The President and CEO of a leading residential real estate investment lender says there are unique challenges in growing a real estate-focused platform into a national entity.
Jeff Ball said underwriting real estate transactions is a challenge for platforms because no one has created the methodology and technology to perform remote due diligence.
In contrast, with unsecured consumer lending credit scores are predictive of consumer behavior regardless of where the applicant lives, he explained.
“The hard part of lending in real estate, especially remotely, is the challenge posed with assessing the property’s condition and the area it is in,” Mr. Ball said.
This problem is especially acute in certain areas of major cities where revitalization efforts are taking place. In areas of Baltimore and Philadelphia, for example, some blocks can feature five or six houses which have been redeveloped and which are in good shape. A half-block down the street, someone may want to renovate a house between an empty lot and a burned-out home.
Tough to see that when you are working several states away.
One step Visio takes is to verify the borrower’s experience level, Mr. Ball said. If they have previously borrowed for several successful “fix and flips,” this says the borrower has at least some idea of the work involved and how much profit those efforts can reasonably expect to generate.
Take an example of a house valued at $100,000. A borrower may have a goal of putting $40,000 of improvements into that home and then selling it for $180,000 to generate a net return of $40,000, minus loan costs.
The experienced participant will look for a property in fairly good shape that would benefit from painting, new fixtures and maybe some flooring.
The rookie may not know what to look for when buying that first “fix and flip” and end up with a house that needs to be stripped to the framing.
“All of a sudden that house is worth less than $100,000,” Mr. Ball said.
Such repairs are beyond the scope of the weekend handyman, leaving them to have to hire a professional contractor. That increases costs and deceases profit margins, Mr. Ball added.
“If the deal goes sideways the platform now has to find someone to fix the property, which is especially challenging if the house is halfway across the country.”
That is why Visio only finances property purchases, Mr. Ball said. The borrower must be able to bring their own money into a deal to cover the upgrades.
Another challenge for real estate lending platforms is finding enough quality deals they can cost effectively perform due diligence on and present to investors, Mr. Ball said.
This problem is especially acute for remote lenders, Mr. Ball said.
“The risk for (remote) platforms is they get negatively selected,” he explained.
“If you are not the local guy you can get taken because if a local lender liked the deal they would have done it.”
Platforms can attract better quality deals by providing access to flexible and cheaper capital that gives them a cost advantage, Mr. Ball said.
When people are considering investing with a platform, there are many questions to consider, Mr. Ball said. The investor should know how the platform services the loans and what their approach is when deals do not work out. Some say they do not have deals that go sour, which is unlikely if they have any reasonable amount of deal flow.
Trustworthy platforms actually state what happens if the platform goes out of business, Mr. Ball said.
Visio uses a third-party servicer, which capital partners appreciate, Mr. Ball said. The servicer accepts payments and distributes funds to Visio and others.
Some platforms accept payment directly into their own general accounts, Mr. Ball explained. This provides less control over how the funds are spent. If a platform experiences financial stress, available funds are deployed wherever the operator chooses to send them.
Wise platforms also use a collateral agent who serves as a document custodian, Mr. Ball added.
During and immediately following the mortgage crisis, many people challenged a company’s ability to foreclose on a property. As loans were packaged and repackaged, it was hard to track ownership and keep proper files.
“Collateral agents hold the original loan files,” Mr. Ball said.
More attention is being paid to how the different lending platforms will react when the market hits a down part of the cycle. Mr. Ball believes it is sensible to assume those companies which combine decades of industry knowledge with technical expertise will fare better than those whose founders are great with technology but have scant experience in the field.
“Many of these underwriting models have not been tested through down cycles and I believe they are underpricing risk,” Mr. Ball said.