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Contribution Details

Type Master's Thesis
Scope Discipline-based scholarship
Title Rental Home Backed Securities (RBS) An Alternative Investment Opportunity in Switzerland?
Organization Unit
Authors
  • Nicola Della Morte
Supervisors
  • Thorsten Hens
  • Leta Bolli
Language
  • English
Institution University of Zurich
Faculty Faculty of Business, Economics and Informatics
Number of Pages 79
Date June 2017
Zusammenfassung Rental Home Backed Securities (RBS) – or single-family rental (SFR) securitizations – are a new financial instrument created through securitization and secured by mortgages on a portfolio composed by single-family rental homes. This securitization process produces coupon bonds, which are divided into different tranches depending on their riskiness. The tranches are then rated by one or more rating agencies and sold to investors (bondholders). Since bearing more risks requires a higher return, high rated tranches provide lower coupon interest rates than low rated tranches (Hull (2012)). In contrast to MBS, the monthly coupon payments of the bonds are not ensured by the monthly mortgage payments but by the monthly rental payments of the underlying portfolio of single-family homes. Consequently, RBS are very sensitive to the vacancy rate. If the vacancy rate of the underlying portfolio remained constant, there would be enough monthly rental payments to cover all debt obligations. If the vacancy rate rose, there would not be enough monthly rental payments to cover all debt obligations. Bondholders of the lowest rated tranche would not receive or only partially receive their principal and coupon payments. The higher the vacancy rate, the more the losses increase and have to be absorb by the superior, higher rated tranches. As stated by Fields, Kohli and Shafran (2016), RBS allow large investment companies to gain liquidity up front and to improve profits using leverage. Large investment companies started investing in single-family rental homes after the last financial crisis, exploiting the opportunity to invest in undervalued properties and rent them to make a profit. The Blackstone’s rental business unit, Invitation Homes, issued the first RBS ever – called “Invitation Homes 2013-SFR1” – in December 2013. As of December 2016, there are 32 RBS in the U.S., which are composed by 85’000 properties with a market value of $16.5 billion (Fields, Kohli and Shafran (2016)). However according to Morgan Stanley, investment companies have acquired about 528’000 single-family homes for $68 billion. This means that they have almost 450’000 SFR homes in the pipeline, which they could securitized in RBS! Although the RBS market in the U.S. is expanding, there is still no RBS in Europe. Purpose of this master thesis is to find out whether RBS can be an alternative investment opportunity in Switzerland. To answer this question, I create a model based on a portfolio of 500 single-family rental homes in Zurich, Northwest Switzerland and Bern. As in the U.S., a single loan worth CHF 443.6 million made to the borrower backs the securitization. The loan collateral consists in both the mortgages on the 500 single-family rental homes and a pledge of the equity in the borrower (Moody’s (2014)). In the case that the borrower defaults on the loan, the special servicer will liquidate the portfolio in order to repay the bondholders. The results of the model confirm that RBS can be an alternative investment opportunity in Switzerland. The Swiss RBS is divided into five tranches: the Aaa-tranche represents 81.1% (CHF 359.6 million) of the initial loan amount, the A2-tranche 5.3% (CHF 23.5 million), the Baa2-tranche 3.1% (CHF 13.8 million), the Ba2-tranche 4.0% (CHF 17.9 million) and the equity-tranche, which includes the risk retention class, 6.5% (CHF 28.8 million). Interestingly, the Swiss RBS has the biggest Aaa-tranche – expressed in percentage of the initial loan amount – among all RBS examined. Hence, the Swiss RBS has low borrowing costs, since the higher the rating, the lower the coupon interest rate and consequently the lower the cost of borrowing. This is a very positive aspect of the Swiss RBS. Furthermore, the Swiss RBS defaults – according to the developed model – only with real estate bubble at least 1.7 times bigger than the real estate bubble, which burst in Switzerland in the early nineties. These two positive results are due to the stability of the Swiss real estate market in the last years. The Aaa-tranche provides a slightly better yield compared to the U.S. Government Bonds and a much better yield compared to the Switzerland Government Bonds. This is an important result since the Swiss RBS provides a diversification possibility to Swiss fixed-income investors who still want to invest in Switzerland and not abroad. Swiss fixed-income investors, who decide to invest in the Aaa-tranche of the Swiss RBS, can diversify their portfolio with a real estate product and receive a regular, stable and much higher return than what they would have received investing in the Switzerland Government Bonds. The Swiss RBS seems also to be competitive if compared to real estate investments fund. However, there are also some drawbacks. Firstly, the single-family homes market in Switzerland is a niche segment. Although the Swiss RBS is only composed by 500 single-family homes and it should not be an issue to create such a small portfolio also in a niche segment, the Swiss single-family homes market is probably not large enough to allow the issuance of dozen of RBS. Secondly, the Swiss RBS has a lower diversification compared to the RBS issued in the U.S. In fact, the Swiss RBS is only composed by 500 single-family homes, much fewer than the 3’207 single-family homes of Invitation Homes 2013-SFR1. Thirdly, the portfolios of the RBS issued in the U.S. were mostly purchased in bulk sales. In Switzerland, there are no bulk sales for single-family homes, meaning that investment companies should buy the single-family homes on the real estate market paying the full price. Fourthly, the price to rent ratio in Switzerland is three times higher than the price to rent ratio in the U.S. Since the cash inflow comes from the rental payments, a higher price to rent ratio means that investment companies have to invest upfront three times more than in the U.S. to receive the same return on equity. Because of these reasons, the profit margin of the Swiss RBS seems to be smaller than the profit margin of the RBS issued in the U.S. If the interest rate of the U.S. Government Bonds, which I used as a risk free rate for establishing the coupon interest rates, increased to the level before of the last financial crisis, the coupon interest rates of the Swiss RBS should increase so much that the securitization would become impossible. The cash inflow (rental payments) would not be enough to cover the cash outflow (coupon payments, taxes, expenses, and fees). Nevertheless, I used conservative assumptions in the evaluation model. Partially relaxing these conservative assumptions should provide a higher profit margin. In conclusion, according to the results of my model, RBS could be an alternative investment opportunity in Switzerland. However, this master thesis should be seen as a “go / no go test” and further research should be made. In case of future works on this topic, I recommend considering also mixed portfolios composed by single- and multi-family homes. A mixed portfolio could provide more diversification and probably higher returns. Although this master thesis deals with RBS in Switzerland, it could be interesting to evaluate the RBS’ performance in other countries in Europe. Since Switzerland has a high price to rent ratio (35 years), investment companies have to invest more to receive the same return on equity than in a country with a low price to rent ratio. Hence, a good approach could be to select countries, in which the price to rent ratio is lower (e.g. France has a price to rent ratio of 26 years, Global Property Guide (2017)).
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