Residential transition loans (RTL), which real estate investors use to renovate old houses, are in themselves nothing new. But light issuance in the US RMBS market this market — alongside a shift in the market driven by the regional banking crisis — is pushing the niche assets towards the mainstream securitization market.
On Wednesday, MFA Financial priced a $184m deal backed by residential transitional loans. It was the sixth deal of its type so far this year, taking total 2023 issuance from the asset class to $1.3bn.
Though the asset class remains small, investors are welcoming the deals. Two of the recent three transactions from Kiavi, the biggest originator and issuer in the space, were increased in size.
Syndicate bankers say there will be at least two more deals before the end of the year.
So far, all the deals to have have priced were unrated. But DBRS is developing the first rating methodology for RTL securitization.
“I think the fact that it's becoming more mainstream is a byproduct of some of the institutional capital that's come into the space,” said an RTL securitization banker.
With overall RMBS supply down 60% year-on-year amid higher interest rates and lower mortgage origination, niche sectors have been garnering the attention of investors looking to put money to work. Some of the more prominent asset classes have seen even more precipitous falls. Prime jumbo volumes are 75% down, for example.
“There's certainly a supply-demand technical as there's been less issuance, and some investors have to look to other asset classes to invest in,” said the RTL banker. ”The [RTL] space has certainly been a beneficiary of that.”
The regional banking crisis, which shifted origination from regional banks to private lenders, has also been driving the active RTL securitization market, according to John Beacham, CEO of Toorak, an investment firm focusing on acquiring and securitizing RTL and DSCR loans.
“Regional banks have historically been a major originator of RTL loans, but after the banking crisis, their lending volumes have decreased very significantly,” said Beacham. ”A lot of those borrowers who historically would go to those banks are entering the private markets, which [has] certainly helped securitization volumes because private lenders don’t have deposits to fund the loans.”
Growth in the asset class faces the same headwinds as most fixed-income sectors do: rising interest rates.
Toorak issued the first RTL-backed securitization in 2018. But it hasn’t tapped RMBS buyers since July last year as a result of the higher funding costs on offer in capital markets.
“Securitization is just an alternative financing vehicle for us,” said Beacham. “But we are looking forward to returning the market if the rated deals improve the pricing.”
Appealing returns
RTL loans usually have shorter durations of between 12 to 16 months, and securitization structures have developed unique structures to accommodate this. For example, during an RTL securitization funding period, which lasts between one to three years, the sponsor can reinvest the proceeds and contribute new loans to the deal.
This makes RTL the only securitization in the RMBS market that regularly uses a revolving structure, potentially translating to more uncertainty regarding collateral and closing time. In this aspect it is somewhat like a CRE CLO.
Yet the higher returns on offer — as well as the undersupply of the market — are encouraging more investors to explore the novelty, said Arvind Mohan, CEO of Kiavi, the biggest originator and issuer in the space.
“In 2021 the deals were happening with a 2% to 4% range,” said Mohan. ”Now the yields are above the 8% range, which is high enough to get more and newer investors excited and willing to learn and invest in the asset class.”
RTL borrowers are mostly investors trying to fix and upgrade rental houses, which means they are less sensitive to rates than most mortgage borrowers. They have also been benefiting from the stable rent growth across the US.
As a result, the sector has shown strong growth in origination, and more issuers are exploring securitization as a term financing option. One syndicate banker said there will at least be another two RTL deals priced in the primary market before the year ends.
“The RTL market is also underpinned by some strong structural tailwinds from undersupply in the housing market,” said the banker, “As new construction remains slow, there will be more demand for renovated old houses.
“It might still seem like a small asset class in the securitization market, but we definitely think this is an asset class that is here to stay, with strong bedrock fundamentals behind it.”