{"id":144268,"date":"2022-08-18T10:33:27","date_gmt":"2022-08-18T16:33:27","guid":{"rendered":"https:\/\/www.biggerpockets.com\/blog\/?p=144268"},"modified":"2024-02-24T12:10:43","modified_gmt":"2024-02-24T19:10:43","slug":"layers-of-lending","status":"publish","type":"post","link":"https:\/\/www.biggerpockets.com\/blog\/layers-of-lending","title":{"rendered":"Keeping the Lending Cake Upright: How the Lending Industry&#8217;s Liquidity Crisis is Affecting Investors"},"content":{"rendered":"\n\n      <iframe loading=\"lazy\" frameborder=\"0\" height=\"200\" scrolling=\"no\" src=\"https:\/\/playlist.megaphone.fm?e=BIGPOC9567509730&#038;light=false\" width=\"100%\"><\/iframe>  \n\n\n\n\n<p><span data-preserver-spaces=\"true\">Recently, when the <a href=\"https:\/\/www.biggerpockets.com\/blog\/rising-interest-rates-challenge-investors\" target=\"_blank\" rel=\"noreferrer noopener\">Fed raised interest rates again<\/a>, my company, an institutional real estate investment lender in the <a href=\"https:\/\/www.biggerpockets.com\/blog\/private-money-lending-is-a-perfect-alternative\" target=\"_blank\" rel=\"noreferrer noopener\">private lending<\/a> community, was bombarded with calls from investors saying, \u201cMy lender suspended me for 45 days. They are waiting to see if Wall Street starts buying again!\u201d<\/span><\/p>\n\n\n\n<p><span data-preserver-spaces=\"true\">How can that happen?&nbsp;<\/span><\/p>\n\n\n\n<p><span data-preserver-spaces=\"true\">Rising interest rates are forcing everyone across the real estate investment lending spectrum to make quick adjustments.&nbsp;<\/span><\/p>\n\n\n\n<p><span data-preserver-spaces=\"true\">In this case, Wall Street banks, which purchase loans from lenders like us (who loan to investors like you), suddenly stopped buying those loans.&nbsp;<\/span><\/p>\n\n\n\n<p><span data-preserver-spaces=\"true\">This caused interruptions for some retail lenders who did not have enough of their own liquidity to continue funding (some discontinued funding temporarily, and others did so permanently.)<\/span><\/p>\n\n\n\n<p><span data-preserver-spaces=\"true\">This, in turn, created a liquidity crisis for some real estate investors.<\/span><\/p>\n\n\n\n<p><span data-preserver-spaces=\"true\">This is just one example of a lending industry in flux and its impact on borrowers.&nbsp;<\/span><\/p>\n\n\n\n<p><span data-preserver-spaces=\"true\">If you are an investor looking to ensure continuity in your project\u2019s financing, it\u2019s to your benefit to understand how money flows in the lending industry and what is taking place behind the scenes right now.<\/span><\/p>\n\n\n\n<h2 class=\"wp-block-heading\"><span data-preserver-spaces=\"true\">The Lending Industry Can Be Described Like a Cake<\/span><\/h2>\n\n\n\n<p><span data-preserver-spaces=\"true\">I\u2019m a lender, not a baker, but I will use the analogy of a three-layer cake to explain how money flows in our industry.<\/span><\/p>\n\n\n\n<p><span data-preserver-spaces=\"true\">The whole cake represents the institutional private lending industry.&nbsp;<\/span><\/p>\n\n\n\n<p><span data-preserver-spaces=\"true\">The cake\u2019s three layers provide liquidity amongst themselves while minimizing the risk within the cake.<\/span><\/p>\n\n\n\n<ul class=\"wp-block-list\">\n<li><strong><span data-preserver-spaces=\"true\">Layer #1 (Top):<\/span><\/strong><span data-preserver-spaces=\"true\">&nbsp;<\/span><em><span data-preserver-spaces=\"true\">Sovereign wealth,<\/span><\/em><span data-preserver-spaces=\"true\">&nbsp;<\/span><em><span data-preserver-spaces=\"true\">insurance money, large pension funds, endowments, overseas investors, and REITs (real estate investment trusts, such as MFA Financial, Inc. and Two Harbors Investment Corp.)