When real estate is bought with all cash, buyers have a lot more flexibility and are able to take many more shortcuts. When Wall Street funnels billions into securitized bonds this becomes real power. The fact is that few main street buyers do all cash deals. Whether they are buying their primary home or investing in a rental house, Joe and Jill Q. Public, by far, make up the backbone of the residential real estate business. Their mortgages are also dependent on a professional appraisal supporting the value of the property. The general mortgage market and the market giants (Fannie and Freddie) in particular demand professional appraisals back Main Street purchases.
So why is Wall Street different? Blackstone Group LP’s Invitation Homes is the largest private equity landlord in the country with some 120,000 rental homes backed by $15 billion in bonds issued on Wall Street since 2013. Blackstone is not alone. There are many more not-so-small Wall Street investment institutions in the business. These private equity funds bloomed during the foreclosure crisis with the belief that if the government (Fannie and Freddie) was selling, they wanted to be buying.
Today, Fannie Mae is guaranteeing the income of all but the bottom tranches of Blackstone’s latest rental securitization. The mission of these government-backed agencies is enabling home ownership (Main Street). Not to, again, give ‘too big to fail’ financial institutions another ‘loss avoidance’ or undeserved ‘deliver on promised returns’ exit strategy.
Enter the SEC, which has opened an investigation into whether bonds backed by single-family rental homes and sold by Wall Street’s biggest residential landlords used overvalued property assessments. The investigation focuses on the use of Broker Price Opinions (BPOs) instead of appraisals. In March, the SEC sent letters to several Wall Street registered companies that provide BPOs. Disclosure of these letters began emerging through regulatory filings in May.
The BPOs were used for determining fundamental financial calculations such as the market value, how much rent to charge, the deal risk, as well as how much investors can expect to recover if the secured bonds go south. The appraisal process that Main Street must use was seen as too costly and time consuming. A BPO is a less rigorous way to evaluate what a property is worth than an appraisal.
Many industry experts consider BPOs overly optimistic compared to full appraisals. In fact, some bond graders applied discounts to bonds that were based on BPOs. For example, Moody’s Investors Service applied a 15 percent discount when grading a transaction last August, citing inherent risks of using BPOs on residential properties instead of appraisals.
Consider the drive-by BPO. A glaring difference between an appraisal and a BPO is the drive by valuation. These are BPO value estimates done from the curb without entering the home. No consideration is given to if the house has a 1970s modeled kitchen and bathroom to say nothing about if the interior walls and fixtures are even intact.
In an April securities offering of about $944.5 million, one major provider (Green River) submitted BPOs that relied on ‘drive-by’ evaluations. As stated in a deal prospectus issued by Fannie Mae, these homes were “assumed to be repaired and in good condition”. As a Main Street investor, would your mortgage insurer accept that assumption?
But why should Main Street care? After all, once Fannie Mae (taxpayers) pays out their guarantee, Main Street buyers will help Wall Street recover their earned losses by paying top dollar as these houses coming up for sale during a period of tight inventory. This helps explain where the foreclosure ‘shadow inventory’ went to.
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