looming foreclosure waves on single family residences.
  • Participation in either the D4L program or an internally run analogous program does not provide the bank with any incremental new capital. The bank may or may not have or want to take a hit to capital depending on whether they believe they can sell the house for its mortgage value in the future.
  • There is no borrower upside in the medium term or long term — Fannie Mae reserves the right to market the property for sale while the lease is in force but the only incentive for the occupant to maintain the house is the threat of eviction.
  • Since the transaction is a Deed-in-Lieu transaction, the bank retains the right to come after the former homeowner for a deficiency judgment in the future if the bank cannot get its mortgage value on the future sale of the house.
  • Fannie Mae will become a landlord and will need property managers. They are unlikely to build that capability in-house to the extent they don’t already have it. This is a positive development for private physical property management services as single family residential property managers will be critical to the success of the D4L program.

The broad implication is positive as the program validates our company, Lifeline’s, rental and property management model as well as the social desirability of keeping homes occupied, ideally with its former owners.

S. Jafer Hasnain is a Managing Partner of Lifeline Assets, a Chicago-based real-estate private equity firm which he co-founded in 2008. Mr. Hasnain was previously a portfolio manager and analyst at AllianceBernstein for 14 years with stints at Merrill Lynch, Citibank and Goldman Sachs prior to that.

Don’t Want to Buy Distressed Assets? Then Try Insuring Them

Thursday, September 17th, 2009

Warren Buffett’s Berkshire Hathaway has started selling insurance coverage on foreclosed homes occupied by distressed borrowers with the goal of making money from banks hurt by the mortgage market collapse.  These policies are riskier than usual home coverage because the properties may be neglected or vandalized.

“It’s part of the standard practice of Berkshire, which is to respond opportunistically,” said Tom Russo, a partner at Gardner Russo & Gardner, which owns shares in Berkshire.  “They have the capital to act and the credibility.”

mp_main_wide_warrenbuffett2Buffett, whose Berkshire Hathaway has $24.5 billion in cash, cut back on coverage of large commercial properties against catastrophes like hurricanes when the recession started and demand fell.  The home insurance venture positions Omaha-based Berkshire Hathaway to benefit from the supply of foreclosed properties that has grown fourfold in three years.  Because Buffett came through the subprime crisis in good shape, he has been able to increase his holdings in companies hurt by the recession in markets where demand is growing.

Berkshire Hathaway’s expansion in the area of foreclosed and distressed property insurance is noteworthy.  What’s key is that they have been able to come up with some level of asset valuation (i.e., home price or home replacement cost) in order to be comfortable pricing such insurance.  This is a good signal which would indicate that, at minimum, smart money is comfortable with home valuations at some level, and is willing to underwrite to those values.

S. Jafer Hasnain is a Managing Partner of Lifeline Assets, a Chicago-based real-estate private equity firm which he co-founded in 2008. Mr. Hasnain was previously a portfolio manager and analyst at AllianceBernstein for 14 years with stints at Merrill Lynch, Citibank and Goldman Sachs prior to that.