<\/span><\/em><\/li>\n\n\n\n<li><strong><span data-preserver-spaces=\"true\">Layer #2 (Middle):<\/span><\/strong><span data-preserver-spaces=\"true\">&nbsp;<\/span><em><span data-preserver-spaces=\"true\">Private equity, Wall Street banks, and hedge fund companies (such as Blackstone, Nomura, and KKR).&nbsp;<\/span><\/em><\/li>\n\n\n\n<li><strong><span data-preserver-spaces=\"true\">Layer #3 (Bottom):<\/span><\/strong><span data-preserver-spaces=\"true\">&nbsp;<\/span><em><span data-preserver-spaces=\"true\">Loan originators (like us)<\/span><\/em><span data-preserver-spaces=\"true\">&nbsp;for&nbsp;<\/span><em><span data-preserver-spaces=\"true\">retail investors (like many of you)<\/span><\/em><span data-preserver-spaces=\"true\">.&nbsp;<\/span><\/li>\n<\/ul>\n\n\n\n<p><span data-preserver-spaces=\"true\">When these layers function fluidly, everyone benefits. However, a disruption in one layer affects them all. When that happens, you\u2014the investor\u2014may not get your piece of funding to complete your project. If you do, it may not be at the interest rate you anticipated.<\/span><\/p>\n\n\n\n<h2 class=\"wp-block-heading\"><span data-preserver-spaces=\"true\">How the Layers Function<\/span><\/h2>\n\n\n\n<h3 class=\"wp-block-heading\"><span data-preserver-spaces=\"true\">Layer #3<\/span><\/h3>\n\n\n\n<p><span data-preserver-spaces=\"true\">Loan originators (us) lend money to investors (you).&nbsp;<\/span><\/p>\n\n\n\n<p><span data-preserver-spaces=\"true\">We typically sell your loan to layer #2, which provides us with cash flow to continue lending. For assorted reasons, some of us carry some loans on our books (smaller lenders cannot do this for long without running out of money.)<\/span><\/p>\n\n\n\n<h3 class=\"wp-block-heading\"><span data-preserver-spaces=\"true\">Layer #2<\/span><\/h3>\n\n\n\n<p><span data-preserver-spaces=\"true\">These companies are aggregators of all types of investments, including real estate whole loans.&nbsp;<\/span><\/p>\n\n\n\n<p><span data-preserver-spaces=\"true\">They buy high volumes of investments (with billions in buying capacity) from layer #3, bundle them together into \u201csecurities,\u201d and sell them to layer #1 as \u201cinstruments.\u201d&nbsp;&nbsp;<\/span><\/p>\n\n\n\n<h3 class=\"wp-block-heading\"><span data-preserver-spaces=\"true\">Layer #1<\/span><\/h3>\n\n\n\n<p><span data-preserver-spaces=\"true\">Layer #1 companies\u2019 primary job is to put money to work by investing in various asset classes. They analyze the projected return of each class daily to determine where to put their next dollar. Layer #1 tends to have lower return hurdles and longer time horizons on these investments, so they can buy the securities from layer #2 at lower interest rates or price points.&nbsp;<\/span><\/p>\n\n\n\n<h2 class=\"wp-block-heading\"><span data-preserver-spaces=\"true\">Co-Dependency: Interest Rates<\/span><\/h2>\n\n\n\n<p><span data-preserver-spaces=\"true\">As the cost of money (interest rates) rises, it affects all three layers, and each must adjust its return parameters.