What Lenders Should Look for in a Capital Provider
Choose Your Partners Carefully to Avoid Risk
by Eli Novey
A Demand for Housing Means a Demand for Capital
The need for capital in the residential real estate market has never been more acute. The lack of available housing inventory, already an issue before the pandemic, has only become more complex and widespread in the past 18 months.
For more than a decade, the United States has massively underinvested in its housing stock, with the amount of new housing being built woefully unable to keep up with population growth. Housing supply was further constricted as the expected exodus of Boomers from their homes never happened, and mortgage credit issued by banks following the 2008 housing crisis remained tight.
As of today, the median price for a single-family home rose the most on record in the first quarter of 2021. For lower-income renters, the situation is even more dire, as the U.S. currently has a shortage of 7 million affordable rental units for families with incomes at or below the poverty line.
Not only is capital required for ground-up construction projects to meet this staggering market need, but it is also necessary for renovating and rehabilitating America’s aging housing stock. The pandemic has underscored the importance of this by changing the way people work, and thus changing their housing needs—both in terms of the geographies they wish to live (suburbs over dense urban areas) and in the features they desire for their homes (such as home offices and swimming pools).
Despite this great need, residential real estate lenders should remember that not all companies providing capital are created equal or hold themselves to the same high standards. When choosing who to partner with, lenders should differentiate candidates based on the following criteria: access to capital, a consistent and reliable funding process, excellent service levels, industry expertise, and a disciplined approach to credit.
Access to Capital
It should go without saying, but reliable access to capital should be among the most important considerations when seeking a lending partner. For the lenders, much of this value comes down to repeat business. Home renovation projects are typically short term, with most loans having a duration of less than two years. Given this timeframe, borrowers are in the position of having to generate a constant stream of new opportunities, especially considering renovation stock has a finite supply in today’s housing shortage market. Having a reliable lending partner with ready access to capital saves valuable time, allows for faster turnover, and builds stronger relationships for lenders.
Consistent and Reliable Funding Process
Lenders in the residential bridge loan industry depend on volume to meet market demand, which in turn relies on a steady stream of available capital. In choosing a capital provider, it is critical to select a partner that will purchase loans from lenders on a steady basis—allowing for a measure of predictability and liquidity to apply to new opportunities.
A good capital provider provides transparent guidelines to lending partners for guaranteed execution. Lenders should be cautious of those who ask them to share all the loans they are working on and only buy the ones they like, rejecting many others from a “black box” approach. This approach disadvantages regional lenders, who can only service so many loans at one time and want them off their books as quickly as possible.
Industry Expertise and Recognition
Capital without knowledge has no value, so the provider lenders choose to partner with should have a deep understanding of mortgage credit in the residential and commercial space. They should be well-versed in real estate lending, capital markets, securitization, asset-liability management, asset management and credit. A lack of understanding of the monetary supply chain can lead to false assumptions, incorrect leverage, and unreliable service to the borrower.
Furthermore, the provider a smart lender chooses to partner with will be forward-thinking and can deploy innovations from overseas to address needs generated by the pandemic. For example, as more people seek single family home rental options in the suburbs, the market is responding with increased renovation projects targeted towards long-term rentals instead of resale. Toorak Capital Partners has adopted a lending model that determines credit based on the income generated by the rental property itself (not solely on the income of the borrower) and gives borrowers another option for growth.
A Disciplined Approach to Credit
Lenders should only consider capital partners that center the borrower experience and prioritize getting property valuations right. When valuations are accurate on the front end, this helps ensure that large losses are incurred on the back end, which eliminates significant risk.
Beyond credit checks and related due diligence performed at the time of initial loan funding, borrowers are required to substantiate renovation progress of their investment property before they can draw on any portion of the loan. This process provides for an additional touch point during the loan term and can act as a canary in the coal mine that indicates early signs of distress.
Excellent Service Levels
The ideal capital provider will have impeccable customer service. Ideally, a capital provider invests in technology that streamlines the customer experience for its network of lending partners. This technology can combine ready access to a qualified representative with real-time information on the status of each bridge loan. Such an investment sends the message that immediacy matters—and that experts are in place to handle the inevitable unexpected question. Again, this level of service speaks to expediency. Any issue that is not managed in a timely, professional manner takes away from the lender’s available bandwidth.
Grave Implications of Choosing the Wrong Approach
If there is ever a cautionary tale of what can happen when capital is provided to lenders in an irresponsible manner, look no further than the Global Financial Crisis of 2007-08. In the years leading up, mortgage-backed securities were often backed by inexperienced lenders looking to “fix and flip” properties in a low interest, capital-intensive marketplace. This asset class suffered from poor visibility into the core asset, limited credit checks with little or no income verification, and confusion exacerbated by assets being constantly sold and resold to new ownership. These securities were operating on a poor foundation—one that inevitably came crashing down.
Today’s market is ripe with opportunity—but lenders should choose their partners carefully. To avoid an unfortunate outcome and minimize risk, residential real estate lenders who make direct loans to borrowers should only work with partners that operate within a disciplined, well-capitalized, and reliable frameworks for providing capital.
