October 2021 – Page 7

Predicting the Market

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Whatever the Future Holds, Be Ready to Act Quickly by Danny Byrnes If there is one thing that everyone in our industry will agree on is the ebbs and flows are not always correctly predicted. Pre-pandemic, many felt the origination and refinance volumes had peaked and there would be a downturn. Those that planned around that likely found themselves short on resources and personnel to handle the incredible volumes that followed. Pre-meltdown, many felt that the capital markets business was growing at an unprecedented rate. When the meltdown occurred, many found themselves with resources that were going to go to waste, and talented and skilled employees were now out of work. Navigating your way through the ups and downs of the real estate industry takes experience, skill, ability to move quickly and probably most of all… luck. What experience or knowledge does one need to make executive decisions that will keep your company relevant, viable and always ready to pivot? Understanding the entire loan life cycle is a must and enables you to make sound and conservative decisions on where you will invest your time and money as you prepare to deliver. Software development, platform enhancements, R&D, talent acquisition, M&A are all high dollar items. Spending money you did not need to can, in the end, wipe out profit margins. Don’t spend it and then need it will put you in a position of not being able to take advantage when there are increasing lines of business or put you in a position of over promising and underdelivering. “It’s better to have it and not need it than to need it and not have it” does not work out well here. Nor does “build it and they will come.” Luck or Good Predictions At Nationwide Title Clearing we are fortunate to be involved in many areas of the residential real estate market and have had a fair amount of success planning around the trends we see. At first glance I would say we have been very lucky. However, in reviewing events that brought us that success, there actually were some intelligence and good predictions involved. So, what next? What do we prepare for and how much do we invest? For over a year there has been a lot of attention on default and the effect that will have on our industry. If everyone acted on that when it was first a concern it would have been wasted effort and money. What will happen when forbearance truly comes to an end? How much should we invest in development, staffing up, office space, contracting outsource vendors, etc? If and when interest rates increase, what do we do with all the resources we invested in to manage the volume we have experienced in the past 18 months? I’ll leave the conservative, broad answers to the experts but I can tell you why I am comfortable with our approach. At NTC we have put a lot of time and effort into diversifying our services across several areas of the industry. When one line of business dips what tends to happen is another side increases relative to the decrease. Our approach to software development has taken the same direction. NTC’s PerfectDocs platform is known for processing hundreds of thousands of mortgage Lien Releases. However it is also used to do the same for Assignments of Mortgage, a key part of the default process or any capital markets loan sale transaction. As refinance volumes decrease, we typically have experienced an increase in capital markets activity loan sales and an increase in default. And the final plan of attack is to ensure that we are cross training our employees so we can move them around to deliver different services as the market shifts as opposed to having teams of SME’s specific to a single service. There is a huge financial benefit to this, and it also minimizes the ramping up and down of employees through a hiring or firing process. This approach likely made us look like we predicted shifts in the industry correctly when in reality, we were simply well prepared regardless of our prediction and nimble enough to move quickly.

So You Want to Scale Your Real Estate Business?

