The national media reported at various times last year that the residential home-flipping investment market was alternatively flourishing, flagging and even flopping, based on short-term sales data. Most of these reports on the ups and downs of the market missed a bigger story — that more mom-and-pop investors than ever before are buying, renovating and selling single-family homes and properties with fewer than five units.
There’s another underreported story about home flipping. For mortgage brokers, this might be the best time to work in this space. Where cash was once king in these deals, brokers can draw from a larger pool of potential clients and also tap financing options that can better compete with cash.
Residential bridge lending, which provides short-term loans to buy and renovate residential investor properties, remains widely misunderstood. This space is still perceived as the domain of free-wheeling, Wild West-style hard money lenders. In fairness, the precrisis housing bubble and its lax lending standards continue to cast a shadow over residential bridge lending.
Bridge financing that caters to fix-and-flippers and fix-and-renters has traditionally been less developed than other areas of commercial mortgage lending. There were few true national lenders in this space, and the underwriting standards varied tremendously among numerous regional and local lenders. For borrowers, this resulted in limited access to capital and less-than-favorable terms and pricing.
To be sure, the media also has contributed to confusion. Last year, the narrative on the economics of home flipping changed with the latest data release. In April 2018, for example, NPR ran a story titled, “A Decade After the Bubble Burst, House Flipping Is On the Rise.” Before the end of that year, new data was released and the headlines turned decidedly negative in articles by The Washington Post and MarketWatch. By April 2019, the sentiment shifted again in The Wall Street Journal with “House Flipping Is Back to Pre-Crisis Levels. Here’s Why It’s Less of a Concern.” Two months later, Yahoo Finance reported just the opposite: “Why home-flipping numbers could signal a problem for the housing market.”
The institutional investors that once competed directly with mom-and-pop investors to purchase properties are now financing the mom-and-pop projects.
Beyond these headlines, one story about this market was underreported — how residential bridge lending directly addresses the nation’s housing availability and affordability crisis. Residential bridge loans help local communities provide new housing opportunities, repair unsafe or unhealthy housing, and increase the overall quality of life.
These loans finance many projects that increase housing affordability. Examples include modernizing and rehabilitating outdated housing stock, converting industrial and retail properties into residential units, and conversions of single-family properties into multifamily properties. Additionally, residential bridge loan borrowers have a substantial positive effect on local construction employment, as real estate developers hire and pay laborers in these trades.
Also overlooked has been a major change unfolding in the market — the evolving role of institutional capital. First, as CoreLogic demonstrated in a June 2019 special report, the homebuying rates for institutional investors — those who own more than 100 properties — have been steadily declining since 2013. The overall investor homebuying rate, however, remains at a 20-year high as mom-and-pop investors, or people with 10 or fewer properties, offset the declines in institutional-investor purchases. The mom-and-pop segment currently comprises more than 60% of the U.S. investor homebuying market.
A second, less-documented trend has been increased accessibility of residential bridge loans and lower costs of capital for mom-and-pop investors. In the past two years, institutional investors have pumped billions of dollars into residential bridge loans, sparking a marked improvement in loan terms and a 200-basis point or more improvement in average interest rates.
Residential bridge loans and small-balance multifamily loans are now being securitized, providing further credit standardization and liquidity for the market. The result is that local investors are entering the market at a time when access to capital is increasing and its cost is falling. The institutional investors that once competed directly with mom-and-pop investors to purchase properties are now financing the mom-and-pop projects.
So, residential bridge lending has evolved. Yet the space continues to be tagged with the pejorative “hard money” label, similar to how consumer mortgages that don’t meet all the standards of a qualified mortgage are labeled “subprime” with all the negative associations from the past. Once institutional capital entered the bridge lending space, terms improved significantly, as well as the quality of the loans. Today these loans have average FICO scores above 700, loan-to-value ratios set at a conservative 65% and repayment rates that average less than two years.
Today’s residential bridge loan market looks more like the traditional owner-occupied mortgage market than the syndicate-based “hard money” style of bridge lending that took place in the past. In that sense, residential bridge loans no longer deserve the hard money stigma that the industry as a whole continues to attach to this space.
Competing with cash
Despite the entry of sophisticated national lenders in the space, the majority of the home-flipping market is still an all-cash business. More than half of the homes flipped nationwide in 2019 were purchased with no financing. Compare that to the consumer homebuyer market, where more than 80% of borrowers use financing.
The biggest competitor for residential bridge lenders isn’t a short-term downturn in the market or large institutional property managers. Their biggest competitor is cash. And the biggest competitor for a mortgage broker working on behalf of a client who needs financing to buy an investment property is the all-cash buyer.
The reason mom-and-pop investors favor cash has nothing to do with aversion to leverage. Rather, it’s a matter of access. The post-crisis residential bridge lending environment was dominated by local private lenders. Traditional banks and institutional players were nonexistent, forcing lenders to rely on syndicates for funding.
That meant borrowers sometimes went through a long, complicated process only to be turned down because the funding had run out. Preapproval didn’t really exist. Credit and underwriting standards varied widely, which made it nearly impossible to shop around for the best rate. After all that hassle, the investors who did receive financing were saddled by high rates and unfavorable terms — and so, in that sense, the “hard money” label placed on the lenders in this space was earned.
The emergence of institutional funding for the residential bridge market has dramatically changed that dynamic, however. With lower interest rates, increasingly uniform credit and underwriting standards, and increased liquidity, mom-and-pop investors have better financing options and that financing is expected to be increasingly prevalent.
Even if residential investor profits dip somewhat, investors with access to lower-cost financing will be able to better allocate capital, increase project size and scope, then repeat the process knowing that abundant institutional capital means their lender won’t back out on them at the last minute.
Lenders who see the opportunity in residential bridge loans are partnering with an institutional funding source to provide this type of financing. This also is opening up new sources of funding for local real estate investors, as well as providing new opportunities for the mortgage brokers who serve them.