George Smith Joins S-F Rental Experiment

The concept of pooled single-family rental housing has been slow to catch on in the months since the government launched its official program for distressed assets, yet real estate companies and financiers are increasingly finding ways to get involved with the housing.

The concept of pooled single-family rental housing has been slow to catch on in the months since the government launched its official program for distressed assets, yet real estate companies and financiers are increasingly finding ways to get involved with the housing. In September, George Smith Partners announced it had arranged financing for several pools purchased by an entity known as 29th Street Capital in the Sacramento area. The properties that are being acquired were foreclosed on and then purchased through trustee sale auctions.

“We see this market as one that will likely grow for the next few years, and it will be interesting to see if this becomes a greater trend, where you have neighborhoods built with single-family homes all managed professionally,” said Malcolm Davies, senior vice president at George Smith Partners, a national real estate investment banking firm based in Los Angeles.

The Federal Housing Finance Agency launched its REO to Rental program in February, with an initial focus on real-estate owned property in the hardest-hit metropolitan areas. In April, the Federal Reserve issued a policy statement offering guidance for banks interested in renting foreclosed-on properties, further extending the possibilities.
In one recent deal, private distressed real estate buyer The Cogsville Group L.L.C. snapped up 94 single-family homes in the Chicago area that were part of Fannie Mae’s pilot sale out of the FHFA REO initiative.

So far, single-family rental properties are offering returns that are 200 to 500 basis points higher than those on traditional apartments, generating a more generous investment yield, according to Davies. And with demand for rentals growing as people favor them over owning their own properties in the continued volatile economy, demand seems likely to grow. According to the National Multi Housing Council, 34 percent of U.S. households are renter occupied.
The biggest challenge for owners of what George Smith is terming “horizontal apartments” is the management and maintenance, especially since they are likely to be spread out across disparate locations. Residents of these properties usually demand large square footage, yards and neighborhoods that are different from the usual apartment living environment, noted Davies, and the property pools require a very sophisticated strategy involving anywhere from 30 to 100 people managing hundreds of thousands of homes.

The concept can also be a nightmare for lenders because of the number of individual properties under one blanket loan. Many, if not most, are uncomfortable with the concept for two reasons: Placing security interests (deeds of trust, titles) on each home purchased in a portfolio of hundreds could present a logistical hardship for the lender. And applying securities individually would disqualify many of the properties in the pool, because several of these properties would not traditionally meet the lender’s requirements on their own.

“Purchasing single-family residences to rent in very large pools like this is a relatively new concept in the real estate world, and often a foreign concept to lenders,” Davies observed.

George Smith Partners decided to take on the challenge as a third party, helping arrange $10 million in financing on behalf of owner/operator 29th Street Capital. “We met this need by creating the terms of the loan agreement organically, working from the ground up to construct a loan that was comfortable for all parties involved,” explained Davies.

The company created an individualized loan tailored to the specific needs of the client. Then it educated and negotiated extensively with lenders, which helped successfully secure financing for the properties on behalf of its client. The loan was divvied up into three periods: an accumulation period; a fixed-rate, interest-only period; and a floating-rate, fully amortizing loan period. According to Davies, the three periods give the client greater flexibility in achieving its debt-service coverage ratio as the properties are stabilized.

The client first purchases these single-family properties as a pool, Davies explained, then transfers them into a long-term holding pool upon stabilization. (By transferring the property over to the holding pool, the client frees capital to acquire more properties in the acquisitions pool.) Each lender then secures its interests in the properties through a blanket deed of trust, which allows the individual assets to remain free of any liens.
In the end, though, management remains the biggest complication. “The key to this industry are the groups that have mobilized the execution of a solid management team to accomplish the unique nature of this marketplace,” Davies concluded.