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James Dennin, Kapitall: Publicly traded funds are buying up rental properties like hotcakes. We found 5 of the big players.
One of the ways many financial firms were able to make so much money in the years leading up to the financial crisis was through
mortgage-backed securities (MBS). While a lot of people know that these kinds of investments were implicated in the financial crisis, not a lot of people know exactly what they are.
[Read more about housing from Kapitall: 6 Real Estate Development Stocks With High Debt]
At face level, it's not that complicated. First, a financial firm buys up a mortgage on someone's home as an investment. Rather than collect the payments and interest directly from the homeowner, they bundle that mortgage several others, and sell shares in the bundle to individual or institutional investors (bear with me here).
If the mortgage isn't sub-prime, the financial middleman can take advantage of flexible financing offered to multi-billion dollar lenders who are very unlikely to default – and the investor can enjoy returns off of interest payments from dozens (if not hundreds, or thousands) of happy homeowners.
This system worked well for a while - until the housing crisis happened. The money was so good, banks started chasing mortgages that were worse and worse so they could sell more MBS. Too many sub-prime loans found their way onto the balance sheets of major financial institutions, who eventually realized they wouldn't have enough capital to cover the losses if homeowners began to default.
Once confidence in the system was shaken, the dominos started to fall. As people defaulted on loans they probably couldn't afford in the first place, they moved out of their homes. The empty houses depressed property values of entire neighborhoods. Soon, it started to make sense for homeowners to default, rather than keep paying interest on a mortgage that was worth twice the value of their home (now on an empty block).