&nbsp;<\/span><\/p>\n\n\n\n<p><span data-preserver-spaces=\"true\">With inflation hovering <a href=\"https:\/\/www.biggerpockets.com\/blog\/cpi-report-june-2022\" target=\"_blank\" rel=\"noreferrer noopener\">around 9%<\/a> and interest rates rising across all asset classes, asset managers in layer #1 continually review each class to find the best risk-adjusted returns available. (The risk-adjusted return is the return on capital one gets for the perceived risk in the investment.) They review factors such as treasury rates to determine how much premium they will receive for that investment over those treasury rates.<\/span><\/p>\n\n\n\n<p><span data-preserver-spaces=\"true\">Layer #2, which also manages risk across many assets classes, can no longer buy whole loans from layer #3 at lower rates due to increased financing costs from their lending partners (typically big banks), and lower demand from layer #1 for their securitizations at current coupon rates.<\/span><\/p>\n\n\n\n<p><span data-preserver-spaces=\"true\">So, layer #2 raises their pass-through rate, or \u201cbuy rate,\u201d to layer #3, which must then increase the rate to their investor borrowers to make their spread.<\/span><\/p>\n\n\n\n<h2 class=\"wp-block-heading\"><span data-preserver-spaces=\"true\">The Layers Have a Liquidity Crisis<\/span><\/h2>\n\n\n\n<p><span data-preserver-spaces=\"true\">Since layer #1 drives a lot of the demand (liquidity), there is a traffic jam of loans on layers #2 and #3 as demand has waned.&nbsp;<\/span><\/p>\n\n\n\n<p><span data-preserver-spaces=\"true\">Layer #2\u2019s balance sheets are overflowing with previously purchased lower interest rate loans. Because layer #1 now expects a higher interest rate, layer #2 is slowing down the securitization process.<\/span><\/p>\n\n\n\n<p><span data-preserver-spaces=\"true\">Layer #3 lenders also have loans they cannot sell. If their balance sheet is large enough, they can carry those loans until liquidity returns. If not, they may need to halt investor draws, stop lending temporarily, or even close their doors.&nbsp;<\/span><\/p>\n\n\n\n<p><span data-preserver-spaces=\"true\">This overall situation is also causing delays in closings, lenders to disappear, reputable lenders to tighten their borrower pools, and loan brokers to fall behind, as lenders fund their preferred clients.&nbsp;<\/span><\/p>\n\n\n\n<p><span data-preserver-spaces=\"true\">As you may have already experienced first-hand, all of this is trickling down to you, the investor, in the form of higher rates, less loan security, and fewer loan options.<\/span><\/p>\n\n\n\n<h2 class=\"wp-block-heading\"><span data-preserver-spaces=\"true\">The Cake Flops (or Does It)?<\/span><\/h2>\n\n\n\n<p><span data-preserver-spaces=\"true\">Will this cake flop?<\/span><\/p>\n\n\n\n<p><span data-preserver-spaces=\"true\">We don\u2019t think so.&nbsp;<\/span><\/p>\n\n\n\n<p><span data-preserver-spaces=\"true\">At some point, layer #2\u2019s ability to start securitizing loans will turn back on. But no one knows when that will happen, and in the meantime, a lot of lenders could be in limbo.&nbsp;<\/span><\/p>\n\n\n\n<h2 class=\"wp-block-heading\"><span data-preserver-spaces=\"true\">How to Have Your Cake and Eat It Too<\/span><\/h2>\n\n\n\n<p><span data-preserver-spaces=\"true\">Here are some things you can do to make sure your next project gets funded and stays funded:<\/span><\/p>\n\n\n\n<p><span data-preserver-spaces=\"true\">1. Build strong relationships with reputable lenders.&nbsp;<\/span><\/p>\n\n\n\n<p><span data-preserver-spaces=\"true\">2. Talk with your lender. (Be aware that not all lenders go through the layer #2 securitization process, including hard money lenders, private money lenders funding from 401(k)s and IRAs), and some lenders with finite funding capacities of $10 to $100 million that keep all their loans on their balance sheets.)