“Securitization involves the creation and issuance of debt securities, whose payments of principal and interest derive from cash flows, which are generated by a separate pool of assets,” notes Todd Keator of Thompson & Knight, a law firm. An Apartment REIT, for example, may obtain a loan by allocating a portfolio of residential homes to a separate entity.
There are obvious motivations. A securitization agreement contains less debt covenants compared to bond issuance. Management faces less regulatory scrutiny. And in the current pygmy interest rate environment, the securitization cost of borrowing is lower than debt markets. Moreover, lenders to REITs prefer securitization. He who pays the piper calls the tune.
Securitization is less risky from the lender's perspective. Post securitization the lender is indifferent to the operating performance of the issuing company. If the company mismanages the real estate portfolio, the lender’s security is unchanged. Securitization also offers a senior position on rents revenue. The pass-through structure enables the lender to collect the rents first, to deduct the interest, and then pass the monies to the company.
Proceeds from securitization have proliferated in REITs. American Homes for Rent (NYSE: AMH), in five separate transactions, issued a total of $2.3 billion in securitization in the past two years. The company pledged 17,776 homes, out of a portfolio of 38,780 single-family properties, representing about 45 percent of the real estate portfolio. Management noted the securitization proceeds allowed the company pay down credit facilities and general corporate purposes. That is an understatement.