The yawning gap between private equity landlord sales talk and what they are delivering is finally being exposed.
One of the reasons many investors have been skeptical of the way private equity firms have gone full bore into buying distressed single family homes is that property management is a hands-on business even when it’s done it the most favorable possible setting, an apartment building. Individuals who have invested in single family home rentals almost without exception report that even when they found it to be an economically attractive proposition, it was still oversight-intensive. Admittedly, there are some private equity firms who have bought rental properties who actually do seem to be targeting markets and renters in such a way that they might be able to do a decent job of property management, for instance, by buying homes where they can rehab the kitchen and bath plumbing using the same fixtures, screening tenants in person, and then inspecting the properties monthly and giving the tenants points for passing that they can convert into credits against a purchase or take in cash.
But the biggest fish in this ocean, Blackstone, is clearly taking the opposite approach, of doing as little as they can to maintain the houses and trying to fob off the responsibility onto the tenant, even when local regulations clearly prohibit it. So managing dispersed homes is no problem if you never planned to do the job in the first place.
Blackstone tries to evade this duty formally, through lease terms, and informally, by making themselves inaccessible. And because Blackstone is the largest and highest profile player in this space, they may be hoping that if enough PE landlords follow their lead, communities will accept the new finance-dictate bad standards, just as they have with foreclosure abuses.
But the difference here is while stressed borrowers were the ones that were hurt in foreclosures, and foreclosures and bankruptcies are seen as shameful event, there’s no reason for a victim of a bad landlord to be seen as unsympathetic. Moreover, deliberately negligent PE landlords like Blackstone traditionally have hurt the value of neighboring properties. If this trend continues, abused tenants and their neighbors face a common threat.
Notice that contracts that violate local law are almost certain to fail a legal challenge. In New York, which has more extensive tenant protections than other cities, landlords sometimes try to include provisions that are impermissible, like prohibiting a tenant from having a roommate. Housing court judges exhibit a bit of zeal in smacking down landlords when challenges to those leases come before them.
NC readers got early warning that this strategy in a March 2012 post, via this comment, which we flagged in later posts, from someone clearly affiliated with a PE fund:
In many markets, the maintenance obligations fall to the tenant. Grab a sample set of local real estate board form leases and you’ll find this to be the case. Moreover, while these same form leases do place the burden of capital repairs on the landlord’s side (as is the case with multi-family properties), this is an identifiable risk that can be assessed just as it would be by a skilled operator acquiring larger-scale multi-family properties. Falling trees are non-discriminatory – they will crush the roof of a single-family home and a two or three story garden-style apartment building with equal vigor. The previous run of the “for sale” cycle has created legions of well-qualified providers of ownership related services, from inspectors to repair specialists, many of whom are thrilled to raise the tenor of their operations by contracting locally and regionally on a bulk basis with professional owners. At the risk of introducing cliche, don’t overlook how frictionless the management oversight of this type of service effort has become in this age of pervasive connectivity.
We’ve been to a couple of conferences where PE landlords keep saying they’ve found these great local guys to handle the maintenance. But this sounds an awful lot like those bank servicers who hire firms to secure vacant homes….that often wind up falling into disrepair and being stripped of appliances and copper.
Doug Terpstra took issue with this cheery view about making tenants maintain their rentals:
Your perception of being able to put all maintenance responsibility on plantation tenants only goes so far. Beyond neglect, a whole lot can go wrong in a hurry from a disgruntled or distressed tenant. And even in regressive red states like Arizona, there’s a lot of legal wiggle room for a put-upon tenant who might decide to get uppity:
“The landlord and tenant of a single family residence may agree in writing, supported by adequate consideration, that the tenant perform the landlord’s duties specified in subsection A, paragraphs 5 and 6 of this section, and also specified repairs, maintenance tasks, alterations and remodeling, but only if the transaction is entered into in good faith, not for the purpose of evading the obligations of the landlord and the work is not necessary to cure noncompliance with subsection A, paragraphs 1 and 2 of this section.” (Subsection A, BTW, is quite comprehensive and affords tenants considerable leverage, including damages for untimely compliance)
Now to the update on Blackstone’s latest escapades, via some original reporting at In These Times. The article, Game of Homes, makes for good one-stop shopping if you want to get friends and colleagues up to speed on this topic. For NC readers, the first two-thirds of the article covers familiar terrain. Here are the sections that discuss how Blackstone, which is using “Invitation Homes” as its brand for its single-family rentals, is trying to evade its duties as landlord:
Antonio Hernandez, 34, moved with his family into an Invitation Homes-owned property in Chicago’s Belmont Cragin neighborhood in February 2013. He says the company has tried to shift most of the responsibility for maintenance of the home onto him….
