An entire segment of the mortgage lending industry, known as Non-QM, was severely affected overnight due to the economic wrath created by COVID-19.
Non-QM is industry lingo for loans that are outside the Qualified Mortgage rule established by the Dodd-Frank bill, post-2008 recession. It was the new “Subprime” loan, except it required more skin in the game from the borrower and adopted an alternative method in verifying income through the analysis of personal bank statements. The introduction of the Non-QM segment had spearheaded the revival of several real estate sub-markets, including loans for self-employed borrowers, Fix and Flip, and Fix and Hold investments. Specifically, in Miami, it had also become a viable option for harder to place Foreign National borrowers that typically could not qualify for a Conventional Qualified Mortgage, the first tier in mortgage financing options.
Once the pandemic began to impact U.S. cities, the dislocation in the secondary market for this type of paper was immediate. The economic consequences were becoming clear with the spread of the Coronavirus and from a weary Wall Street that had already endured significant loses from extraordinary exposure in the 2008 mortgage meltdown. This time however, they pulled the plug quickly. The impact triggered a fragmented market that now has no middle tier. At the first tier, conventional QM loans were propped up by government reducing the discount rate and adding liquidity to stave off a severe recession. The third tier in mortgage lending is known as the Private Mortgage Marketplace. This tier is not cohesive or uniformed, which results in a lot of misunderstanding within the real estate and mortgage industry.
In this article, we will survey the multiple levels and differences in approach of the third tier of mortgage lending, with the goal of giving real estate and mortgage professionals a better understanding when trying to source financing for borrowers.
Most of the players in this bottom tier operate outside the scope of RESPA (Real Estate Settlement and Procedures Act) which provides the backbone for legal regulatory compliance in the conventional QM world. Private lenders, instead, originate and fund business purpose and commercial investment loan transactions. Terms like Hard Money, Bridge, Private, and Hard Equity are commonly incorrectly used interchangeably by our professional real estate and mortgage community. Now with more capital going into this market as investors look to implement more risk-based pricing on their loans, the confusion is growing even further.
In order to clear the obscurity of the Private Money tier, we must identify the players and outline their key differences. Let’s start by getting a better read on the difference between Hard Equity and Bridge Lending:
Hard Equity vs. Bridge Lending
Hard Money or Hard Equity loans are based 100% on the quality and valuation of the property. Required documentation of the sponsor is very light and almost inexistent. Since no financial information of the sponsor is provided, the interest rates and fees on these loans are substantially higher. Lenders involved in this level usually follow a “lend to own” philosophy. Bridge loans, on the other hand, require more information about the sponsor’s financial strength. Bridge loans are designed for experienced and professional investors that need quick access to capital to execute real estate investment strategies. By providing information about the intended transaction and their financial strength, investors can access lower rates and fees. Lenders involved in this level usually follow a “lend to earn” philosophy.
Participants in the Hard Money sector are usually individual investors and or small funds that are looking for real estate upside while earning a return. Their abilities to fund transactions are usually independent of lines of credit or loan committees, which makes them nimble to respond and close deals. However, their terms and rates are significantly higher. With COVID-19 there has been an influx of these types of lenders that are looking for short term opportunities and are charging rates reflective of risk pricing between 12-15%
Bridge lenders are looking to make smart decisions while navigating the uncertainty in valuations that the COVID-19 economy has created. They are focused on working with business partners, developers and savvy investors for long term relationships and referrals. They are more structured and work in a more formal and professional setting. Bridge Lenders also commonly have the ability to work on higher loan amounts and offer rates between 8-9%. They will also be quick to fund, usually 10 business days to close. This is where Vaster Capital operates.
Hybrid Private Lenders
Also, emerging from the post COVID-19 market, are Hybrid private lenders. These are smaller community banks that are funding residential asset types under commercial underwriting guidelines and regulations. These new balance sheet lenders leverage their platform to accommodate traditional private money loans. They are more formal and structured and will look at sponsor liquidity and reserves along with any income the property produces. We are currently experiencing a retraction on lending with commercial assets due to current economic conditions. So, these Hybrid private lender are turning their attention to residential type assets like Single Family Homes, Condos, and Town-homes being purchased by domestic and foreign investors- They are also looking at Multifamily buildings but with a lot of caution. Receiving rent payments is in peril with millions of unemployed individuals.
We are also noticing diverse investors coming into the market as private lenders who are trying to seize opportunities with high returns versus low cost of capital. They come from family offices, small hedge funds, sovereign funds, and a myriad of individual opportunity investors with small balance funds. The influx of capital is also being influenced by previous NON-QM investors that are creating spin-offs of their companies to focus on private lending only.
Competitive Advantage in a Time of Uncertainty
With so many actors in this theater of operations, playing such diverse roles, it will be important to understand and identify the differences and the advantages of working with particular lenders with a set of specific parameters to fit the specific transaction. For example, if speed is of the essence, on a client facing a potential contractual default, you must be able to assist the client to understand and navigate why taking a hard equity deal at a higher rate could make sense. When working with a sophisticated client, that has found it difficult to get access to financing through traditional banks, a bridge loan can get him the financing to recapture equity and invest in opportunities that will be available in the COVID-19 economy.
The private money market is just not that straight-forward right now. Having professionals in the field that can help you understand the differences and advantages of using particular lenders will give you a competitive advantage in a market rife with uncertainty.