How to Own a Rental Property for Free

by JT McGee

blackstone dealMajor institutional investors are buying real estate in droves, and they need your help.

The Wall Street Journal reports that Blackstone needs new funding to buy more homes. The private equity firm needs debt investors, but this financing vehicle comes with a twist.

Pre-packaged payments

Ordinarily, private equity players finance deals with syndicated, subordinated debt and bank loans. Blackstone won’t go that route. Instead, it has intentions to raise new financing by selling off chunks of single family rental cash flows.

Here’s how it will work:

Rental payments from 1500-1700 homes will be packaged together. Those cash flows will then be securitized into a debt obligation. Following me so far? Blackstone will sell you a slice of the rental payments from 1,500+ single-family homes for an upfront payment today.

So let’s say the rentals generate $20 million in annual cash flow. Blackstone might sell three different tranches in its quest for new financing.

  • The first tranche might sell for $200 million, and have claim to the first $14 million in cash flows. This is the high quality stuff, since investors will be paid in full so long as there is at least $14 million in annual cash flows. Yield comes in at 7%.
  • The next tranche might sell for $50 million, and have claim to the next $5 million in cash flows. This implies a yield of 10%, which is higher than tranche 1 because of greater risk (anything beyond a 30% decline in rental cash flow would start cutting into returns.)
  • Finally, the third tranche might sell for $5 million for the remaining $1 million in cash flows. Investors get a yield of 20%, but a 5% decline in total rental cash flow would mean investors in this tranche never see a dime in cash flow for their investment.

All-in, Blackstone gets $255 million and gives up $20 million annually in rental cash flows. Future cash is turned into present dollars. (These are example figures, not actual figures from the deal. We won’t know the actual details until September.)

Why this is so cool

I love financial engineering, especially when it’s a new twist on an old idea. Securitization is nothing new – auto, credit card, and mortgage receivables are bought and sold all the time. REITs sell preferred stock which is basically a perpetual royalty paid for by earnings on real estate.

What makes this so interesting is that it basically makes the homes free to Blackstone. If Blackstone uses its financial scalpel to the cash flows and sells them for at or near the amount invested to buy the homes in the first place, Blackstone retains the ownership of the homes with ZERO investment of their own.

In effect, Blackstone is carving out the biggest option ever on the valuations of single family homes. If prices dip, no problem! Blackstone acquired the homes at the price of…wait for it…nothing. Any increase in American home values would represent an infinite gain on its investment.

Isn’t finance awesome?

{ 4 comments… read them below or add one }

krantcents July 31, 2013 at 15:42

It sounds as though there are different risk factors in each tranche. I would rather be the general manager or in this case Blackstone. I like the idea of the capital gains and the risks more identifiable.

Reply

JT McGee July 31, 2013 at 15:55

Yeah, Blackstone is definitely getting the better end of the stick, but that’s what happens when you put your money on the line first. I think this could be a really interesting alternative asset/risk play. If it is successful, I’m sure countless other deals will follow.

Reply

PK August 1, 2013 at 09:10

Finance – passing money from hand to hand until there’s none left.

Is it sad I’m still watching the yields that come out of this? Ever since I saw the WSJ piece last year on securitized rental payments I’ve been interested, haha.

Reply

JT McGee August 1, 2013 at 14:21

Computer engineering – the industry behind Webvan, Pets.com, and many more! 😉

Not at all. I’m watching the yields too because I think the top tranche will be a pretty good wager. REIT preferreds are in the 6-8% area depending on capital structure. The best-rated stuff will probably price at the lower end of that.

Reply

Leave a Comment

*

Previous post:

Next post: