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   ARTICLE   |   From Scotsman Guide Residential Edition   |   December 2017

A Bridge to Opportunity

Helping real estate investors flip homes can be rewarding

A Bridge to Opportunity

Many residential mortgage originators are familiar with the traditional bridge loan as a strategy to increase activity in the residential purchase market. These short-term, often interest-only loans are used to provide a financing “bridge” between two other transactions, such as when homebuyers need to purchase a new home before closing on their old one.

That is not the only way bridge loans can be used, however. So, what other options are available for residential originators who are looking to expand their scope of business beyond the conventional homebuying sphere? Why not take a turn at flipping houses?

Investor bridge lending is another type of bridge loan that has been in the tool belt of many mortgage brokers and originators for some time. These loans have yielded beneficial and advantageous results for their overall businesses by opening the door to real estate investors involved in fix-and-flip operations.

Originators armed with bridge loan products can expect additional revenue outside of the traditional business they are used to. The process and documentation involved with investors is less cumbersome, so investor loans close much faster than the traditional residential loans originators work with.

In addition, originators can close multiple bridge loans with the same investor client, whereas in residential lending, homeowners typically purchase only one home that they keep for a few years until they buy again or refinance. Working alongside investors also opens doors to a multitude of networking possibilities and chances to connect with other Realtors.

Perhaps you have already received inquiries about bridge lending but didn’t know how to proceed. Let’s take a look at what you need to know about the bridge loans that real estate investors use, so you can become more familiar with and confident in your ability to work in this growing market of opportunities.

Nuts and bolts

You’ve likely seen the TV shows portraying flippers who buy distressed properties, rehabilitate — or rehab — them and, before the 30-minute show ends, have them ready to sell for a major profit. What these shows don’t clarify is that most investors don’t use their own money to finance both the purchase and repair costs of their fix-and-flips. Instead, they may use bridge loans offered by private or hard-money lenders.

Bridge loans are usually structured with a term of 12 to 24 months, with the expectation of repayment by or before maturity. Most lenders restrict the property type eligible for these loans to non-owner-occupied, one- to four-unit residential use, although a few have expanded into multifamily as well. Best of all, these bridge loans can be closed within 10 to 14 days if you find the right lender.

Because of the natural potential risk in these loans, interest rates are higher than conventional loans and points are charged. Lenders split the revenue from the points with the brokers who originate the loans. Even with higher rates, leveraging this funding allows real estate investors to hold their own capital while they get to the end-game of profit from the sale.

Loan calculations

Lenders calculate the loan amount based on a percentage of the total cost of the purchase price and the budget for the rehab, which produces a loan-to-cost ratio, or LTC. Lenders also limit the loan-to-value (LTV) amount, which is based on the “after-repaired” value, or ARV.

Most investors don’t use their own money to finance both the purchase and repair costs of their fix-and-flips.  

Generally, lenders allow up to 75 percent LTV. The end value in the ratio will be based on an appraisal using the renovation details and budget, which are provided by the investor. Viability of the project and the loan approval hinges on an end value that will cover the loan payoff and provide solid profit.

Take an investor who qualifies for a 90 percent LTC structure on a $100,000 purchase and a repair budget of $50,000, for example. This investor will be able to borrow up to $90,000 of the purchase price and $45,000 on the repair budget for a total loan of $135,000.

If this investor’s rehab will bring the property value up to $200,000, the LTV will be about 63 percent, which would be allowed based on the 75 percent maximum LTV. In this scenario, the investor stands to pocket $40,000 or more for a few month’s investment, depending on loan and project costs.

Experience matters

Lender guidelines vary, but most lenders approve the LTC and LTV based, in part, on the previous experience of the borrower. Because of potential complications in the construction process and the need for an understanding of the market, experience is a big factor that determines the percentage of the borrower’s contribution. Personal credit, liquidity level and claimed income also can be factors.

Some more established lenders provide online application technology that will give immediate quotes based on the borrower and the deal. This can be helpful to originators because of the different factors that work together to determine the terms of approval. In this lending space, FinTech, or financial technology, is becoming increasingly important for efficiency and accuracy, because it removes much of the guesswork in the process so there are fewer surprises.

Individual investors will usually be the personal guarantors for the loan, but the borrower of record is their entity, such as an LLC or corporation. This shouldn’t be a hurdle because serious investors have an established entity or entities for a few strategic reasons anyway. Non-recourse loans, where there is no personal liability, are limited in availability because of the extended risk with these loans.

To ensure completion of the project, the lender will usually set up a “repair escrow” at closing. The investor will request draws as they reach milestones. At these points, the lender will usually have inspections performed, and then they will release the funds based on the inspection. This should be a quick and efficient process so that cash flow into the project stays on track.

Originators will want to make sure their investor clients understand this process and/or have the experience necessary to bring the project to completion. They also will want to vet the lenders to make sure the draws will go smoothly. One bad project can sour the originator’s relationship with the client or the lender, or both.

Bridge loans take a considerably shorter amount of time to close compared to traditional financing.  

Experienced investors also will have an “exit- strategy” to pay off the loan, whether by selling the property or refinancing it as an income- producing rental. A few lenders offer rental financing as well so that the originator can efficiently help the investor refinance the bridge loan into a 30-year mortgage when renovations are completed, often with little effort because all of the information is already on file.

A growing number of investors are seeing the upside of holding properties, so this may be an important consideration for originators looking for bridge lenders. For those clients who don’t qualify for conforming refinance, they may need private-money term loans instead.

Opportunities abound

For residential mortgage brokers or independent originators, bridge loans can be a lucrative product. According to Attom Data Solutions, in this past second quarter, investors financed an estimated $4.4 billion in flipped homes, a  29 percent increase from the $3.4 billion financed  during the second quarter of 2016 and an almost 10-year high.

Serious investors are constantly active in the fix-and-flip or fix-and-hold market. Some may do one deal at a time, while others complete multiple deals at once. Building a relationship with an investor provides an originator with an ongoing opportunity for consistent and reliable business, which is usually not the case with residential lending.

Additionally, originators can have greater confidence in fast and successful closings because experienced investors are familiar with bridge loan financing, and bridge loans take a considerably shorter amount of time to close compared to traditional financing. The end result is more deals and faster closings, which translates into quicker and more frequent commissions.

Beyond the direct benefits originators get from offering this product, just having it in their arsenal can be a real conversation starter with Realtors and other groups of trusted advisers. Some Realtors specialize in the real estate owned, or REO, market, and bridgeloans are a great way to open doors to this segment.

Investor-borrowers also can make introductions to their Realtors. Most have “go-to” agents they use in different markets, which originators can potentially add to their own network. This also can work the other way. If an investor decides to sell a property instead of holding it as a rental and needs a Realtor, this can be a potential lead for one of the originator’s Realtor partners. Once this network is created, it can provide more and better opportunities for presenting bridge loan products as well as loan programs in the future.

•  •  •

Thousands of investors have relied on bridge loan financing to help generate substantial wealth and cash flow. These loans have an impact beyond just profit or a commission, however. This impact is felt in neighborhoods and residents that benefited from the work of these investors, which turned home values around in certain areas and contributed to stabilization of previously blighted communities.

The takeaway seems clear. If you are a residential mortgage broker or independent originator, and you don’t yet offer this product, you could be missing opportunities.


 
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