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Try Diversifying Your Capital Stack by Kendall Bazan As a real estate investor, you are constantly seeking strategies that can help expedite the growth of your real estate business. One strategy you may not have considered is diversifying how you finance your deals. In fact, a diverse “capital stack” can be a game-changing way for you to increase your velocity. To meet your real estate business’s unique goals, you should understand the various sources of funding, the advantages and drawbacks of each, and when it strategically makes sense to use one over another. Capital stack is a term used to describe the various sources of financing a real estate investor utilizes in their real estate investment projects. These most often include private money, hard money, conventional bank loans, or personal funds, like cash. Though there isn’t a formula for building the perfect capital stack, each funding source has its benefits. Understanding the differences can have a huge impact on the speed of execution—and ultimately the profitability—of your projects. PRIVATE MONEY Private money is based on a relationship between two parties, such as a friend or family member. Private money is often more flexible than a bank loan or a hard money lender, so it’s often an excellent choice for an investor who doesn’t necessarily fit the lending box that other lenders require. Terms and rates can be more agreeable because the lender is often an individual and therefore doesn’t require institutional lending boxes or standards. If you operate at a relatively low velocity and have time to manage relationships, private money might be a good addition to your capital stack. The flexibility that comes with private money could be a huge selling point for some borrowers, but it is still essential to consider some of the drawbacks that come with it. As private money is often relationship-based, it can require a hefty amount of networking that may demand much time on the borrower’s part. Furthermore, private money is often much more finite than other funding sources, meaning that you may run into limitations or have to manage multiple private lenders at once. If truly scaling your business is your end goal, private money is likely not a sustainable option as a stand-alone source of funding. It also carries additional risk compared to other options. Because private lenders may not be bound by legal obligations, their personal preferences and opinions may start to have an impact on your investments. BANK LOANS The bank is one of the first places investors may look when in need of a sizable loan. While many real estate investors use bank financing for their acquisitions, it’s important to recognize its pros and cons. One of the biggest upsides to using a conventional bank loan is that it often has much lower interest rates than private or hard money. Moreover, it’s usually structured over a more extended period of time than a short-term loan. Investors often use a bank loan when executing the BRRRR (Buy, Rehab, Rent, Refinance, Repeat) or buy-and-hold strategy. Once the project is rehabbed in a BRRRR or buy-and-hold, often with short-term funding, an investor will pay off their bridge note with a lower-rate conventional bank loan. When it comes time to do a cash-out refinance using the BRRRR strategy, investors can take out a mortgage from the bank to turn their equity into cash and purchase a new property. These rental properties’ steady stream of income can go towards these long-term mortgage payments at a much lower interest rate. Similarly, investors who buy-and-hold might use a bank loan to pay off the bridge loan used to secure the property enabling them to pay a lower rate than the bridge loan. While a bank loan can be an attractive option in some circumstances, there are quite a few caveats to consider before choosing a conventional bank loan. Banks are notorious for taking their time when underwriting a deal. They can also lack the flexibility that a high-velocity real estate investor needs when executing multiple projects and strategies at once. A bank will also have stricter requirements than other financing methods, such as a credit score threshold, an extensive record of historical performance, property condition requirements, and extensive administrative paperwork. While banks can be useful when financing longer-term and lower-risk projects, they may not share your urgency when financing your investment project. HARD MONEY The last major funding source are “hard money loans” (sometimes used synonymously with “short-term bridge loans”). This method provides a short-term lending solution for real estate investors to finance their rehab and new construction projects. These loans are provided by lenders who may specialize in real estate rather than a traditional financial institution or independent investor. Many seasoned real estate investors are fans of this financing method, as they can utilize the speed, reliability of funds, and lender’s customer service to increase the velocity of their real estate investment business. Successful real estate investors are often the most profitable when they move quickly on projects, keep capital in circulation, and use leverage. In this way, one of the most notable advantages of using hard money is the ability to grow your real estate portfolio without running into a shortage of funds. Unlike banks, a good hard money lender will focus on the asset, the scope of the project, and the borrower’s investing experience rather than their financial position or liquidity, making the underwriting and administrative process much less stressful and demanding. While hard money loans are an attractive option for investors looking for fast, flexible capital, they do come with some potential drawbacks. The main con of using a hard money lender is typically a higher interest rate; due to these loans’ convenient, short-term nature, the interest rates tend to be more than those of a bank or private money. As a result, it’s essential to ensure that your project can be completed and become profitable in that short time frame. In this way, a suitable lender will be transparent

