Key takeaways Wall Street has begun partnering with tech lenders to package loans to home flippers into mortgage obligations (also known as mortgage-backed securities). Securitizing remodel-and-resale loans will accelerate much-needed renovations of America's housing stock, but for some it also harkens back to ill-fated financial innovations of the past. Real estate agents and other professionals can take advantage of this trend by forming referral partnerships with remodel-and-resale lenders.
Wall Street and new online lenders are bundling loans to home flippers into renovation-and-resale mortgage obligations, giving hedge funds, private equity firms and other institutional investors a new way to invest in the housing market.
The bonds could help accelerate a long-overdue renewal of America's housing stock, but not without raising doubts about untested financial innovation.
Mortgage bonds, also known as mortgage-backed securities (MBS), allow large investors to buy large amounts of mortgages, freeing up lenders' balance sheets so they can make more loans.
For decades, this has boosted credit for ordinary homebuyers, and fix-and-flip mortgages could provide similar benefits to home flippers.
Bond issuance and sales
“This is a way to leverage this asset class to really create access to capital that historically hasn't been able to be invested,” said Paul Stockamore, vice president of capital markets at LendingHome.
LendingHome uses credit lines from investment banks to underwrite six- to 18-month loans that cover up to 90% of a property's purchase price and 100% of renovation costs at interest rates between 7.5% and 15%. The company has originated more than $1 billion in mortgages since it was founded in 2014.
LendingHome has partnered with Nomura Securities International, a financial services group and investment bank, to recently create a mortgage securitization vehicle.
The two companies have used this to issue three bonds totaling $126 million so far, which Stockamore says have been sold to large investors including hedge funds, private equity firms, real estate investment trusts and asset managers.
Fix-and-flip loans don't lend themselves well to bonds because of their short duration, but higher yields and demand for new technology have made securitization feasible.
“This translates into such large transaction volumes that it's actually justified,” said Nav Aswal, CEO of online lender RealtyShares Inc. Mr. Aswal said his company may issue fix-and-flip mortgage bonds in 2017.
Since its founding several years ago, RealtyShares has provided more than $300 million in capital to residential and commercial investors.
Wall Street replaces “Country Club Capital”
The bond builds on recent changes in financing for home flippers, who have typically only been able to get loans from local “hard money lenders” and have used “country club capital” to make loans.
Many of these lenders were hurt by the collapse of the housing bubble, said Matthew Neeser, co-founder of LendingOne, a Boca Raton, Fla.-based renovation and resale lender that pays referral fees to real estate agents and other real estate professionals.
But after reshaping the single-family rental market, Wall Street has turned to home resale, backing online lenders such as LendingOne and building remodel-and-resale lending units such as Colony American Finance Inc. Both are using new underwriting techniques and market analysis to offer large volumes of loans at low rates.
“These companies bring scale and uniformity to lending to real estate investors, as well as specialized lending practices,” said Rob Bloomker of OneSharp Capital, an investment management firm that is seeking to create a reform-and-flip mortgage bond. Bloomker was previously CEO of reform-and-flip lender Dwell Finance, which was acquired by Blackstone-owned B2R Finance in 2015.
The rapid reduction in capital has led to sharp cuts in financing fees for home flippers, with interest rates typically falling to 9% to 12% (or even less for the most experienced flippers) from 12% to 15% a few years ago, industry observers say.
About one-third of home renovations were financed in 2016, the highest rate in eight years but still well below the two-thirds peak in 2005, according to Atom Data Solutions. Meanwhile, total home renovation sales reached a 10-year high of $50.4 billion, and gross profit per renovation reached its highest level since at least 2000, according to the data provider.
“There's a huge amount of institutional participation in this space,” said Brew Johnson, CEO of PeerStreet. “We have partners ranging from endowments to large hedge funds to banks, all kinds of institutions that are interested in accessing this asset class.”
Benefits for home resellers
PeerStreet sources renovation and resale loans from lenders across the country and boasts Michael Burry, immortalized in the film “The Big Short” for his contrarian bet on the housing market, as one of its investors.
By making it easier for fix-and-flip lenders to sell large volumes of loans, fix-and-flip mortgage obligations could allow lenders to make more loans at even lower interest rates.
