If the leading forecasters are correct, refinances will slow this year, pushing the mortgage industry once again into a purchase market. Most likely, this means that mortgage brokers and originators will yet again be scrambling to reestablish themselves as purchase loan experts. This is not a bad strategy, but a predictable and a somewhat overused one. A better strategy for 2020 — and the new decade — might be to focus on a specific subset of the purchase market: single-family rental (SFR) investors.
Why is this segment so attractive?
First, the demand for rental housing is growing faster than for home purchases. In terms of transaction size, repeat business and motivation, the SFR investor is potentially a more attractive client than the average homebuyer.
There also are new lower-cost financing options, particularly investor cash-flow loans — loans to investors based on projected future cash flows — that will immediately appeal to both seasoned investors who are looking to refinance properties and portfolios, as well as renovate-to-rent investors with high-cost hard money loans. Finally, because the investor market has traditionally been served by hard money or small-balance commercial lenders, it’s less crowded from the perspective of a residential mortgage broker.
The average investor most likely isn’t a one-off refinance candidate but potentially a repeat client who owns half a block in Texas, for example.
Let’s start with the demographics. Today, the share of Americans who are renters — 108.5 million in 2018, according to research company RentCafe — is higher than at any time since at least the 1960s. From 2010 to 2030, an estimated 13 million new rental households are expected to form, according to the Urban Institute. So, the demand is there and it’s going to get bigger.
According to Forbes, 53% of all U.S. rentals are SFRs or two- to four-unit properties — 23 million units in all. A few years ago, there were lots of stories about large private equity firms and hedge funds buying up the SFR market. But even at the peak of this trend, these large institutional owners never held more than 2% of SFR properties.
Then, as now, most of the SFRs in the U.S. were and are owned by smaller investors. The typical SFR investor today owns fewer than 10 properties and controls somewhere between 11% and 13% of all U.S. single-family housing stock.
Now think about that investor as a potential client. The average investor most likely isn’t a one-off refinance candidate but potentially a repeat client who owns half a block in Texas, for example. Show these prospects that you can take their existing hard money loans and convert them into a lower note rate, and they’ll instantly understand that you’ve improved their cash-flow position. Chances are this means you end up taking on their future loans. What do focused investors do when their cash flow goes up? They buy more properties, which creates more lending opportunities.
Although no strategy is market-proof, focused investors tend to be a bit more resilient because they won’t disappear if the 10-year rate goes up by 20 basis points or down by 20. This differs from your favorite aunt, who might go down the street or wait until next year to refinance if her rate goes from 3.75% to 3.875%. Investors are less rate sensitive and more keyed in on a holistic cash-flow approach.
To borrow a phrase from infomercials, “Wait, there’s more.” You know those dead times of the year, such as the holiday season, when people don’t want to move the kids or the Christmas tree? Investor business isn’t affected by seasonality. In fact, many investors look to buy properties during the holidays because if a property hasn’t sold by then, it’s going to sit on the market for a while, meaning there are bargains to be struck and potential business for you.
Selling the concept of investor cash-flow loans is relatively easy if you can get in front of the right person. Mortgage brokers often find that their current referral network — real estate agents, accountants and financial advisers — are good sources to reach smaller investors.
Originators have been very successful in using mail campaigns. It’s not uncommon for an investor who has one- to four-unit residential investments to hold them in a limited liability company (LLC). An easy way to compile a mailing list is to go to your title-insurance representative and say, “Give me a list of every one- to four-unit property owned in an LLC.” When you see these kinds of properties in an LLC, chances are they are owned by investors and it’s likely there isn’t only one property being held.
In many respects, these are some of the easiest loans to do. The borrower is qualified primarily based on the cash flow of the property (rent) in similar fashion to a commercial mortgage.
Four or five years ago, the majority of nonqualified mortgages were mainly full-documentation loans for primary residences, essentially agency- and jumbo-fallout deals. Bank-statement loans comprised a small share of the market and a slice of these were asset-depletion and investor cash-flow loans.
Fast forward to today and the investor cash-flow loan is one of the fastest-growing products in the non-QM sector. The primary reason this financing category is growing so fast is because it’s an attractive alternative to hard money loans, which can come with higher interest rates and fees.
Simply put, these loans give investors the opportunity to cash out their equity for far less than a hard money lender would offer. Cash-flow loans also provide improved flexibility in terms of long-term investment strategies. They can be 5/1 or 10/1 adjustable-rate mortgages, or 30-year fixed-rate loans, versus a hard-money note that may be due in two years.
In many respects, these are some of the easiest loans to do. The borrower is qualified primarily based on the cash flow of the property (rent) in similar fashion to a commercial mortgage. It’s basically a no-income, no-employment loan. What underwriters look at is the rent that the investor is receiving versus the new mortgage payment, plus taxes and insurance.
Can there be problems? Sure, if there is currently no tenant or the potential rent is in question, coming up with a reasonable, defendable cash-flow estimate will require more work on the part of the underwriter, as well as lengthier discussions between the broker and the client. Experienced wholesale lenders, however, can help brokers anticipate issues and counsel their clients.
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Ongoing education programs also can help mortgage brokers and originators get comfortable with cash-flow products, fine-tune their marketing programs and create strong investor relationships that generate repeatable, profitable business. So, if you’re looking for a new niche in 2020, it’s worth investing the time to understand the investor cash-flow loan market.