For more than a generation now, like it or not, Wall Street’s financial engineering has helped determine whether the average American can buy a home. Once upon a time—before Wall Street stuck its nose under the mortgage tent—the formula for homeownership was pretty simple: if the neighborhood banker thought you would pay it back, you had a pretty good chance of getting a 30-year mortgage. The local touch gave both parties the incentive to do the right thing. Keep making mortgage payments, and you get to keep your house; the banker, meanwhile, has a valuable asset on the balance sheet. Everybody’s happy.
This sensible dynamic between borrower and lender began to change in 1977. That’s when the Brooklyn-born Lew Ranieri came up with the clever idea that everyone would be better off—the borrower, the banker, and of course Salomon Brothers, his Wall Street employer—if there were a way to buy up mortgages from local banks; package them together, thereby spreading the risk presented by any one borrower across a broad portfolio of borrowers; and sell slices of the resulting bundles to investors the world over, offering varying rates of interest depending on an investor’s risk appetite. Ranieri, who started at Salomon in the mail room, assembled a team of Ph.D.s to package, slice, and sell mortgages after he realized “mortgages are math”—streams of cash flows that investors might want to buy. This powerful idea, dubbed “securitization,” was one of those once-in-a-generation innovations that revolutionized finance.
Ranieri’s idea caught on and, so the theory goes, helped reduce the cost of mortgages for borrowers all over the country, since the market for mortgages became far more liquid than when they had simply sat on a local bank’s balance sheet tying up capital for years. Salomon Brothers—and Ranieri—made a fortune by implementing his insight. In 2004, BusinessWeek dubbed Ranieri one of “the greatest innovators of the past 75 years.” But Ranieri’s innovation also forever changed the ethic of banking, from one in which a buyer knew a seller and vice versa, to one in which the decision to buy something was separated from local market knowledge.
In 2007 and 2008, we learned how that turned out, after Wall Street’s greed machine rewarded bankers and traders for manufacturing more and more of these mortgage-backed securities with lower and lower credit standards. In the ensuing crash, two of the nation’s largest and most successful investment banks (Bear Stearns and Lehman Brothers) disappeared, and two others (Merrill Lynch and Morgan Stanley) would have too, but for last-minute rescues by large commercial banks, with a timely assist from the Federal Reserve.
Now, five years later, the fast money has returned to the housing market, but in a more tangible way: big, institutional investors are buying up thousands of single-family houses out of foreclosure, renovating them if needed, and renting them out to people who can no longer afford to buy them. Leading the pack is one of the smartest guys in any room, Stephen Schwarzman, and his publicly traded private-equity behemoth, the Blackstone Group. Eighteen months ago, Blackstone created Invitation Homes to buy and then rent out single-family homes in 13 markets across the country, with a focus on places scarred heavily by the bust, such as Phoenix, Las Vegas, and Orlando. To date, Blackstone has purchased some 32,000 houses from banks, spending more than $5.5 billion in the process, plus another $500 million on renovations. Some 1,000 people work for Invitation Homes, and the venture, at the time of this writing, is continuing to invest at a clip of about $125 million a week. Blackstone’s executives believe they have created a new engine of innovation, and that the struggling economy, and Blackstone, will benefit as home prices rise.
Nothing on the scale of Invitation Homes has ever been tried before, and a lot of people have been wondering what the venture might portend. Historically, when nonlocal investors have started speculating on houses, unfortunate consequences have tended to follow. In early June, the New York Times editorial board, noting a surge in home sales and prices, asked whether Blackstone and its ilk were inflating a new housing bubble. Just weeks later, new data showed that home prices in 20 large cities had risen 12 percent in the year ending April 2013—the largest increase in prices since 2006.
At least for now, these fears seem overheated. For all its scale, Invitation Homes is a flea in comparison with the U.S. housing market, representing three-hundredths of 1 percent of the nation’s 115 million housing units. And house prices have been rising nationwide, not just where Blackstone has been buying. Jonathan Gray, the powerful head of Blackstone’s real-estate group and the mastermind behind Invitation Homes, says the rise in house prices is a simple function of supply and demand, in which his firm is playing only a tiny role: the combination of a steadily increasing population and a dearth of home construction in recent years has led to the higher home prices. “Why are the home prices up 11 percent in Salt Lake City,” where Blackstone has made no purchases, Gray asked me in his corner office, far above Park Avenue. “Is it the ghosts of us?”
Still, the question lingers: What, exactly, are Blackstone and its brethren up to? And what is that likely to mean for the economy?
Here’s the logic Gray used to convince his partners to form Invitation Homes and to bet Blackstone’s capital: To keep up with its rising population, the country needs to build about 1.5 million new houses each year, but in the past four years, the pace of building has been less than half that, even as several hundred thousand houses have been razed annually. At some point, with demand outstripping supply, prices simply have to rise. Invitation Homes was started, in part, to profit from this phenomenon. Gray predicts that the housing market won’t move into balance until the value of existing homes rises sufficiently to approximate the cost of building a new home. “Then you’ll get more construction, and you’ll get back to equilibrium,” he says. All the talk of a new “bubble” in the housing market is nonsense, he believes. Using data produced by housing experts, Blackstone’s models show that housing prices are still 22 percent below the 48-year “trend line” between 1951 and 1999—it’s as if the run-up in the 2000s never happened.
But according to Gray, Blackstone isn’t planning to simply flip the houses it has been buying. Rather, the firm sees a new, untapped market that it believes it can serve—a growing group of renters who, thanks to tightening credit standards, can no longer afford the down payment to buy a home, or have been unable to convince a bank to give them a mortgage, or who have simply soured on the idea of homeownership. Since the crisis, Gray says, the number of single-family houses being rented has increased from 11 million to 14 million. Yet many people are renting from small, absentee landlords who have not always kept the houses in great condition, and who may not be responsive when something goes wrong. His idea is to “professionalize” the level of service offered to these renters by fixing up the homes and by fixing problems reliably, with on-call maintenance through a 24-hour hotline. “The downturn created an opportunity to create a business,” Gray says, “and in doing so we actually could do something for tenants that never existed before … Wouldn’t somebody pay for that experience?” He says that 93 percent of Invitation’s homes are rented out within 60 days of renovations’ being completed.