Since the financial crisis of 2008-2009, banks and traditional lenders have scaled back their funding of real estate projects. However, private lenders have stepped up to fill the gap.
The private lending landscape is made up of both individual and institutional investors. Data collected by ATTOM Data Solutions indicates that one prominent real estate marketplace lending platform saw a 70 percent increase in home flipping loan dollar volume in 2017 over the year before, and a 50 percent increase in loan originations. Another prominent fix-and-flip lender experienced a 100 percent increase in loan originations. The average gross return on investment (ROI) for flipped properties that year, according to ATTOM, was $68,143.
The data shows that house flipping is growing in popularity. As a result, house flippers are getting deals financed in record numbers. But they’re not going to banks. They’re going to private lenders and marketplace platforms where lenders pool their money to fund real estate investments.
Why Private Lenders Should Fund Your Next Real Estate Project
Private lenders fund more than fix-and-flips. In fact, private lenders may fund virtually any type of real estate investment. That includes mortgages, home improvement projects, HELOCs, commercial and industrial ground-up developments and leases, and more.
They also use a variety of different business models, including marketplace lending, direct lending, and hybrid approaches.
The JOBS Act of 2012 opened the door to private lending for many real estate professionals who have struggled to find funding for their projects. The landmark legislation allowed lenders to use technology in new ways to market their products to potential borrowers. As a result, online lenders, most of them private lenders, have proliferated.
According to the Federal Reserve Bank of New York, online mortgage lenders have improved efficiency and benefited borrowers. They are able to process transactions more quickly than traditional lenders and respond more agilely to demand fluctuations and market conditions. The same is true of online lenders in every vertical.
With more than 200 real estate crowdfunding platforms in the U.S. alone, and billions of dollars funding investments each year ($33.7 billion in 2017), there has never been a better time for real estate developers and investors to find private capital for their deals. You just have to know where to look.
Private lenders do not place as much emphasis on FICO scores as traditional lenders. Rather, they look more closely at deal structure, real estate experience and track record, and project financials. Due to innovation in underwriting and risk assessment practices, private lenders have expanded their influence and helped more real estate pros realize greater profits and fund more deals.
Expectations for the Future Growth of Private Lending in Real Estate
In May 2019, The American Association of Private Lenders (AAPL) surveyed members of its Government Relations Committee to ask them about expectations for private lending in the next five years. The answers were interesting. Industry professionals said they expect
- the number and size of private lenders to grow;
- increased “professionalization”;
- new capital infusion to meet housing demands;
- private lenders to specialize in specific niches;
- private lending to drive platform innovation;
- higher returns with fewer players;
- private lenders to embrace technology;
- private lending to outperform banking;
- significant consolidation among capital providers and originators;
- increased state regulation.
In other words, it appears that private lending insiders expect the market to mature, and since real estate is one of the hottest markets for private lenders, we should expect the real estate lending market overall to mature.
Another thing that could impact the growth of real estate private lending are proposed rule changes for accredited investors. Among these proposed changes, the Securities and Exchange Commission is considering the addition of new investor classes based on occupation and certifications. Other classifications that could gain accredited status include registered investment advisors, rural business investment companies, family offices, and Indian tribes that meet certain investment criteria. If these proposed changes are passed, it would widen the door of demand on private capital, which will lead to market newcomers, new lending products, and a rise in private lending volume. The public comment period for these proposed changes ends mid-February.
How to Find a Private Lender for Your Next Real Estate Project
While market demand for private capital is growing and opportunities for investors are better now than ever, there is intense competition among private lenders, and among investors and developers for private money. That’s a good thing. Still, different real estate projects have different capital needs. Therefore, a search for capital should begin with identifying the type and amount of funding necessary for project completion.
Next, make a list of private lenders who can potentially fill that need. This will require some research.
When evaluating private lenders, look for the types of investments they focus on. If a lender specializes in home improvement projects and your project is a commercial ground-up development, that is not a good match.
You also want to look for a private lender who’s funding criteria match your project capital needs. Does the lender have a minimum or a maximum? Some lenders look for small deals in the range of $50,000 to $100,000. If your project requires millions of dollars in financing, then there’s an obvious non-match. On the other hand, if your project is a smaller project and a lender typically finances larger deals, you can eliminate that lender from your list of potential capital providers.
Another area where you’ll find a lot of diversity is with credit risk terms. Some lenders only fund projects if a developer provides some of their own capital. Others require a strong FICO score or a certain amount of experience. Some lenders use a loose risk assessment analysis while others are quite stringent. You’re looking for potential lenders whose terms match your ability to meet them.
Narrow your list to 3-5 potential lenders before making a final decision. Try to include a mix of lending models — for instance, direct lenders as well as marketplace lenders. You may even include friends and family members.
After you’ve got a solid list of 3-5 potential private lenders, create a presentation with your project details. It should include all project parameters, from acquisition costs to material requirements. Anything pertinent that a potential project funder would want to know should be included. In the case of marketplace lenders, find out what their project deal parameters are and make yours conform.
Finally, you’ll want to perform your due diligence on each potential lender. What is their reputation among real estate professionals? How many deals of your type have they funded? What is their success rate? Create a list of criteria that are important to you and evaluate each lending candidate according to that criteria. You want to create an apples-to-apples comparison so that you can choose the best lender for your real estate project. When you arrive at your conclusion, you should feel good about the funding source you have chosen and its match with your project.
In the competitive landscape of private lending, it’s important for real estate developers to find a lender who is the perfect match for them and their project. Marketplace lending is an excellent funding model for some projects, but it isn’t for everyone. Perform your due diligence based on your project, its funding requirements, and your personal values.
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