The Crowdfunding Investor

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Make Sure to Read the Fine Print by Carrie Cook There is no doubt that the rise of online crowdfunding platforms altered the face of the real estate lending industry. Real estate crowdfunding companies appeared overnight and quickly became one of the most popular ways for the average investor to participate in investments that were once reserved for the very wealthy. However, unlike the seasoned traditional and private institutions in the lending industry, these crowdfunding companies are still fresh faced, having only been around for less than a decade. This means that, much like any other business, the resilience of a crowdfunding platform has only been time tested by the bare minimum criteria. In other words, if the company’s platform is easy to use and the company provides consistently good product (performing real estate investments) with a competitive return, then they will continue to thrive. If they do not, then the company will fail to retain their current capital base and generate new capital, and eventually fizzle into nonexistence. While this is all well and good for business, the fact that these crowdfunding companies have yet to undergo the true test of their validity and sustainability – a full-blown real estate market correction – is largely understated. Unfortunately, this may be to the detriment to millions of investors who will soon realize the true extent of their exposure the hard way, and here’s why. Who stands to lose? When the Securities and Exchange Commission originally opened the door to crowdfunding with the passage of Rule 506 of Regulation D in 2013, these investments were originally reserved for accredited investors. Accredited investors were seen as being sophisticated enough to perform their own due diligence and understand the inherent risk, but more importantly, they are wealthy enough to handle the potential losses. In 2016, the door was thrown wide open when the second part of the Jumpstart Our Business Startups (JOBS) Act went into effect, allowing non-accredited investors to participate in these crowdfunding platforms. While this initiative to give the average investor more opportunities to expand their investment portfolio was well-intended, there will most likely be unintended consequences. These investments are not much different than what is being offered to accredited investors, exposing the average investor to a similar risk profile that they are less likely equipped to understand nor handle financially. What is the actual investment? Unfortunately, due to the more recent availability of these types of investments on the market, the average investor is simply not experienced enough to understand the investment as it is presented to them by the crowdfunding companies. Investors see the exciting pictures of real property online and assume that is what they are investing in, but really it is the fine print of the crowdfunding company’s Private Placement Memorandum (PPM) and the people running the company that they are investing in. Reading the PPM is monumental to understanding the investment. On the surface, the investor is led to believe that the investment is collateralized by a tangible asset. An investor must be savvy enough to request, read and understand the company’s PPM, or dig through the company’s website to find the true nature of the investment. The actual investment is typically referred to as a Borrower Payment Dependent Note. This Note is dependent on the borrower making their payment on the loan for the investor to receive returns and their principal back in full. The crowdfunding company is the one that is collateralized by the asset in the case of default and/or foreclosure. This leaves the investor vulnerable to losing their entire principal investment because they are simply relying on the good faith of the crowdfunding company and not the tangible asset to fall back on in case of default and/or foreclosure. When is the last time crowdfunding experienced a correction in the real estate market? Many traditional and private lending institutions have endured decades of market fluctuations and troublesome borrowers, which means they have extensive experience not only as a loan servicer, but also as an asset manager and coordinator for default resolution. To achieve recourse on a portfolio of defaulted loans, this experience is invaluable. They are more conservative in who they lend to and what regions they lend and will be less likely to overextend their servicing portfolio to any one borrower or investment type. They are also more likely to have contingency plans and funds in place for the next real estate correction. With these risk mitigation strategies in place when the market does correct, traditional and private lending institutions will be better equipped to continue as “business as usual”. The private investors investments are collateralized by real property, so they do not stand to lose their entire investment due to default and/or foreclosure. Crowdfunding companies formed well after the most recent market correction are driven by the volume of loans they can produce to feed the marketing of their online platforms. These companies are in as many regions and work with as many borrowers as they can, which makes it less likely they will be able to manage their book of business if the real estate market was to experience a correction. Investors will most likely be in a less favorable and more vulnerable position. How will the crowdfunding industry react to the real estate market correction? The real estate default and foreclosure process typically does not resolve itself overnight, especially if these loans are made in states that follow the judicial process for default resolution. This can therefore rack up extensive legal and management fees over time. An investor should review the crowdfunding company’s financial statements to determine if the company has any contingency funds set aside for the resolution process of a real estate correction to secure the investments on behalf of their investors. Investors will find the majority of the company’s income is allocated toward loan servicing and marketing to keep the online engine flowing. This means that when a default and/or foreclosure occurs, which is

