The Rise of Private Equity Firms

Despite the FHFA’s latest efforts to improve circumstances for first time homebuyers, the housing market has maintained stagnant levels. With millennials eclipsing the baby boomer population, their choice of housing widely affects the housing market.

However, a significant amount of millennials are grappling with overwhelming student loan debt. Over 40 million Americans are reported to have student loan debt with an average balance of $30,000 upon graduation. Thus, rental properties are becoming an increasingly popular living option as opposed to purchasing a home.

Rentals allow millennials to bypass unattainable mortgages in an uncertain market in addition to letting them focus on paying off their debts to avoid default. But, rental properties are not just ideal for millennials. Rentals can be a safe haven and sometimes, the only option for Americans struggling with poor credit that disqualifies them from obtaining a mortgage. With the popularity of rentals on the rise, small- and mid-sized investors are receiving greater access to capital through private equity firms.

After the financial crisis, the economic conditions made it necessary for private equity firms to utilize different strategies for survival. The burst of the housing bubble offered renewed chances of financial stability.

According to a client note from investment banking firm Keefe, Bruyette & Woods, private equity firms in conjunction with hedge funds and real estate investment trusts have spent a minimum of $25 billion on over 150,000 houses since 2012. Suffice it to say, firms have accumulated an impressive portfolio of single-family homes. Typically, these single-family homes are purchased for the sole reason of converting them into sought-after rental properties.

With the current market, small- and mid-sized investors have been eyeing rental properties more and more. But, small investors do not always have the means to secure loans. Interest rates and credit history are just some of the variables preventing investors from tackling the rental market on their own.

This is where private equity firms come into the picture. They offer more flexible financing with interest rates as low as 5 percent. Investors that do not qualify for loans from the government-sponsored enterprises can likely receive them from loan origination groups within private equity firms. For example, the private equity powerhouse Blackstone Group created a loan origination group called B2R Finance.

According to HousingWire, “B2R Finance originates loans on the potential cash flow of the investment property, not on the investor’s personal debt-to-income ratio, so the company relies on market data to assess the potential cash flow of a property and uses FIRREA appraisals to assess value.”

This allows small real estate entrepreneurs to have access to loans like never before. It is a win-win situation for both parties since small investors can have access to the rental properties they desire and private equity firms can tap into a plentiful demographic.

Small investors can obtain loans from a wide range as well. For example, B2R Finance offers loans that range from $500,000 to $50 million. The only caveat from Blackstone is that investors must purchase at least five single-family rental properties.

However, the risk associated with owning rental properties remains the same. Previous experience is often critical for those looking to expand their portfolios with rental properties. The newfound ease of obtaining loans through private equity firms does not mean investors should necessarily apply for these loans.

It is one thing for a novice, small investor to adopt the responsibilities of a landlord for a single property, let alone the multiple properties that are required for private equity firms to provide funding.  The hiccups that can occur along the way can be overwhelming for some.

In particular, small- and mid-size investors must endure the sporadic property repairs that can arise. Repairs can range from relatively inexpensive appliance replacements to complete overhauls such as major roof repairs or termites.

Not all tenants that appear to be ideal candidates in the beginning will remain ideal candidates across the life of their lease.  Unexpected roadblocks such as unemployment or perhaps a car breaking down completely can prevent a tenant from paying rent.  These negative variables add pressure to the role of being a landlord and are bigger issues for inexperienced investors taking on additional properties.

And, what about vacancy rates among the rental sector? An influx of vacancies will heavily affect the market. Luckily, this has largely been a minimal issue. According to a survey conducted by the U.S. Census Bureau, the fourth quarter of 2014 ended with a 7 percent vacancy rate for rental housing. This number is down from 2013’s fourth quarter of 8.2 percent. Since the financial crisis, vacancy rates have also decreased by an average of 2.47 percent.

With an easier road to financing and a healthy rental market with lessening vacancies, it seems as though conditions cannot be any better for small investors. Private equity firms have opened a gateway that connects investors with the capital they need to pursue their aspirations of owning multiple rental properties.

But, let’s take a closer look at the firms that investors will actually be utilizing. After all, an investor must have a firm awareness of who they are accepting financing from as it is a major investment to undertake.

Right now, the major players in the realm of private equity include the origination groups of B2R Finance, FirstKey Lending, and Colony Capital. B2R Finance will be the main focus as it is part of Blackstone, the world’s largest private equity landlord of single-family homes that has also been trending in the news in recent months.

Blackstone has immense influence in the housing market as the owner of Hilton (through a $26 billion leverage buyout, no less), the new owner of the Willis Tower which was formerly the Sears Tower, and of 41,000 homes that were acquired in the past two years alone.

Blackstone is rapidly amassing properties with rumors of more major purchases within the coming year. Perhaps venturing into financing for small investors is a natural step for the powerhouse firm but it can also be viewed as a strategy.

Although novice investors may struggle with expanding their rental portfolio, experienced investors are more likely to capitalize on the current market. When it comes to landlords, tenants are far better off having an individual rather than a major private equity firm. It is in the best interest of Blackstone to have investors act as landlords rather than the firm itself.

This sentiment was validated when Blackstone’s real estate portfolio company, Invitation Homes, was sued last year over its inability to properly maintain a tenant’s single-family home rental. According to the plaintiffs, cockroaches, leaks and mold were rampant in the home. Without the intimate, personable nature of a single landlord, some aspects of landlordship can suffer.

In the lawsuit, water damage and mold spread throughout the house causing unsuitable living conditions. The plaintiffs were essentially forced out of the rental because of health concerns related to the mold and were unable to retrieve belongings due to locks that were added to the property. Despite their ordeal, Invitation Homes still ordered the plaintiffs to pay rent for a property they could not live in.

The lawsuit is not a singular example. Many more tenants nationwide have complained of major hedge funds and private equity firms failing to properly manage rentals. With private equity financing on the rise and the possibility of thousands of small- to mid-size investors managing their own properties, this could be the beginning of a much-needed respite for equity firms in regards to single-family rentals. As for commercial properties and other common investments, it is safe to assume that it is business as usual for the burgeoning private equity firms dominating the market right now.