When Hernandez began renting from Invitation Homes, he was also perplexed by a section of his lease that says he must rent the property “as is.” He isn’t the only one. In These Times obtained a copy of Invitation Homes’ lease and presented it to Mark Swartz, legal director at the tenants’ rights organization Lawyers’ Committee for Better Housing, and Kelli Dudley, director of the nonprofit Resistance Legal Clinic. Both housing attorneys told In These Times that several sections of the lease violate Chicago’s Residential Landlord Tenant Ordinance (RLTO), a longstanding document that establishes the baseline of tenants’ rights and governs most residential agreements in the city.
In response to inquiries from In These Times about the legality of the lease given to Chicago tenants, Invitation Homes spokesperson Andrew Gallina wrote in an e-mail, “Invitation Homes complies with all fair housing laws and regulations. We use standardized leases adopted by state and local real estate associations, which comply with local statutes.”
But Dudley notes, for example, that while commercial leases sometimes say that tenants have to rent a property “as is,” putting this stipulation in a residential lease “is a violation of the RLTO, which clearly places the greatest responsibility for repairs on the landlord. … [Invitation Homes] is definitely overreaching and trying to shift all the risk and the expense to the tenant,” she says. Swartz adds that the lease’s attempt to indemnify Invitation Homes for any damages, including those caused by its own negligence, violates Illinois’ Landlord and Tenant Act. He also points to several other sections of the lease that are illegal under the RLTO, including a stipulation that tenants must pay the associated fees in the event that Invitation Homes employs an attorney to enforce an eviction or collection of rent.
Keep in mind that unlike New York and San Francisco, which have strong protections for tenants, Chicago does not have a reputation of being a pinko, pro-tenant town. It’s not hard to imagine that its tenant-related laws are middle of the road. Thus Blackstone and any of the other PE players that are joining its race to the bottom in major cities are likely in violation of local ordinances. And Doug Terpstra’s Arizona example suggests that even low-density, supposedly conservative states aren’t necessarily any landlord-friendlier. I welcome comments from any readers who can give a reading as to whether their state or municipality would permit Blackstone “the tenant eats most problems” style leases.
Now this might not be as bad as it sounds if the rentals were in such super-duper shape when the tenant took occupancy that there really was no reason to expect the home to need any maintenance. But that’s not how this is playing out. Back to the article:
Hernandez also says that since moving in, he’s faced a slew of problems with the home. Most recently, he says, after Invitation Homes ignored multiple requests to fix a railing in the basement, his mother-in-law fell down the basement stairs and hit her head…
Hernandez’ experience resembles those of Invitation Homes renters in other cities who have complained that major plumbing and electrical problems have gone unaddressed for weeks or months on end, according to a report by Ben Hallman and Jillian Berman in the Huffington Post. Hallman and Berman also spoke to former Invitation Homes employees who told them that the high volume of complaints and the wide geographical distribution of rental properties amounted to a near-impossible feat for workers tasked with fielding maintenance requests. Tenants renting with Colony American Homes and American Homes 4 Rent, the two other major investors-turned-landlords, have reported similar complaints
So much for “frictionless management” and economies of scale.
And here’s how the managers evade their duties, by hiding from them:
Hernandez also says that it is difficult to reach personnel with complaints and that he
has had six different property managers over the course of his yearlong tenancy. A forthcoming report from Occupy Our Homes Atlanta and the Right to the City Alliance also found that while some Invitation Homes tenants in Atlanta are given a specific point person to relay concerns to, most receive only a phone number and are asked to communicate requests via voicemail…
While labor activists have long bemoaned Blackstone’s strategy of buying out companies and then refusing to acknowledge responsibility for worsening conditions—a problem labor reporter Josh Eidelson refers to as, “Who’s the boss?”—Blackstone’s place at the head of a housing empire may now raise a new question: “Who’s the landlord?”
Here we have one instance, in which Blackstone is telling the press, and presumably investors, blatant falsehoods about its compliance with housing regulations. The piece presents evidence on another front, the lease-up rate, where Blackstone again looks to be making misrepresentations:
Indeed, an In These Times survey of a portion of the 2,500 Blackstone-owned homes in the greater Chicago area suggests high vacancy vates in homes purchased during the past year. Using data from the Cook County Recorder of Deeds, In These Times identified approximately 200 properties in the city’s northwest neighborhoods acquired by Invitation Homes during the past year. In February and March, In These Times surveyed 50 of these properties and discovered only 17 that were occupied. Invitation Homes indicated that it may take the company six to eight months to rehabilitate and rent out properties, but declined to comment on the record about its occupancy rates. However, 24 of the properties surveyed had been acquired by Invitation Homes at least eight months prior, and half of those were still unoccupied.
Blackstone’s exit strategy appears to be rental securitizations; it launched the first deal of this type, which was heavily oversubscribed, last October. Its prospectus forecast a credulity-straining 94% occupancy rate. Standard & Poors, in a rare show of integrity (or commercial good sense) refused to rate the bonds, saying the market was too young to be able to project rental payment streams.
Blackstone burned investors; Bloomberg reported that rent receipts had fallen a stunning 7.6% in a mere three months after its deal was sold. Yet more investors appear to want to go to slaughter and buy these dubious securities out of ZIRP and QE induced desperation for return.
The high vacancy rate raises another issue: Blackstone may be withholding properties to try to move rent levels higher. This would seem to make no sense (how can the loss on vacancies be compensated for by, say, 5% or 10% higher rents on the properties they do lease?) unless you understand the name of the game is keeping the strategy looking attractive as long as possible. Rising rents, even if they are created via market manipulation, creates a positive selling point (“look at the rent increases!”) that is critical to their exit strategy. And with interest rates low, the cost of keeping the homes empty may not be too terrible.
But the problem is this strategy works only if the giant landlords hold enough rental homes in particular markets to dictate prices. Blackstone, and presumably many of its competitors, are trying to goose prices to make up for economics that are more difficult than they naively anticipated:
And while Invitation Homes rents vary widely by neighborhood and city, some studies suggest that the heavy concentration of investor-owned housing is already having a detrimental impact on affordable housing. A report from DePaul University’s Institute for Housing Studies found that the rapid growth in investor-owned single-family housing may be one factor fueling a widening gap between the supply and demand for affordable rental housing in Chicago and the surrounding suburbs, given that the median rents in single-family-home rentals are 41 percent more expensive than those in other types of rental properties, once utilities are facored in.
Moreover, as the stock of vacant homes dwindles, investor-landlords may seek to raise rents in order to pass the increasing costs of acquiring homes onto tenants, notes a February 2014 report from the Center for American Progress. The report also predicts that Invitation Homes could raise rents if overall occupancy rates aren’t being met, in order to continue making monthly payments to bondholders. “Managing portfolios of tens of thousans of single-family rental homes across the country may be more expensive than most institutional investors have planned,” Sarah Edelman, the primary author of the report, tells In these Times. “These expenses, along with increases in home prices, could put upward pressure on rents as operators try to deliver the returns on investment they have promised.”
But these landlords aren’t the only game in town. As noted, some PE landlords were being much more disciplined about their buying, rehab and tenant screening strategies. The PE landlords that set out to be higher touch and mom and pop landlords will be able to cherry-pick the better tenants, for instance, by offering longer leases (say three year; note that move ins and out are the biggest source of wear and tear on a rental). And Invitation Homes’ reputation is also getting out, so over time, only the uninformed or those with no options will rent from them. That will likely mean lower credit quality, higher turnover tenants, putting Invitation Homes in the highest-cost corner of their market.
No wonder they want to securitize these properties and get out as fast as they can. We can only hope investors will wake up to why they should avoid these deals like the plague. But given the way investors merrily bought subprime bonds during the peak of the housing bubble, I have my doubts.
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