Despite inflation and rising interest rates, private lending is expected to grow in 2022 and into 2023. Real estate private lending has excellent growth prospects for one simple reason: Real estate loans are in high demand.
It isn’t just private lending in real estate that is growing. Private lending all around is expected to grow, and it’s easy to see why.
Since the financial crisis of 2008-09, banks and other financial institutions have pulled back from the lending market. According to a paper published by Baker Institute’s Center for Public Finance, there are two primary reasons for this. First, after the crisis, Congress passed the most sweeping bank regulation reforms since the Great Depression. The Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 was designed to make the financial system safer but resulted in restrictions on banks that caused them to lend less.
The second change has to do with Fed monetary policy. Essentially, the Fed now pays interest to banks on excess reserves, which has been characterized by some as “paying banks not to lend.”
In any marketplace, where there is demand for a product, enterprising businesses will arise to meet that demand. Hence, the private lending market has steadily grown since 2009 to pick up where bank lending has left off. While the pandemic in 2020 temporarily impacted all sectors of the U.S. economy, including private lending, as the economy picked up again post-pandemic, pent-up demand gave rise to more private lending. We are on the verge of seeing a huge surge in private lending, especially in real estate, unlike anything we have ever seen before.
3 Reasons Private Lending Is About to Explode
No matter who you ask, everyone agrees: There’s a housing shortage in the U.S. There’s a shortage of homes to buy, and there’s a shortage of rental properties too. The shortage of homes and rental properties is driving up prices of homes across the nation and driving up rents. This is part of the reason the Fed has become aggressive in raising the funds rate. Fighting inflation is another.
The supply of housing, rising real estate prices, and high demand for homebuying as well as rental properties have created an idyllic environment for real estate investors. Whether the strategy is fix-and-flips, rental properties, or ground-up development, investors have incredible opportunities.
That isn’t changing.
While there has been something of a slowdown in the real estate market in the past few months, due to inflation and rising interest rates, that slowdown hasn’t been enough to make a huge dent in investing or lending. Private lending is about to pick up for three primary reasons:
- The housing shortage isn’t going away. People need homes. If they can’t, they’ll rent. The demand for housing is higher than ever and the supply is low. While higher interest rates are likely to slow down the increase in pricing, and in some places, it could cause real estate prices to decline, homebuyers are going to need loans. If they can’t get a loan from a bank, or if interest rates are too high for them to afford the loan, private lenders and real estate investors can write their own loans to accommodate the needs of homebuyers.
- Ground-up development is growing. Developers are building properties wherever there is raw land. There are still many cities with places to build, and in large cities with little raw land left, builders are developing single-family and multi-family properties outside of those cities. They will need loans for development.
- Fix-and-flip investors rely on short-term loans. While there are plenty of cash buyers in the market, many investors still use short-term loans even if they are cash rich. Borrowing money for property acquisition and rehabilitation allows them to leverage their net worth to grow their incomes.
In short, low housing supply and high demand is still driving the market in most places around the U.S. That means there is a huge opportunity for private lenders.
Misconceptions About Private Lending
Private money lending is as old as lending itself. It’s not new and it’s not innovative. But it is lucrative for financiers who have money to lend and can vet their borrowers, mitigate risks, and maintain a steady stream of customers. Even though private lending has been around for a long time, there are some misconceptions regarding the practice. Here’s the lowdown on private lending in 2022:
- Private loans are a means of last resort. Not true. Many real estate borrowers use private money loans to purchase properties and make necessary repairs. It is not a measure of last resort for many such borrowers. In fact, it’s their first line of attack in pursuing a profitable real estate investing business.
- Private loans require strong credit. Many private lenders do not run credit checks on borrowers. Not only that, but private lenders are free to set their own criteria for borrowers, so many of them have no requirement for credit score or credit history.
- Private lending terms are restrictive. Because private lenders set their own criteria for borrowing, terms are often less restrictive than bank and institutional loans. Every private lender sets its own criteria. Some are collateralized and some are non-collateralized. Some require upfront capital and some do not. Check with your private lender to find out their borrowing terms.
- Private loans take too long to acquire. Private loans typically have less red tape than bank loans. Some borrowers get a loan in less than a week.
Bloomberg reports that private lending hit a lull last year but that it is picking up again right where it left off. Banks haven’t opened to lending yet and are still restricted by legislative restrictions and monetary policy. Real estate markets are still characterized by high demand and low supply, which means there is a rich market for private lenders to step into. A recent survey shows that private lenders themselves see the opportunity.
- 88 percent say the private lending market is wide open
- The Russia-Ukraine war has not impacted lending and 70 percent of direct private lenders do not charge extra to compensate for volatility and uncertainty
- 94 percent say their asset allocation strategy has not been impacted by global events
What all of this says is that execution risk in the private lending market remains low.
If the private lending risk is low and opportunities are on the rise, we can conclude that private real estate lending is healthy coming out of the third quarter and going into the fourth. Private real estate lending is likely to remain strong throughout 2023, as well.