Tired of dealing with a bank? Then it might be time to put your money where your house is. Not the one you’re living in, mind you, the fixer-upper that you want to flip for a profit.
Private money lenders are increasingly stepping into the void left by ever-tightening banks in the aftermath of the 2008 housing meltdown and that’s good news for professional investors whose business is buying, renovating and then selling homes.
“Banks provide, in a very limited way, (loans) to the absolutely best and largest companies where the principals have really big balance sheets,” says Jan Brzeski, founder and principal of Los Angeles-based Arixa Capital Advisors, LLC.
“Most people in this business can’t get a bank loan so they end up getting a loan from somebody like us.”
Here’s how the the trust deed process works – would-be borrowers go to a private lender’s website, request a quote and submit their application. Shortly after, sometimes later that same day, they’ll receive a response with the proposed rate and terms, provided they passed muster, of course. Within a few days, the money will be in their account.
In exchange for the lender’s capital, all a borrower needs to do is put the soon-to-be renovated property up as collateral.
Companies such as Irvine, California-based Equity Wave Lending will fund the loan initially and then sell the trust deed to investors.
“Instead of me holding on to the trust deed, I can sell them to a number of investors who are looking to collect a better coupon than if they left their money in the bank,” says Jack Suddarth, president of EWL.
A loan’s terms, of course, depend on the review of the customer, but the major determinant is the equity in the real estate. The more you own, the better the rate.
The company funds the loans internally and then sells them to one or multiple investors (the latter is called fractionalizing. For example, a $200,000 loan could be split four ways at $50,000.)
Arixa is a little different from most players in this space. Rather than following the Equity Wave model, they have a number of high-net-worth investors who invest in their funds and then the funds make the loans.
“When we make a loan, we don’t sell it to somebody else. We hold it until it matures,” Brzeski says.
Historically, a mortgage broker would find a borrower who had a house on which they needed a loan and then try to match them up with an investor who wants to earn a decent yield. After the transaction, everybody goes their separate ways.
The benefit of dealing with a fund, he says, is the flexibility it provides. If, for example, a borrower from a personal lender needs a three-month extension because their renovation took longer than anticipated, they’d be out of luck if the lender had gone on a round-the-world trip and was unable to sign the necessary documents.
That’s a flaw in the system, he says.
“We are the matchmaker and the investor together,” he says.
The Arixa model also addresses what he considers to be another problem, Brzeski says, where the broker doesn’t have any economic interest in the outcome of a loan. If a loan goes off the rails, the only thing incenting the broker to help the investor out is protecting their reputation.
“If the investor lost half their money, the broker doesn’t lose anything, he got paid up front,” he says.
But it’s not just the growing demand from home renovators that’s driving the market, it’s also being propelled by investors looking for yield.
It also helps that banks and credit unions have been forced to tighten their lending practices over the last few years. The Federal Deposit Insurance Corp. has increased constraints on them, requiring more capital be kept on hand, which reduces their ability to lend.
That reluctance to lend can also create opportunities for investors to use bridge lending to save for their retirements.
Suddarth says investors with a self-directed IRA can often make a solid gain by investing in trust deeds.
“You can buy one for $30,000 and make a very handsome return instead of investing in the stock market, which may be vacillating on a monthly basis,” he says.
It’s difficult to say exactly how big the market is but Brzeski is confident it’s reached the tens of billions of dollars. Just how big it could get is anybody’s guess, particularly with increased regulatory scrutiny. Brzeski welcomes it.
“One of the big things that has held this (sector) back from being an asset class for investors is that it was hard for typical investors to tell the difference between legitimate operators and somebody who is inexperienced, negligent or worse. Now when somebody sells a trust deed and investors buy into it, the state considers it the sale of a security,” he says.
Even though it seems this type of financing was created by the 2008 housing crisis, that’s definitely not the case, he says. There’s no question, however, that it accelerated it.
“It has been around for as long as lending has been around. The first real estate loans, which were likely made hundreds of years ago, weren’t done by a bank,” he says.
“It was probably by one person who had money and another who needed money but had a piece of property.”