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    Blackstone Planning IPO Based on its Holdings of Residential Rental Properties

    by Jeanne Roberts

    The Blackstone Group L.P., (NYSE:BX), a publicly-owned hedge fund and financial advisory firm headquartered in New York City, is planning to offer an IPO based on its holdings of rental properties under the name Invitation Homes, based in Dallas, Texas.

    Investors and financial analysts are asking the same question. How do rental properties translate into effective investor venues?

    The answer is less than certain. Blackstone, currently the nation’s largest home rental resource, hit its real-estate stride during and after the Great Recession when the housing bubble erased more than $6 trillion in household wealth.

    The result – homeowners with mortgages that exceeded their home’s value (dubbed “underwater” mortgages) sought financial relief, turned to the government, and – in extreme cases – simply walked away from their investment.

    Blackstone, in the right financial place at the right time, bought up $10 billion worth of these foreclosed properties. Today, these properties comprise roughly 50,000 homes in 14 major cities, mostly on the West Coast and in Florida.

    Invitation L.P. is Blackstone’s brand designed to handle the massive amount of paperwork and footwork needed to keep the properties occupied and paying for themselves. Invitation is also the largest player in the field, leading even American Homes 4 Rent, which got its start in 2012 and now owns about 48,000 rental houses in 22 states.

    In third place is Colony Capital, another REIT (real estate investment trust) whose January 2016 merger with Starwood formed a $7.7 billion single-family rental company under the name Colony Starwood Homes.

    “Show me the money” seems to be the rallying call of potential investors, who wonder – quite rightly – how mega-scale home rentals will be able to show a profit, especially now that rental markets are beginning to sag after years of inflation.

    This downturn, which cuts across the grain in America’s major cities, is typified by San Francisco, where rent for a modest one-bedroom has fallen almost seven percent since last year – and a full 10 percent from its October 2015 peak. This year-over-year decline, notes one expert, exactly reflects the situation in April 2010, at the bottom of the bubble. This time, however, it’s a blip and not a bubble.

    Another expert, noting that the single-family home rental market is typically small in scale – one owner per one to three properties – sees the offering as a test of Wall Street’s unremitting attempt to “financialize” almost everything.

    However one views the IPO (a financial instrument or the reason for retirement insecurity), Blackstone has its work cut out for it. It has to offer rental rates that will maintain occupancy and show a profit. Too pricey, and renters will opt to take that leap of faith to become owners. Too cheap, and the properties will attract precisely the wrong kinds of renters. It’s hard to strike a balance. In Phoenix, where Blackstone bought its first house in 2012, home prices are up almost 60 percent since 2012. In Las Vegas, prices are up even more.

    It also has to continue to expand its stable of rentals, buying from a pool of homes that have become exponentially more expensive now that prices have returned to normal. (Is there a “normal” anymore in home prices?)

    But the biggest obstacle in the REIT rental market – and the stumbling block for shareholder imaginations – will be the cost of keeping many different properties in disparate locations going. Economies of scale seem almost unapproachable. How does one collect the rent, routinely inspect the properties, make repairs, and negotiate new leases without spending a bundle?

    This is a problem that management companies only enhance, since the cost of management generally runs as much as 12 percent per unit. Own up to 10 rental units in the same area, and said management company may only charge seven percent, but even that is a narrow margin once the rent is virtually shaved to the bone to keep the property occupied.

    Of course, Blackstone is managing itself, but it has also spent about $25,000 upgrading each rental home, so the profit margin is already narrow enough to slip a credit card through. The only advantage Blackstone has is a playing field of prime locations – an advantage the company has capitalized on by choosing homes in very good areas (i.e., the top school districts and upwardly mobile, attractive communities with good roads, “green” spaces and family-type entertainment and dining options).

    Turn that equation upside down by noting that the homeownership market in the U.S. has now hit the lowest level since the mid ‘60s, and the potential of rising interest rates now makes the opportunity even less likely for an emerging marketplace comprised of Millennials.

    Blackstone’s move is a surprise, given existing circumstances and the fact that American Homes (NYSE: AMH) – which had its IPO in August of 2013 – has shown a net loss every year and an almost consistent negative PE ratio. In spite of which, its December 12 stock price opened at $20.73.

    Colony hasn’t done any better, though its stock also rose to an all-time high of $30.35 on Dec. 9.

    And a final bit of advice: given the likely rise in interest rates, says one pundit, anyone investing in REITs would do well to avoid houses and take a plunge in warehouses. After all, why not?

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