Unbreakable Financial Discipline

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Technology Continues to Reshape What is Possible with Digital Wallet by Jake Harris How much more could we accomplish if unbreakable financial discipline was hard-coded into our projects? If lenders, owners, general contractors and subcontractors had complete trust and confidence in one another? If funds were available whenever needed, and could only be used for their intended purpose? How much time and energy could be returned to the work at hand, and away from project politics, playing the cashflow shuffle, and undue financial stress? Real estate investment is the ultimate platform for those who want to improve themselves and the world around them. Once the players, process, and products are known, it should be a simple rinse-and-repeat moneymaker all the way to retirement. But why isn’t this true for everyone? Surely it is for some, but unfortunately for most it is the exception, rather than the rule. What stops most of us from living the dream? It is a simple yet undervalued skill. It’s not taught in school, and it will never go viral on TikTok, but it is nonetheless essential to our success. Financial discipline. Those who have it will prosper, but for those who don’t, countless avoidable professional failures will usually follow. Achieving Financial Discipline thru Technology It’s elusive because there cannot be any weak links in the chain. All parties involved need to practice financial discipline for ultimate success—not just a select few. It is just as important that the owner practice responsible budgeting and cashflow as for the GC and the Sub. Any weak link, and any project is in danger of crashing down, no matter how big or how small. And of course, projects are complicated. They involve the work of many individuals over many months, and no two projects are alike. This has made the concept of financial discipline so hard to realize in the past. But technology can now step in where analog plans once fell short. “Digital wallets” are real, financial accounts that allow users to store funds, pay for, and receive payment for goods and services, on a simple, single digital platform. Their groundwork was laid in 2019, when the U.S. Office of the Comptroller of Currency changed our laws to allow American banks to create and manage digital wallets for their clients’ funds on deposit. This change was unprecedented. For the first time, funds could be moved by a computer program, not by an individual. This drastically increased speed and efficiency for these transactions without increased overhead or the risk of human error. Since this banking regulation change, many product platforms have come forth with their own digital wallets to expedite processing speed and avoid expensive transactional charges from traditional credit cards and slow, bank-to-bank ACH transactions. The Possibilities are Endless However, digital wallets provide much more possibilities than a one-time payment processing platform. Because they are now able to combine project management technology with back-end banking transactions, they also offer a platform that can behave like an escrow service with a trusted lawyer. Funds can be programmed and held by a disinterested third party for a specific and definite purpose. Rules and qualifications from contracts can be programmed in and met prior to allowing the transfer of funds from one wallet to another. In brief, funds can be programmed from their initial start, all the way down to their final destination. Purpose-built software planning combined with banking execution unlocks a great number of direct yield benefits for real estate construction and improvement projects. For a start, it allows for more successful loans. Having funds kept and distributed by a disinterested third party eliminates the risk of misappropriation or commingling. This process promotes a healthy portfolio of loans and borrowers with a faster project turn and lower default rates, allowing any lender to focus on growing stronger and more productive loans. Second, it leads to increased speed and efficiency for the GC and construction team, who no longer have to suffer financial stress from their project. By having the funds secured and ready for deployment, the construction team can advance at a much more rapid pace, reducing the time of construction and getting more projects done year after year. Third, digital wallets create a powerful reduction in overhead. Technology has always been used to automate routine tasks, but for the first time, our industry has a system that puts the project scope of work directly in line with the payments, and all with the ease of a button push. This technology is automating and securing entire layers of paperwork and administration duties, making them obsolete while saving time and manpower for everyone involved in the project. The Industry Has Finally Arrived We now live in a world where we can check our e-mails midflight from coast to coast. Where cars can be purchased before we even arrive on the lot, and prescription medications can be requested, prepared, and delivered in minutes. Even more amazing is the fact that these modern services all operate the same way: powerful innovations in technology have afforded us access to these conveniences through a phone and a few swipes of the thumb. But our own industry has taken longer to catch up. Up until very recently, owners were still blind to daily job site progress. GCs and Subs still relied completely on paper invoices and checks in the mail. Lenders held meetings to review portfolios of past work to gauge relative risk for a loan. That’s because the financial discipline problem could not be solved by a quick fix—it’s taken more than just faster bank transfers and emails. It has required a fundamental change in regulations, technology, and a new way to think about the way projects should be completed. As technology continues to catch up to our industry’s age-old problems, we’ll be able to create new in-roads into what is possible, finding more opportunities and unprecedented success.

