Wall Street Is Lending To House Flippers, Should You?
A recent Bloomberg article, "Hard Money Comes Easy as Wall Street Funds Home Flippers," highlighted the evolution of large Wall Street firms lending money to main street real estate investors.
Alternative asset managers with significant real estate lending operations are leading the way, such as Blackstone Group LP (NYSE: BX)'s B2R Finance LP; Colony Capital Inc (NYSE: CLNY)'s Colony American Finance unit; and Oaktree Capital Group LLC (NYSE: OAK), who invested $100 million with Genesis Capital back in January 2014.
"Bridge loans, also known as hard-money or asset-based loans, give flippers cash for home purchases and construction with about a year to repay, and are backed by the real estate," according to Bloomberg.
Traditional lenders such as commercial banks have backed away from real estate loans, which are more speculative in nature.
Do These Firms Make Risky Loans?
Yes, they do. It is a core business focus for firms such as Los Angeles-based $8 billion market cap Oaktree, a global alternative asset manager with over $100 billion of assets under management (AUM).
Inefficient markets and distressed asset are the lifeblood for firms such as Oaktree, which has over 900 people sourcing, underwriting and managing thousands of investments worldwide.
Wall Street - Risk Adjusted Returns
The Sharpe ratio is one metric used to rank investments' returns versus risk, and is used by Oaktree in the chart below to compare performance on a risk adjusted basis.
Private equity firms, hedge funds and alternative investment managers are experts when it comes to calculating risk, utilizing sophisticated quantitative models and proprietary algorithms.
Real Estate Risk & Wall Street - Painful Lessons
However, investors in real estate, mortgages and construction loans have also learned the hard lesson that markets can fail systemically.
Just a decade or so ago, a witch's brew of easy mortgage money, lax appraisal and underwriting standards, fueled a "go-go" market mentality that U.S. home prices only rise over time, led to a real estate asset valuation bubble.
These mortgages -- even the sub-prime loans -- were then bundled by top shelf Wall Street investment banks into agency rated CMBS, and other ingenious derivative securities, which were sold off to institutional investors around the world.
Warren Buffett famously dubbed them "weapons of mass financial destruction."
Be Greedy When Others Are Fearful
Traditionally, one to four unit real estate has been a Main Street, or mom and pop, asset class.
However, after the real estate bubble burst, Buffett notably said on a February 2012 CNBC interview:
"…Single-family homes are cheap now, too. If I had a way of buying a couple hundred thousand single-family homes, and had a way of managing them — the management is an enormous problem because they are one by one — they are not like apartment houses. I would load up on them."
Blackstone, Colony Capital and other institutional investors took heed. By mid-July 2013, Blackstone's Invitation Homes owned 29,000 single-family homes for rent, Colony owned ~10,000, and then-private American Homes 4 Rent (NYSE: AMH) owned over 14,000.
How Wall Street Creates A New Asset Class
Back in 2013 when Blackstone was buying U.S. single-family homes at a rate of $100 million per week, Deutsche Bank had extended Blackstone a $3.6 billion line of credit.
Today, Invitation Homes owns ~45,000 homes and AMH with over 36,000 is the largest publicly traded REIT focused on single-family rentals. Notably, Invitation Homes and American Homes were also the first in the industry to offer CMBS collateralized by pools of rental homes.
Notably, Blackstone's Tony James said in November 2013, "If your access to capital dries up, your business model falls apart. We don't have that problem."
Home Flippers – A Funding Evolution
Home flippers are typically either mom-and-pop, or small to mid-sized business. They also need access to capital, and while these loans are relatively small, they can be quite lucrative if all goes according to plan.
Historically, these types of loans were underwritten by local "home shark" lenders at terms that could vary from 12 to 15 percent, and typically 2 to 4 points on the loan.
According to Bloomberg, Cerberus Capital Management's FirstKey started offering fix-and-flip loans about six months ago and is just beginning to expand the business. Interest rates generally range from 9 percent to 12 percent for 12-month terms.
Firms like Colony American Finance and B2R Finance unit Dwell Finance, can lend to larger home flip operators, making loans cross-collateralized by multiple homes with release provisions, similar to revolving construction loans for new housing sub-divisions.
These strong borrowers can get a better deal from Wall Street firms.
Home Flippers – A Funding Revolution
Since the JOBS Act was passed in 2012, real estate crowdfunding platforms have been established to connect sponsors of real estate projects with accredited investors looking to make loans on various types of residential and commercial real estate projects.
One example of a company funding home flippers, is peer-to-peer (P2P) online marketplace Patch of Land, aggregating individuals willing to investment a minimum of $5,000.
Patch of Land originates, underwrites and services loans, offering these back to accredited investors through crowdfunding exemptions of the JOBS Act and SEC regulations.
Private investors who pool money on crowdfunding platforms are often attracted by high advertised yields for lending money on home flipping projects.
When a Wall Street firm makes riskier investments, a certain percentage can perform poorly and the portfolio can still generate targeted returns.
Individual investors have to guard against putting too many eggs into one basket. That is risky business.
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