“The primary effect of bundling remodel-and-resale loans into mortgages is to increase liquidity in the remodel-and-resale market and allow the proceeds to be redeployed into more loans,” said Rayman Matoda, co-CEO of Genesis Capital.
“Depending on how the bonds are priced, there could be a side effect of lowering the cost of capital, which could be leveraged in one of two ways: lower pricing for borrowers or higher returns on equity for lenders.”
Easing credit will have a socially beneficial effect, industry observers say, by encouraging home flippers to do more to renovate badly needed inventory. The average age of a U.S. home was 37 years old in 2015, up from 31 in 2005, according to the National Association of Home Builders.
“It will be approved within a few days.”
PeerStreet helped Christian Fuentes, co-owner of Diamond Bar, California-based real estate brokerage Re/Max Top Producers, obtain financing to renovate a neglected property.
He said he bought the home with funds loaned by local lender Golden Capital Group, which then sent it to PierStreet.
“I'll buy a house, maybe it was the ugliest house in the neighborhood, and I'll completely renovate it and make it the best looking house in the neighborhood,” Fuentes said, “and then I'll contribute to the neighborhood. Ninety percent of the time, I sell it to a family, someone with kids.”
He can pay a 2% origination fee on a six-month loan with an interest rate of about 9% and a 30% down payment. Three years ago, the same loan would have come with a 3.5% origination fee and 13% interest, he said.
“They primarily look at the actual property and its value, what they're buying it for and the exact strategy,” he said of today's remodel and resale lenders.
“This isn't a regular loan where there's a full vetting. You can get approved in a matter of days, based solely on the property itself.”
Pioneer
LendingHome claims to be the only company to have devised a way to issue renovation-and-resale mortgage notes at scale, but other companies that have created similar notes include Center Street Lending (in partnership with Jefferies), 5 Arch Funding (in partnership with JPMorgan) and Anchor Loans (in partnership with Man Global Private Markets).
Next steps
To stimulate a secondary market in home repair and flip loans, financial innovators need to make it easier for big investors to trade and value the bonds, which means giving them ratings and extending their lives beyond the terms of typical bridge loans.
No one has yet managed to accomplish the first, but Anchor Loans has accomplished the second: The company issued $150 million in bonds in March 2016 and rolls in new loans over typically 11-month periods as the old ones are paid off. The bonds mature in three years.
1Sharp Capital, Genesis Capital, RealtyShares and PeerStreet, which does business with Goldman Sachs, are working on similar securitizations with the goal of eventually securing ratings.
“There's already been a lot more liquidity in this space than there was five years ago,” said Rayman Masouda, co-CEO of Genesis Capital. “Bonds are just going to take that to the next level.”
Genesis Capital, which funds real estate transaction platform Opendoor, with the backing of Oaktree Capital Management, provided more than $1 billion in bridge and construction loans in 2016. That's up from $50 million in the year before Oaktree invested in the lender about three years ago.
'[T]This will be a place to practice.”
The idea of remaking high-interest loans into new financial products has stumped some observers, who see a level of complexity and risk reminiscent of subprime mortgages during the housing boom.
But compared with the subprime mortgage market, the market for fix-and-flip loans is small, and today's institutional investors know not to buy bonds filled with bad loans, the people said.
He added that it's not at all clear that rated fix-and-flip mortgage bonds would be cost-effective.
“As this market continues to grow and more securitizations happen, at some point there will be a reality check and more sophisticated investors looking to expand into this space will look at the numbers and say, 'Hell, this doesn't make sense,'” predicts Dennis Cisterna, chief revenue officer at Investability and former managing director at FirstKey, a now-shuttered lending firm that reportedly provided loans to rental investors and home flippers.
“I'm sure we can do it.”
Kevin Dwyer, senior vice president of mortgage-backed securities at Morningstar Credit Ratings, said he has discussed the possibility of rating fix-and-flip mortgages with some bankers.
“I'm sure it can be done,” he said.
But he added that rating agencies will want to scrutinize the underlying loans and the past performance of similar loans by the issuer and its competitors.
“If not, we'll make some assumptions and those assumptions will be conservative and may affect whether it's economically viable,” he said.
Email Teke Wiggin.
Editor's note: This story has been updated to correct that Dennis Cisterna was previously managing director of FirstKey, not CEO.