Servicing single-family rental securitizations.
The single-family residential (SFR) rental market has rapidly evolved with the acquisition, ownership and management of very large portfolios of properties by institutional investors. Securitization has developed into an efficient new source of capital markets financing to support this institutional ownership. [paragraph] These SFR rental securitization transactions are secured by the revenues generated from the rental income from the collateral properties as well as by their residual value. These transactions are unique in that the structures and documentation are primarily based on commercial mortgage-backed securities (CMBS), but the value of the underlying collateral is similar to residential mortgage securitizations. [paragraph] The servicing of SFR rental securitization transactions is an important consideration for sponsors, issuers, rating agencies and investors, and creates new challenges for the master and special servicers. This article describes the responsibilities of the servicers and the issues associated with the administration and management of securitized transactions in this emerging market.
Single-family properties have historically been a major component of the residential rental market. The ownership of single-family residential rental properties has changed since the market disruption associated with the economic downturn and recession starting in 2008.
Opportunistic investors such as Blackstone, Colony, SilverBay, American Residential Properties and American Homes 4 Rent have aggregated very large portfolios of single-family properties, and are bringing institutional ownership and management to the business. Institutional investors currently control about 200,000 properties. Many were purchased at discounted prices from lenders that acquired the properties through foreclosure or other means from overleveraged homeowners.
The SFR rental market is large and ownership is diverse-- from large institutional ownership to "mom-and-pops" who own and rent a single property.
The market is comprised of approximately 14 million homes, or 10 percent of the total housing market, according to Jade Ramani, research analyst with Keefe, Bruyette & Woods (KBW), New York.
Historically, one-to-four-unit properties comprised about 40 percent of the total residential rental market. Ramani projects that SFR rental securitization issuance could reach $65 billion in total.
The next evolution of the SFR rental finance market will be the securitization of newly originated loans made to smaller investors who own and manage 10 to 500 properties. These multi-borrower SFR rental securitization transactions represent a different challenge to servicers.
The initial single-family residential rental securitization transactions have been structured to finance large portfolios owned and managed by a single sponsor/borrower. These sponsors are utilizing securitization as a funding vehicle to finance their stabilized properties. The sponsor is responsible for leasing, managing and maintaining the individual properties, which are typically in multiple markets spread out nationwide.
The transactions are structured with a lockbox and cash-management structure so the sponsor collects the rents directly from the tenants and submits to the servicer who then applies gross proceeds to debt service, reserves and escrows. The excess is returned to the sponsor.
The servicer has no direct contact with renters of the properties. The sponsor also prepares consolidated financial statements, rent rolls and other collateral performance information on a monthly or quarterly basis and submits to the servicer.
While the basic primary and master servicing activities are similar to those in typical single-borrower CMBS transactions, the single-family residential property characteristics, as well as the number of properties and geographic distribution creates new challenges, and the need for specific expertise.
The monitoring of credit performance is similar to multifamily CMBS, while the collateral value is based on a single-family residential construct. Specific expertise and resources are critical if collateral performance deteriorates and the special servicer is required to address a potential default scenario.
The servicer's responsibilities
The single-family residential rental servicer acts as the lender on behalf of the securitization trust. The servicer is responsible for all servicing--loan administration, borrower/sponsor relationship management, monitoring the performance and condition of the collateral, asset management and preparing investor reporting.
The specific servicing responsibilities include: payment processing (collecting, processing and remitting debt-service payments); tax payment monitoring and escrow administration; property and flood insurance monitoring and escrow administration; capital expenditure and reserve administration; springing lockbox and cash-management administration, including covenant testing for debt yield; annual budget review and approval; administering property release and substitutions; collateral monitoring and surveillance, including site inspections; and monthly remittance and reporting to the trustee.
To be effective and efficient, the single-family residential rental securitization servicer must develop a close working relationship with the borrower and property manager. A number of activities are directly managed by the borrower and monitored by the servicer. The transaction structure typically has escrows for taxes and insurance, as well as reserves for capital expenditures. The servicer is responsible for confirming that the escrows and reserves are adequately funded. The borrower is responsible for paying the property taxes to the appropriate jurisdictions, and the servicer monitors and confirms the payments at the property level (through a third-party tax service) and disburses reimbursement to the borrower from the appropriate account.
The borrower also is responsible for paying property and flood insurance premiums, with the servicer monitoring the payment status and disbursing reimbursement from the appropriate accounts. It is critical that the borrower maintain a blanket property insurance policy so that the servicer does not have to monitor adequate coverage at the individual property level.
The servicer monitors the payment of applicable homeowners association (HOA) fees by the borrower. The servicer also is responsible for the administration of capital expenditure reserves to maintain the properties. Typically there is a minimum monthly disbursement amount of $50,000 to make the process more efficient for the borrower and servicer.
