Atlantic Cities

Behold: The Rental-Backed Security

Behold: The Rental-Backed Security
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You've heard, probably menacingly, about mortgage-backed securities. To quickly recap that innovation that helped undermine the American economy: Banks bundled mortgages from many homeowners, then offered slices of the resulting pool to investors in a financial product so far removed from a single homeowner that one missed mortgage payment posed meager risk.

The idea severed the traditional ties (and incentives) between a homeowner and her local bank. As a result, many people who shouldn't have become homeowners were encouraged to. And when a whole lot of them started falling behind on their monthly payments – spanning entire blocks, then whole neighborhoods – the resulting mess turned out to be chaotic to untangle.

With that history in mind, now meet the next big innovation in financial engineering: rental-backed securities.

There's a kind of ominous symmetry to their creation. As a result of the housing crisis, families who were once homeowners have shifted to renting. And properties that were once owner-occupied have, by the tens of thousands, fallen into foreclosure. The same savvy investors who brought us mortgage-backed securities looked at those two trends and saw a new opportunity: Buy up foreclosed, single-family homes, and convert them to rentals for the very people who are now averse to homeowning. Turn Wall Street, in effect, into a landlord of national proportions.

William D. Cohan wrote in the October issue of The Atlantic about the giant private-equity firm, Blackstone, that's been pioneering this model. Its Invitation Homes vowed to "professionalize" rental services (although some Invitation Homes tenants would beg to differ). The idea was intriguing. Could a national company like this be more than a slum lord? Or would this system create its own perverse incentives, forcing renters to coax repairs from an anonymous, faraway property manager?

Cohan hinted in October that Blackstone might also be weighing an additional, unsurprising move: securitizing those rent payments. Now, per The Financial Times, Blackstone is preparing this week to roll out these new securities, which constitute "the world’s first bond backed by home rental income."

From Tracy Alloway and Anjli Raval:

The sale will be closely watched by bankers, hedge funds and private equity firms, with a belief that strong demand for the bonds could give birth to a new asset class and provide a fresh source of capital to finance their purchases of foreclosed houses in the US.

That breathless anticipation is probably reason enough to give us pause. For now, it feels like rental rates are rising in many cities with no end in sight... which is, come to think of it, a lot like how the for-sale housing market felt six years ago.

Top image: Monkey Business Images/Shutterstock.com

Emily Badger is a former staff writer at The Atlantic Cities based in Washington, D.C. She now writes for The Washington Post. All posts »

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