Foreclosure-to-Rental Programs Face 'Formidable Obstacles' — Morningstar

Banks and government agencies face "formidable obstacles" with their plans to rent out their backlog of foreclosed properties, especially if they try to securitize those rentals, according to Morningstar Credit Ratings.

Both banks and mortgage investors are increasingly looking to the capital markets and securitization to help them recover from losses on soured loans. Banks holding thousands of delinquent mortgages are trying their luck renting properties to previous homeowners, then securitizing the pool of single-family rentals and selling them off. Bond investors, meanwhile, are more likely to buy vacant distressed properties in bulk, fix them up and find new renters to fill them.

But nobody really knows how the rental-based securitizations would be structured, raising many questions about whether these plans would actually work, say Morningstar analysts Brian Grow and Lawrence Kwoh. In a report published this week, they raised concerns about whether single-family rentals can be pooled together and securitized, because there is so little historical data on the newly-emerging asset class.

Grow and Kwoh also questioned how such securitizations would be structured and whether rental income would provide enough stable cash-flows to satisfy bondholders. Adding to the uncertainty is the cost of vacating, securing and repairing rental properties.

"Everybody got really excited about foreclosure-to-rental but the securitization part is a little fuzzy," Grow said in an interview. "It's not really clear what the collateral would be and what the bond structure would be. What do they do about lease turnover and who is going to rent these properties?"

The analysts say it may be difficult to manage thousands of single-family properties nationwide, particularly if repair and maintenance costs are hard to quantify.

"It's still not clear what route the market will go," Kwoh said in an interview. "Everybody is looking to figure out how to get financing."

The Federal Housing Finance Agency said it received strong interest from bidders last month for a Fannie Mae test program, which involves the bulk sale of 2,500 properties located in Sun Belt states. The FHFA first disclosed the program in December as a way to more efficiently unload real-estate owned properties.

The Federal Housing Administration this month also expanded a bulk sales program with plans to sell up to 5,000 defaulted loans each quarter.

In their report, the Morningstar analysts suggested that REO-to-rental programs may have a disproportionate impact on home prices in a local area and that returns could vary dramatically. Two-thirds of REOs are concentrated in just nine states, including California and Florida.

"It's not clear what the impact will be at the house price levels," says Grow. "Once one of these houses sells for 30 cents on the dollar, everybody will look at the values and say, 'What is my house worth?'"

Evan Gentry, the CEO of Money 360, a peer-to-peer lending service that matches borrowers with private lenders, says there has been "a lot of hype" around REO-to-rentals in the last couple of months.

"The property management side is very difficult to handle on a national basis and there are just a lot of unknowns as it relates to property repairs and how these tenants are going to perform," Gentry says.