The Future of Real Estate Lending
A few weeks ago I wrote an article exploring the new rent backed bonds Blackstone has begun issuing. When I wrote that article I thought their next step would be to start buying leases from investors and bundling them up. Turns out, I was wrong…but not by much.
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Blackstone is calling their next step B2R. I recently had a phone call with one of their employees, and I thought I would share my thoughts on what this means for the real estate market.
What is B2R?
At its core, B2R is similar to a bank. Both lend out money to real estate owners, sell the debt to a third party, and start the process over again.
The difference is who they sell it to. In the case of banks it’s either a government agency like FNMA or a private note buyer.
B2R takes a bunch of these notes, bundles them up as a bond, and sells them to investors (mostly institutional). This is known as securitizing the notes.
To make this bundling process easier B2R only lends money on 5 or more rental properties.
Why would anyone buy these new bonds? Well…it’s repayment is not only backed by the mortgage but also the rental cash flow, so, in theory, it should be a safe place to park your money.
Why is This Good for Investors?
Make no mistake about it, this is the next big thing. If all else stays the same, this model will become the NORM, not the exception. Here’s why:
Less regulatory headache
If you don’t know already know, starting in 2014 the red tape you have to jump through to get a loan is going to exponentially increase. It's to the point that many smaller banks don't think they will be able to afford the extra administrative staff and are going to cease lending all together.
Enter the B2R model.
Since they’re securitizing their debt and selling it privately, they can avoid much of the bureaucracy.
At our company, we don’t pursue financing for our residential properties. Why? It’s too dang expensive.
Our average "all in" home cost is $50,000. We're extremely conservative, so at most we would only want to finance 50% of our home values (about $25,000). To get that loan we have to pay loan original fees (up to 2% of loan amount) and appraisal fees (say $1,000). So we're looking at $1,500 to get a $25,000? Up to 6% of the loan amount!? In what world does that make any sense?
I think we can all agree that appraisals are pretty much worthless. It’s one person’s opinion about what the market will support….turns out only the market can tell you that. The reason they’re universally used and so expensive is because regulators have mandated them.
B2R recognizes this.
Since they’re selling this debt on as a bond, they only care about the cash flow…so that’s what they focus on.
They still make an approximation of the value of the portfolio, but they do so by getting appraisals on 10-20% of the portfolio (for a largish portfolio) and Broker’s Price Opinions (BPO) on the rest. BPO’s cost around $100, way cheaper than a full blow appraisal.
How much cheaper? The cost of of us getting $25,000 in financing drops from $1,500 to around $500. Across our entire portfolio that could be $300,000+ in savings!
I’m already working with them to see what terms we can secure.
What Does This Mean for the Market?
Whilst this is the future…it’s also scary.
Bundling up mortgages into securities and selling them to private investors? Does this sound familiar to anyone else? It’s a couple steps further down the road than I warned about in my previous article.
Don’t get me wrong, securitization is nothing new and it serves a purpose. As with everything, they key is moderation. The subprime bubble burst because…everyone was doing it. There was an insatiable appetite for these products and standards were loosened to fill the demand. That’s how you wound up with a janitor making $25,000 per year living in a $1,000,000 home.
Today, the B2R’s standards are high: 1.25 debt service coverage, maximum of 60% LTV (70% recourse) and at least 5 properties.
It’s not Blackstone I’m worried about. It’s their competition. As more people clamber into the market, the debt service coverage might drop to 1.2, then 1.1, then 1. LTV might rise to 60%, then 70%, then 100%.
That’s still a few years off…we’ve got time.
Wrap it Up: Rent Backed Instruments are Here to Stay
With the new regulatory mess coming online in 2014, the market needs these instruments more than ever. I think this is going to help prop up the rental market…and by extension the entire market.
We just have to be very careful not to get caught up in the ensuing excitement and overdo it…
Photo: JD Hancock