What is securitization?
Taking illiquid assets and transforming them into securities via financial engineering is known as securitization.
Real estate securitization is the process of taking bank and other lender-issued mortgages and turning them into securities that investors can buy. Essentially, real estate securitization turns illiquid mortgages into liquid assets by “securitizing” them. This process is intended to mitigate financial risk while adding liquidity to the housing market.
When investors invest in one single property alone, they bear most—if not all—of the risk. Pooled interest in which investors own small parts of various properties diversifies their portfolios and reduces their risk of devastating losses.
Securitization has amplified access to capital, allowing investors to have access to investments they otherwise would not have had access to alone. Securitization works to expand capital markets and helps both investors and borrowers.
Real estate mortgages are not the only asset that can be securitized. Other examples include:
- Real estate.
- Commercial debt.
- Student loans.
- Auto loans.
- Accounts receivable.
- Equipment loans and leases.
Securitization case study
ZZZ Bank pools thousands of mortgages. Then, it divides the pool into shares that are sold as securities. Sally buys securities this way and gains the right to collect mortgage payments made by the thousands of homeowners in the mortgage pool. If you’ve ever heard the term “mortgage-backed securities,” this explains why they’re called that.
Securitization protects investors because if a single mortgage in the pool goes bad, all investors who purchased shares in the pool share the loss, rather than one investor bearing the brunt of a significant loss. This is illustrated by the following example:
Theo is one of 100 investors who made an investment of $100K in a securitized offering of 50 mortgages at $2K each. One of the mortgages goes bad, and Theo loses only one-fiftieth of his investment ($2K) rather than losing his entire principal of $100K had he gone at it alone.
The bottom line
Securitized mortgages, or pooling multiple mortgages together and turning them into liquid assets available for purchase, reduces entry barriers into the real estate market for newer investors or those without large amounts of capital. Investors can invest as little as $1,000. From there, they can easily sell their investment for cash at any time.
Other assets such as real estate can also be securitized. Securitization allows investors to reap all of the benefits of real estate investing with the added benefit of lower risk and without the burden of property management. Without worrying about maintenance or management, investors are free to collect their monthly income without worrying or lifting a finger.