Amongst all the news of how glorious the housing market is comes the turd in the punch bowl: the Federal Housing Administration (FHA) is shaking its tin cup at the Treasury, asking for $1.7 billion to shore up its insurance fund. Its reserves have been depleted by defaulted mortgages, despite the Case-Shiller Index being up 12.4 percent from one year ago, its fastest annual rise since 2006.

Despite this rip-roaring price action, the average home price is still 21 percent below the 2006 peak. Which might explain why the FHA must go to Uncle Sam for help. The hole in the FHA reserves comes entirely from losses in the agency's reverse-mortgage program.

Reverse mortgages are what aging celebrities like Fred Thompson and Henry Winkler pitch on TV. Thompson says the average reverse-mortgage borrower can obtain $130,000 in tax free cash with a government-insured reverse mortgage and use it to live the retirement of their dreams.

According to American Banker, “Many seniors who received the loans in a lump sum were later unable to pay taxes and insurance, resulting in a wave of defaults. The reverse mortgage program was projected to have a $5.2 billion deficit this year.” A report issued last November from an independent actuary projected losses for the agency over the next 30 years that will put it $16 billion in the red.

Despite the housing market's improvement, the FHA's serious delinquency rate is still a whopping 8.47%. The agency insured 27 percent of all mortgages last year, and along with Fannie Mae and Freddie Mac, dominates mortgage finance post-crash.

At the end of the second quarter, nearly 24 percent of homeowners were underwater. In parts of Nevada, California, and Florida, the percentage is more than double that. Still, Wall Street is in love with Main Street's houses again. Not fancy structured financial products stuffed with mortgages of various quality.

This time, companies like Blackstone Group LP's (BX) Invitation Homes are buying up homes by the dozen. Invitation has purchased 32,000 homes in 13 markets, focusing on locales like Phoenix, Las Vegas, and Orlando.

The company has invested $6 billion into single-family detached rental homes that it plans to sell when the market recovers. Blackstone believes housing prices are 22 percent below the 48-year trend line between 1951 and 1999. As William Cohan writes in the Atlantic, “It's as if the run-up in the 2000s never happened.”

Up until now, the landlord business has always been a mom-and-pop industry. Blackstone figures it can professionalize the business, offering excellent customer service such as 24-hour on-call maintenance. Of course, cheap money has made this rental proposition compelling for Wall Street, while tight money for everyone else has cleared the playing field for the big players.

Rental REITs on the Rise

The rush to form publicly traded rental REITs began with Silver Bay Realty Trust (SBY) going public last December, followed by American Homes 4 Rent (AMH) and American Residential Properties (ARPI). The question is whether the economies of scale exist to manage multiple units in disparate locations. Managing 100 separate houses is more labor intensive and expensive than running a 100-unit apartment complex that sits on five contiguous acres.

Speaking on the second-quarter conference call of apartment REIT Equity Residential (EQR), company CEO David Neithercut commented on the single-family rental business.

“I think that they will be more challenging to manage than people think. I think that it's likely they will underestimate tenant credit quality, turn costs [i.e., cleaning, painting, repair], re-leasing expenses, capex [or capital expenditures] and maintenance… Not that it can't be done, but the notion that it can be done as efficiently and with the same profit margins as apartments is comical.”

Chris Meyer, the author of Capital and Crisis, recently cited the comments of Camden Property Trust (CPT) CEO Keith Oden. Camden is a large apartment REIT, but Oden said on his company's earnings call that his company had tried to pencil out a single-family portfolio.

His team couldn't make sense of the numbers. For instance, he said developers are modeling $500 for capital expenditures. “That's just astonishing,” he said. “The number could be five times that by the time you rip the carpet out and replace the sheetrock.” He considers the capex numbers “silly.”

Legendary property investor Sam Zell called managing a pool of houses “a hell of an operation to run,” and made the point that no one has ever successfully made such an investment work.

Professor Christopher Leinberger echoes Zell's concerns. “You can cobble something together,” but many units “are going to fall through the cracks as far as day-to-day management attention is concerned.”

Unlike buying a completed and fully leased apartment project, these REITs are acquiring properties so fast their vacancy rates are around 50 percent. This has some investors asking hard questions. “You don't see REITs in any other sector coming public when they're not fully occupied,” Jim Wilson, of JMP Securities, told the Wall Street Journal. “So the investors are saying, 'Are you actually getting these things leased?'”

In his article for the Atlantic, Cohan points out that most single-family homes are not designed and built for the heavier wear and tear that's normal from renters. Also, housing in one market is not the same as housing elsewhere. Consumer tastes change. Young people today are less inclined to get married, have kids, and flood suburban subdivisions. Today's Dallas could be tomorrow's Detroit.

Looming over and above all of these unsolved problems, interest rates are still near record lows. When they rise, the yields produced by these REITs will become less competitive with safer assets.

Investors tempted to play the rental market by purchasing shares of these housing rental REITs should think twice. Yes, with interest rates ticking up, these shares have been punished by the market of late. But the lower prices do not denote bargains.

The Fed's low rates have created a real estate price bounce, but it is only temporary. When the dominoes start to fall, it will be clear that the Fed has merely set up investors for more punishment.