By Amanda Alix | More Articles

September 26, 2012 | Comments (0)

Private-equity firms have been buying up distressed single-family homes for several months now, using pots of money to grab large lots of foreclosed properties which they can fix up and rent, sometimes to the very people who used to own them. Obviously, this venture is turning a profit: Not only are more companies getting involved in the landlord business, but Wall Street is working on a way to turn the income from these rental homes into a new investment vehicle: the rental-backed security.

Financing foreclosure acquisition seems to be the wave of the future. Big banks are in discussions with the ratings agencies, since the better the ratings on such instruments, the more money that can be made. So far, however, the future isn’t looking very bright. The track record for these types of securities is nonexistent, and both the firms buying the houses and the tenants renting them are also unknown quantities. According to Fitch Ratings, at least, these newfangled securities would probably be rated A, or lower.

Big players in the industry would probably be the first to test the new financial products. Investment groups like Kohlberg Kravis Roberts ( NYSE: KKR ) and Och-Ziff Capital Management ( NYSE: OZM ) are good candidates, as they have been in the foreclosure-buying business for a couple of years now, and own — literally — lots of them.

Two Harbors Investment ( NYSE: TWO ). a real estate investment trust, has also been on a single-family spending spree and is rolling these properties into a new entity called Silver Bay Realty Trust, which has registered for its own IPO. Though new, Silver Bay would have the backing of Two Harbors, which may give it some heft with banks offering financing.

Last, but not least, is the Blackstone Group ( NYSE: BX ). While the company says it won’t be spending the $1 billion that the media reported, it will likely be investing in the Tampa Bay area of Florida in the near future. The firm has already spent over $250 million so far this year on single-family foreclosures, so it certainly has quite a large stable of properties by this time, not to mention its reputation, to back up any financing deals it might desire.

One Fool’s take

While the whole concept of lease-backed securities sounds a bit shaky, that might be just what investors crave in these times of low-investment returns. Not only can rental checks be counted on less than mortgage payments, but these securities would not have the backing of Fannie Mae and Freddie Mac, as most mortgage-backed securities do. This makes them more risky, but also increases the potential for higher returns. Particularly with the Fed scooping up MBSes, this new type of security will likely have investors lining up to buy them.

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Fool contributor Amanda Alix owns no shares in the companies mentioned above. The Motley Fool owns shares of Citigroup. The Motley Fool has a disclosure policy . We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. Try any of our Foolish newsletter services free for 30 days .