The need for specialized expertise
The unique nature of the underlying single-family residential properties requires the servicer to have specialized expertise to address credit performance monitoring and asset management issues. The servicer collects and reviews the quarterly consolidated portfolio operating statements, rent rolls and other leasing and collateral performance information prepared by the borrower. SFR rental loans typically are structured with covenant tests based on debt yield, and with a springing lockbox and cash trap if the revenues decline below a specified level.
The servicer may be responsible for reviewing and approving the borrower's annual operating budget. The servicer is also responsible for administering property releases and substitutions in accordance with the loan documents.
Additionally, the servicer is responsible for securing property site inspections. Typically inspections are conducted on 10 percent of the properties that have a rental turn during a 12-month period. All borrower-initiated asset management requests, lender consents and approvals are reviewed and analyzed by the servicer. The servicer recommends an appropriate course of action, administers the approval process with the special servicer and directs certificate holder as required.
The emergence of multi-borrower securitization transactions adds additional complexity to the servicing activities. While the basic servicing responsibilities are similar, instead of collecting debt-service and performance information from a single institutional borrower, the servicer has multiple borrowing entities, with different capabilities and expertise.
The specialty finance companies that are sponsoring these transactions originate the loans secured by portfolios of properties, securitize the loans to repay their warehouse lenders and originate new loans.
Borrowers will have different property management and reporting systems, which require consolidation into a standard format for investor reporting. These multi-borrower transactions may also have multiple subservicers responsible for the primary servicing activity, in which case the master servicer would be responsible for their management and oversight, as well as the aggregation of debt-service remittances and reporting for the entire portfolio.
The investor reporting for the single-borrower SFR rental se curitization transactions has been standardized across multiple transactions. The basic format is similar to the Commercial Real Estate Finance Council Investor Reporting Package (CREFC IRP) for multifamily CMBS loans.
The information on financial operating performance, leasing, occupancy, rents and property characteristics is provided by the borrower to the servicer and then formatted and delivered to investors through the transaction trustee. The investor reporting standards have yet to be developed for the multi-borrower deals; however, the basic information template will likely be similar to single borrower deals.
The management of all of the servicing data; collateral property information; tax, insurance and HOA status; and financial performance information requires a very sophisticated and flexible servicing technology platform, with the capacity to load thousands of individual property records for each transaction. This infrastructure is critical to the effective loan administration and management of the securitized transactions, and to support the monthly reporting and remittance cycles.
The ongoing credit performance of these transactions is very important to bond holders and rating agencies. The securitization master servicing responsibilities include evaluating any deterioration in credit performance, monitoring performance covenants, transferring the loan to the special servicer on default or imminent default, and advancing debt-service and protective advances to the extent recoverable.
Both the master and special servicer share responsibilities for reviewing and approving lender consents, approvals, waivers and borrower-initiated asset management requests. The special servicer is also responsible for loss mitigation; default management; asset management and workout; and resolution or liquidation of the collateral, which may be comprised of thousands of single-family residential properties in multiple markets nationwide.
The master and special servicer for a single-family residential rental securitization transaction are responsible for acting in accordance with the servicing standard and maximizing recoveries on a net present value basis on behalf of all of the bond holders and without regard to their compensation. It has been the experience of CMBS servicers in addressing credit issues that maximizing net recoveries is best achieved by diligent surveillance and early intervention to address credit issues before they manifest in defaults.
Optimal default management results are achieved by minimizing expenses, expediting the resolution process and maximizing net recoveries.
The special servicer should actively monitor the economic performance of the transaction; the leasing and maintenance of the collateral; and address any deterioration with the master servicer, borrower and property manager. Regularly scheduled conference calls or meetings should be held with the master servicer to review the economic performance of the transaction, as well as the condition of the underlying collateral and the performance of the manager.
The special servicer's activities and interactions with the master servicer will increase if performance continues to decline. As performance deteriorates the master servicer will put the loan on a watch list status to alert the bond investors and rating agencies of increased scrutiny.
Depending on the specific circumstances, if the economic performance deteriorates to the point where the debt-service ratio falls below a designated level, resulting in a cash-trap trigger event, the master servicer would likely consider a special servicing transfer event. In the event of default or imminent default, the loans would be transferred to special servicing in accordance with the provisions of the transaction pooling and servicing agreement.
Prior to a special servicing transfer event, the special servicer should identify the internal and external resources necessary to effectively manage the transaction. Internal resources assigned to the transaction would include the appropriate asset management team to support the collateral valuation and development of alternative resolution and liquidation strategies.
The special servicer should identify and qualify the third-party vendors to support the asset and property management of the transaction. These activities include property site inspections, valuation, property management and leasing, receivership, legal, restructuring advisory, loan sales advisory, and property sales brokerage and auction services. The vendors selected by the special servicer would be based on the specific circumstances related to credit performance deterioration or default and special servicing transfer and the selected resolution strategies.
On transfer to special servicing, the special servicer should immediately engage the third-party vendors, including site inspections, valuation, legal and receivership, and identify prospective property management and leasing vendors with the capability to manage the collateral properties. Through legal counsel, the special servicer would engage the borrower through a pre-negotiation agreement.
