The Rise of Private Capital Lenders and Why It Matters for Real Estate Investing
Things have changed dramatically since the crisis of 2008. Spurred by a collapse of the housing market, the most financially tumultuous time in recent history drove large-scale, well-known banks to pull the e-brake on real estate lending. While the jury is still out, there’s no denying that the crash of the late-2000s was exacerbated by banks handing out mortgages to risky borrowers who, frankly, couldn’t afford them.
So, suffice to say that, even to this day, those latter-mentioned banks are still quite hesitant to give out speculative loans. It’s like selling the same jug of milk within the same financial bounding box. You either fit within the parameters of that box or not. However, it’s this exact hole in the market that’s allowed Private Lenders to enjoy a massive second wind of popularity.
Lending From Non-Bank Intermediaries
Private lending has turned the tables on the traditional banking industry’s foremost product: Loans. Ten years since our nation’s most recent economic downfall, investors, from all industries and niches, having poured literally billions into companies and business that have been deemed by “Big Banks” to be too trivial or volatile to lend against.
Well, it’s turning out that this is an incredibly lucrative, healthy, growing market. Money flowing in is feeding the ten-year-long trend of private lending. In fact, it's valued at $500 billion, according to figures recently published by Bloomberg. The numbers are only growing, quarter after quarter; by 2020, it’s estimated that private lending could top $1 trillion. Much of which is within a completely unregulated financial market.
Tech-savvy Entrepreneurs are jumping on the proverbial train to, quite literally, capitalize on this boom, all while making it easier for small-scale borrowers to find applicable lenders. Jordan Selleck, for example, created DebtMaven, which is like a financial Tinder of sorts, is matching borrowers with lenders. These types of tools are yet to exist at scale in the real estate investment sphere.
Now after just two years, almost 500 lenders are signed up on the platform, ready to match with a growing amount of Private Lenders on the hunt for lending opportunities. “They’re hooked on deal flow and willing to pay,” Selleck told Bloomberg in regards to his lenders. “It’s grown at a crazy pace.” It’s not the same type of lending were used to, but a great analogy of the overall market trend.
What This Means For Real Estate Investing
Since the financial crisis of ‘08, non-bank intermediaries—i.e private equity firms, hedge funds, and other private capital lenders—are continuing to flourish, making up a greater proportion of all global real estate assets. For private real estate lenders, this surge of private capital is amazing news.
So, just why is private credit so intriguing to the lenders? Well, it all boils down to yield and regulation (or lack thereof). Ten years ago when the central bank, essentially, came to a standstill, profits from loans all but disappeared. To this day, those large-scale banks are still struggling to pull yields from those same-era loans.
To the contrary, those who are in the business of private lending can see incredibly lucrative returns. All-in yields of around 8 percent are normal with these loans, sometimes accruing even higher profit percentage rates (spread, interest, junk fees). When you compare that to the dismal 4 percent regularly touted by investment-grade firms and corporate bonds, it’s no wonder why private collateralized lending is enjoying its current hay day.
For outsiders, e.g. borrowers who are looking for loans collateralized by real estate assets, the benefits of these Private Lenders are nearly endless. For one, credit ratings are often not nearly as important in underwriting, due to the collateral and high-security nature of those loans. It’s obviously not the borrower that’s anchored to the loan. It’s the asset. Rates are also typically higher on these financial products. A caveat to the risk vs. reward profile.
Also, unlike bonds, private loans aren’t generally traded in the open market, meaning their interest rates and financial fragility will stay intact over the duration of that loan. These loans, too, aren’t commonly held on the books of a private lender. It’s common to see heavy paper trading of these debt instruments between private financial institutions the second they are funded. It’s a capability that lenders with lower capital costs can enjoy the luxury of profiting from.
Why is this important? Well, in a very compact nutshell, it means this: Your loan (or loans) aren’t bunched together with other financial assets associated with a said private lender. So, heaven forbid that private entity goes under, your loan is associated with company quotas, revenues, etc. when they do inevitably file and fold -- the assets still stand.
It just so happens the larger banks are also noticing a favorable risk vs. reward profile -- and investing heavily. Prior Blackstone, KKR and Goldman Sachs employees have created young startups and are amongst industry veterans that have amassed $9.5 billion in private investment assets over the past few years.
The Future of Fix & Flip Collateralized Lending Is Ripe For The Picking
Private lending is booming and likely on the cusp of a major market shift. Especially within the housing market. The unregulated nature of our industry probably won't last. However its favorable to lenders and even real estate investors who don't check the normal financial product (QM) lending boxes.
Realtors are taking financial compression, Mortgage Brokers are seeking product diversification in a softening QM market and Private Lenders are in an arms race to secure market share. Big financial institutions rarely touch our funding scenarios or our financial products, but are clearly interested in a nicely packaged upside.
There are ~1.3m realtors in the US. The profound market question is, how do you find those individuals sourcing investment opportunities in the real estate market? They self identify as investors, yet in most cases have little to no capital.
Upwards of 60% of these “real estate investors” (purchase decision makers) are realtors themselves, or hold a real estate license. They defer to Private Lenders to save deals falling out of escrow or even to poach an investment opportunity with their advantageous position in finding that property first.
Deal flow isn't about the borrower. Given that private lending is anchored to a physical asset makes lending an entirely different game. It’s no longer about the credentials, income, credit or liquidity of an individual - but their aptitude and ability to hunt and gather strong investment opportunities on behalf of a private lender. Contrary to industry standards these "borrowers" are your sales team. In the coming months or even years, keep your eyes peeled and stay fully focused on this market opportunity.