Could This Lawsuit at The Blackstone Group L.P. Snowball Into an Avalanche?

Is this single-family rental lawsuit an isolated case, or the tip of an industry iceberg?

May 13, 2014 at 8:00AM

Avalanche
Source: Flickr / Peter Dutton.

"Do they have the capacity to properly maintain tens of thousands of units across the country?" -- Kevin Stein, associate director of the California Reinvestment Coalition, from the Los Angeles Times

Should huge corporate single-family home landlords be regulated? That question may seem silly at first glance. However, a recent Los Angeles Times article shines the spotlight on a lawsuit alleging unresponsive and insensitive behavior by the largest U.S. single-family rental landlord, Invitation Homes. This unit of private equity giant Blackstone Group (NYSE:BX) owns 44,000 homes in 14 different housing markets. The lawsuit involves just one family who leased a home in Sun Valley, California.

However, it could easily become a catalyst for legislators and regulators to begin a debate about the need for additional consumer protection.

Uncharted territory
Prior to the Great Recession there was no such thing as an institutional single-family home rental asset-class. This is a brand new business model. The steep nosedive in prices for single-family homes that occurred five years ago created an opportunity for buyers with cash, snapping up homes by the thousands at bargain basement prices with the intention of creating a large portfolio of rental homes.

The first publicly traded single-family REITs came into existence in 2012. In just two years, sector has quickly blossomed to include five fast-growing players.

Partially regulated already
Altisource Residential Corp. (NYSE:RESI) has successfully pioneered a different twist on acquiring single-family homes to rent. The Altisource business model is based upon acquiring portfolios of non-performing residential mortgages. This sometimes results in Altisource foreclosing and acquiring a home that can either be rented out or sold. The negotiations between Altisource and a delinquent homeowner are regulated. This is partially a result of the egregious behaviors of mortgage lenders and the companies that serviced these mortgages in the recent past.

Ocwen Financial Corp. (NYSE:OCN) is the largest servicer of delinquent loans in the U.S. -- with about $473 billion in unpaid principle balances. This related entity is the source of the vast majority of non-performing residential mortgages in the Altisource Residential portfolio. The Consumer Financial Protection Bureau, or CFPB, recently reached an agreement with Ocwen to:

1.     Reimburse $125 million to homeowners who have been unfairly foreclosed.

2.     Grant $2 billion in loan modifications to struggling borrowers.

Additionally, the New York Department of Financial Services has put an indefinite hold on the transfer of the mortgage servicing rights to 184,000 homes from Wells Fargo, primarily due to concerns regarding customer service.

That Sun Valley home is also pledged as collateral
Blackstone's Invitation Homes recently pioneered using single-family rental homes as collateral for issuing mortgage backed bonds. This three-bedroom home is part of a pool of ~3,000 homes which serve as collateral for a $480 million bond offering. This is represents a new hybrid form of commercial mortgage-backed security. Pretty heady stuff.

Historically, renting out single-family homes was done on a small scale by mom and pop landlords. If one home is vacant, it is a major financial burden for a small rental operation. There is a strong incentive to provide quality customer service. The business model employed by landlords with access to Wall Street capital has the potential for mistreatment of an individual tenant baked right into the cake. The plight of one family is frankly not that big of a deal.

A need for oversight?
On the other hand it becomes a huge -- potentially life changing -- ordeal if you are that family. That is the point here.

All states have some sort of landlord/tenant law on the books. I doubt that any of these statutes contemplated a single-family home rental being part of a billion dollar enterprise. Often the rental of one to four dwelling units is less stringently regulated by local ordinances than larger multi-family apartment buildings. Are local government fines or small claims court verdicts really sufficient to prevent a pattern of bad conduct? What if that pattern only becomes apparent when you are able to look at multiple states or jurisdictions?

There is no excuse for any landlord to lease a home to a family that is not habitable or reasonably maintained. In order to protect consumers, should there be national standards of conduct for single-family landlords who raise capital on Wall Street?  The CFPB has already set that precedent for institutional lenders and mortgage servicers. 

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Bill Stoller has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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