Default management and resolution
An asset business plan is critical to the success of default management and resolution. The special servicer develops a detailed evaluation of the collateral properties and value, the borrower and his capabilities and motivations, the asset status and the legal remedies available. Because each distressed portfolio and situation is unique, a resolution strategy is developed based on the specific circumstances and the underlying value of the collateral.
Each potential resolution alternative is then evaluated through the development of an asset business plan. The plan contains a detailed description of the asset, the borrower and any related parties; a financial analysis and valuation of the collateral; a description of the resolution alternatives, including a net present value calculation for each; and a recommendation as to the resolution alternative to be pursued, along with a corresponding detailed implementation budget.
The two most important considerations in developing a resolution strategy are the borrower's motivation, capabilities and resources; and the collateral value under a variety of different resolution or liquidation alternatives.
There may be significant differences in resolution strategies between the institutional sponsors in single borrower transactions and the smaller multi-borrower loans. Depending on the situation and circumstances, the special servicer would be expected to consider the following major categories of resolution and liquidation alternatives:
* maturity extension;
* restructure or modification;
* discounted payoff;
* loan sale; and
* foreclosure and real estate-owned (REO) sale (bulk sale, auction, sale by market or submarket, individual property sale).
To the extent that the borrower is cooperative and a workout strategy is a feasible alternative, the special servicer may choose to "dual track" resolution strategies by pursuing both a consensual resolution strategy and enforcement of a creditor's rights. The asset business plan would be presented with specific recommendations for review and approval to the controlling class holder. On approval, the special servicer would implement the plan and pursue the recommended resolution and liquidation strategies.
In addressing a default of a single-borrower transaction, the special servicer would engage a law firm with the capabilities and experience to address multiple jurisdictions and collateral properties. If appropriate, the special servicer would work with legal counsel to seek from the federal district court the appointment of a receivership company with a large, experienced national platform ensuring the receiver has access to sufficient capital to maintain the properties.
The receiver would take control of collateral and freeze the appropriate bank accounts to gain access to property-related funds. Under the special servicer's direction, the receiver would be responsible for hiring a national management company or multiple regional companies to collect rent, pay expenses, make repairs and liquidate collateral. The receiver would be the single point of management for all properties regarding sales, management, leasing and tenant evictions during the term of the receivership. A default of a smaller, more geographically concentrated multi-borrower loan could be addressed using local resources.
The special servicer would evaluate and select one or multiple brokers, depending on the strategy selected, to liquidate the REO properties consistent with the servicing standard of maximizing net recoveries on a present value basis. If the best strategy is to pursue a foreclosure and REO property sale strategy, the asset management team would evaluate the cost, time and expected proceeds from selling the entire collateral pool in bulk versus market-by-market versus subdivision-by-subdivision versus property-by-property. Many of the properties will remain leased, which would limit retail sales to homebuyers.
The team would then select the vendor or brokers best able to execute on the selected strategy. Under the special servicer's direction, the receiver would establish a strategic relationship with a national residential brokerage firm to provide marketing services for the sale or lease of the collateral properties for a large, geographically diverse portfolio.
On an ongoing basis, the special servicer should provide updates on its performance against the plan to the master servicer, rating agencies, trustee, investors and the controlling class holder.
The special servicer is also responsible for providing valuation and resolution timing information to the master servicer to support the servicing advance non-recoverability analysis. To the extent that modifications to the asset business plan are required due to changing circumstances, an amended plan would be submitted to the controlling class holder for review and approval.
The institutional ownership and capitalization of the single-borrower SFR rental transactions makes the probability of default lower than the multi-borrower deals. However, a large decline in either rental income or residential property values could make it difficult to refinance these transactions and pay off the existing debt at maturity. The scale and geographic diversity of these portfolios would present an asset management challenge to the special servicer versus the smaller multiborrower loans. A number of third-party service providers are building national capabilities to lease and to manage large single-family residential rental property portfolios.
The servicing and special servicing of single-family residential rental transactions has evolved as the securitization market has developed and issuance has grown. The servicing of these transactions requires specialized expertise, resources and technology. The development of multi-borrower transactions will create new challenges for the servicers and special servicers. As issuance grows and the market matures, asset management and credit performance issues will test the structures developed to support this new capital markets activity.
Stacey M. Berger is an executive vice president of Midland Loan Services, a PNC Real Estate business. Midland is a leading provider of loan servicing, asset management and technology for the commercial real estate finance industry, including CMBS master and special servicing. He can be reached at email@example.com. NOTE: The views expressed by the author are his own, and this article was prepared for general informational purposes only and does not purport to be comprehensive. The information and views in this article do not constitute legal, tax, financial or accounting advice or recommendations to engage in any transaction. The views expressed in this article are subject to change due to market conditions and other factors.
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|Author:||Berger, Stacey M.|
|Date:||Oct 1, 2014|
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