The Evolution of the Hard Money Space and then PAUSE...

[Bradley Laddusaw]

The goal of this discussion is not to push any negativity among private lending operations that have started over the past few years. In fact, "mine is one of them". What we want to do is identify and explain how quickly the private lending industry evolved and why some companies had a firm stop as of last week.

In the hard money industry, the rates that are offered, coupled with leverage are a direct result of "supply and demand" of capital. The active real estate investors that were acquiring distressed assets in 2010/2011 may remember a time when everything was priced comparable. Common structures in California, dependent on leverage, started at 12% interest and 2-3% origination, sometimes higher. During this time there was an abundance of properties and not a lot of free capital available for loans. The main source of capital for Private Lending firms were Private Investors looking for a secured return against real estate, or Companies that had their own capital to lend out. Many brokers had borrower relationships but no capital. Brokers would refer these clients to Private Lending Firms.

As the market continued to gain traction in 2012 and into 2013, Private Lending Companies heard whispers that "Institutional Money", "Private Equity", and/or "Wall Street" money was making an attempt to enter the marketplace. Who could blame them? At the time, there were really no comparable investments that had as strong of a risk/return profile as a secured, first trust deed against real estate. There was a hurdle they faced, SCALABILITY. Technology and resources did not allow them to deploy the capital they needed.

From 2014 -2016 another shift started to occur as technology began to improve, crowdfunding became more mainstream, and Fintech started to make an appearance. Companies started to form mortgage pools, or funds, to allow for quicker closings and larger spreads. Online crowdfunding platforms started giving a huge group of retail investors access to loans secured against real estate. Family Offices were coming around to get more comfortable with lending. During this window as technology improved, "Institutional Money" started to make its push into the Hard Money Industry.

This newly available capital was great for the borrower. As access to capital improved, pricing, and leverage reached points that were not previously available. The Private Investors from 2011 and 2012 were now being pushed to compete with these new loan structures that arguably were "too rich for their blood" (ie: too risky). Remember from earlier, rates/leverage/and pricing are based on "supply" and "demand" of capital and there was an extreme "flood" of capital into the market, all while quality deals were becoming scarcer. I remember sitting down with investors in 2016, 2017 & 2018 and walking them through what was occurring. That was not the time to chase yield. Rather, stick to our parameters, even if it meant a reduction in volume. Leverage options were being increased while rates were being driven down. In investing, the term typically goes "More Risk, More Return." In this instance, we were seeing "More Risk, Less Return". The risk/return profile that attracted big money into the industry was being squeezed and this profile was no longer making sense.

In sitting down with investors, we discussed when "Big Money" sees an opportunity for arbitrage, they exploit that market until there is no way to gain an advantage on returns.

As quickly as "Institutional Money" enters a market, it can leave a market. Literally overnight.

Heading into 2019 there were great loan structures being offered to Fix and Flip investors. Fix and Flip investors were able to capitalize on the opportunities to borrow more money at lower costs than ever before. Correspondent lending programs exploded which helped resolve the scalability issue mentioned earlier. From a passive investor point of few, these structures did not appear to be sustainable at the pricing being offered. Again, "supply and demand" of capital.

The more money a firm raises over a short period of time, the faster it needs to get it to "work". We witnessed loan structures at 80%-90% LTP and 100% of the rehab. On paper, this netted over 100% of the purchase price. These were being priced anywhere from 1%-2% origination and rates starting in the low 8's%. A Private Lender was actually able to price out a bridge loan with substantially lower leverage, at an equal or slightly higher rate than a Fix and Flip Loan.

What happened?

Covid 19, Stock Market Sell Off, Liquidity dried up, and EXTREME Market Uncertainty.

How quickly can institutional money leave a market? Overnight. That is what happened last week. Hard Money and Private Lending operations that started over the past few years, backed by this Big Money, put a pause on lending. Not all of them, but a good amount. They are in a wait and see position. In other words, this potentially means, "Wait and Re-Allocate."

What does this mean for Active Real Estate Investors going forward?

This is simply my opinion, but in the short term, pricing and leverage options are going to "revert back to the mean". If you want to call it that. The structures will drift to what was being offered before "Big Money" entered the space and the 85%/100% structure may not make a return. There will be a sticker shock on pricing and leverage, as a majority of the Lending Companies still lending will be pricing risk into their loans. Leverage may be reduced; pricing may increase. There will be liquidity in the marketplace and a majority of this liquidity will be in the form of Private Investors and Companies that have done this dance before.

[Jay Hinrichs]

to ad d a little color to the conversation I first started in the HML space in the mid 80s in SF bay Area as a CA RE broker.
My dad had used HML or private money since the late 60s in Northern CA.

in those days 70s and 80s most hard money or a lot of it was 80 10 10 on owner occ.. because you could not get more than 80% loan to buy a home .. So the broker I worked for in those days did literally thousands of those small seconds and of course a lot of firsts.. rates were 5 and 15 1 to 3 year terms.. I used it to buy my second home in 81  120k  12k cash down 12k second that i paid off in 3 years at 15%  etc.

So we were all going along well and then the thrifts and S and Ls jumped into the space and cut our rates.. so we had to get more creative.. we were still pretty much at 20% apr. And that continued up until the GFC with mid west rates much higher than west coast since the loans were so much smaller.. it was common to write loans at 30% apr .. now those were 30 to 50k loans but we did hundreds per year.. And the majority were for BRRR landlords its how they bought mid west turn key.

Then as you correctly described the last 10 years or so.. 07 to 2011 many got wiped out.. Myself included. not totally but i had a book at 35 million our own money and 28 million of bank LOC that we tagged to lend money. those froze over night in the GFC.. and there went my company from 24 employees to 4 within a year and we basically disbanded.

the companies that started as you said in the 2 and 12 4 and 14 market of 2010 to 2014 did very well.. then its exactly like you said big money came in.. you dont need big margins when U have 100 mil to lend compared to the smaller 10 to 20 million size companies.. and the price war was on .. Especially in CA.. Oregon remained a little higher and the mid west and East coast stayed pretty high as well..So will be interesting to see how it all shakes out

@Dane Fitch  I see you work with lending home.. I looked at broker for them for a while but the price stucture was so low it was hard to really make any money at least what i am used to making.. but i love their pricing matrix. One of my clients uses them a lot back east and he said 2 days ago they lowered the LTVs a bit and raised rates a tad.

Will be interesting to see if this turmoil of the last month actually creates a lot of defaults.