The Multifamily Industry

by Erica LaCentra
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The Phoenix of the Real Estate Investment Space by Erica LaCentra It is no secret that the multifamily space was one of the hardest-hit segments of the industry when the pandemic hit. However, as the housing market has rebounded and thrived over the last year, with single-family rentals being the darling of real estate investors, things in the multifamily space have really been picking up steam and all signs are pointing to a surge in multifamily investor activity in the year ahead with the space already posting impressive numbers this year. And this is by no means a very recent development, by summer of this year, asking rents were once again climbing in many parts of the country. According to Yardi Matrix, “multifamily asking rents increased by 6.3% on a year-over-year basis in June.” This was the largest y-o-y national increase in the history of Yardi’s dataset, which has been tracking this information since 2001. So, what’s causing rent prices to grow and this space to rebound so significantly in such a short period of time? Plain and simple, the demand is growing. Just as we saw people leaving cities when the pandemic first hit, people are once again migrating to cities. People are returning to urban centers like New York, Seattle, Chicago, and Washington D.C. in mass, and these areas, like many other metros, are quickly rebounding. Increased demand from renters in cities with a limited supply of apartments is naturally causing rents to go up. This in turn has caught the eye of savvy investors who see the value in the long-term passive income that can be generated through multifamily rentals and want to take advantage of this rent growth. Yardi reported that “out of the top 30 markets they cover, 27 had positive y-o-y rent growth.” The Southwest and Southeast metros, in particular, are seeing the most drastic rent growth, with Phoenix, Tampa, the Inland Empire, Las Vegas, and Atlanta all experiencing double-digit year-over-year growth in June. While many experts believe this trend will ultimately level off at the end of 2021, these short-term gains have been a boon for the multifamily sector. The rapid growth in rents has also caused a growing interest in another area of the market which should also ultimately boost the multifamily space and give investors another area to direct their attention, affordable housing. The Affordable Housing Opportunity The affordable housing crisis is not new and was an ongoing issue pre-pandemic. The pandemic only served to exacerbate the issue, but as we move through the end of 2021 and into 2022, there is not only hope for a renewed focus on affordable housing, but this area presents itself as a massive opportunity for investors that are willing to get involved in this space. Just as we are seeing a boom in build-to-rent projects in the single-family space, the multifamily sector is expected to follow a similar path as demand continues to swell in major metros. The biggest concern, and potential roadblock, continues to be the increased cost of new construction projects due to material supply chain issues. However, many developers and investors are eyeing multifamily construction prospects in less dense markets that still have easy access to larger metropolitan areas as potential areas of opportunity for affordable housing going forward. Builders also have an increased interest in adaptive reuse projects and converting unused commercial properties, and even hotels, that are already perfectly situated in urban centers into affordable multifamily apartments. These types of complicated issues call for creative solutions, and the multifamily sector seems to be rising to that call and presenting opportunities for those braver investors that are willing to take chances. Lending in the Multifamily Space So, as we have seen the multifamily real estate space rebound rapidly this year, which bodes well for investors looking to get into this space, how is multifamily lending fairing? Multifamily lending took quite the tumble in 2020, but just as multifamily real estate righted itself and then some. Multifamily lending is also poised for a phenomenal recovery meaning investors will have access to the capital they need to get multifamily projects going in 2022. Just to put into perspective how well the multifamily lending space is doing, the Mortgage Bankers Association “expects a 31% increase in commercial and multifamily lending this year” and projects that multifamily mortgage bankers will “close $578 billion of loans backed by income-producing properties in 2021, up from $442 billion in 2020.” These projections and increased transactions continue to speak to the rebound of multifamily as well as the renewed investor interest in this segment. The association also has confidence in the multifamily space through 2022 also. The association is projecting activity “rising to $597 billion in commercial/multifamily originations and $421 billion in total multifamily lending” in 2022. All of this bodes very well for investors that are looking to make the most of multifamily this year as well as in 2022. The multifamily industry is truly a story of resilience, as many thought it would not recover for years after the hit it took in 2020. However, all signs point to 2022 being a tremendous year for the space as well as for any investors that are looking to get in on the action. There is no sign of renter demand slowing anytime soon, especially as housing inventory continues to remain extremely low, meaning profits for multifamily investors are ripe for the taking. It will certainly be interesting to keep an eye on this space and see where it goes in the new year, but for now, it’s nice to see how it’s been able to rise from the ashes of 2020.