<\/span><\/p>\n\n\n\n<p><span data-preserver-spaces=\"true\">3. Underwrite your deal numbers accounting for interest rate volatility.<\/span><\/p>\n\n\n\n<p><span data-preserver-spaces=\"true\">We do not know what impact the upcoming market and interest rate changes will have on lending.&nbsp;<\/span><\/p>\n\n\n\n<p><span data-preserver-spaces=\"true\">As an investor, the best thing you can do to mitigate the uncertainty is to work with a lender who knows their stuff and has the resources to have your back.<\/span><\/p>\n\n\n\n<div id=\"hero-block_62ee867235a1c\" class=\"first:mt-0 hero-block py-4    has-background has-slate-300-background-color has-text-color has-slate-800-color\">\n    <div\n        class=\"gap-10 lg:gap-20 flex flex-wrap lg:flex-nowrap max-w-screen-xl mx-auto px-4 relative lg:items-center \">\n\n        <div class=\"relative z-30 lg:w-2\/3 \">\n            <main class=\"py-4\">\n                \n\n<p class=\"has-theme-slate-color has-text-color has-large-font-size\" style=\"font-style:normal;font-weight:800\">All the cash flow, none of the hassle<\/p>\n\n\n\n<p class=\"my-3 md:my-5 lg:my-8 has-theme-slate-color has-text-color\" style=\"font-size:16px\">Learn how to create financial freedom and passive income in real estate as a private money lender.\u00a0<em>Lend to Live<\/em>\u00a0makes passive income through private lending achievable for anyone. <\/p>\n\n\n\n<div id=button-custom-event-block_64138705d4d27 class='button-custom-event'>\n      <a\n    href=\"https:\/\/store.biggerpockets.com\/products\/lend-to-live?utm_source=blog&#038;utm_medium=marketing_block\"\n        x-on:click=\"window.analytics.track('Blog Block | Publishing: Lend to Live Book', {\n      referrer: 'https:\/\/www.biggerpockets.com\/blog\/layers-of-lending',\n    });\"\n    class=\" btn-shape inline-block no-underline has-background has-theme-blue-background-color has-text-color has-white-color\" target=\"_blank\">Get Yours Now<\/a>\n  <\/div>\n\n\n\n<div id=button-custom-event-block_641384b1eb1d8 class='button-custom-event'>\n  <\/div>\n\n            <\/main>\n        <\/div>\n\n                <div class=\"lg:w-1\/3 first:mt-0 relative h-full lg:flex lg:items-center\">\n            <img decoding=\"async\" class=\"object-cover w-full relative z-20 my-0  rounded-md hidden lg:block\" src=\"https:\/\/www.biggerpockets.com\/blog\/wp-content\/uploads\/2022\/07\/lendtolive-cover-scaled.jpeg\" alt=\"lend to live cover\" title=\"\">\n        <\/div>\n            <\/div>\n<\/div>\n\n\n<p><\/p>\n","protected":false},"excerpt":{"rendered":"<p>Recently, when the Fed raised interest rates again, my company, an institutional real estate investment lender in the private lending community, was bombarded with calls from investors saying, \u201cMy lender [&hellip;]<\/p>\n","protected":false},"author":613620,"featured_media":144271,"comment_status":"open","ping_status":"open","sticky":false,"template":"","format":"standard","meta":{"_acf_changed":false,"footnotes":""},"categories":[7119,8],"tags":[],"class_list":["post-144268","post","type-post","status-publish","format-standard","has-post-thumbnail","hentry","category-biggerpockets-daily","category-real-estate-trends"],"acf":[],"comment_count":0,"_links":{"self":[{"href":"https:\/\/www.biggerpockets.com\/blog\/wp-json\/wp\/v2\/posts\/144268","targetHints":{"allow":["GET"]}}],"collection":[{"href":"https:\/\/www.biggerpockets.com\/blog\/wp-json\/wp\/v2\/posts"}],"about":[{"href":"https:\/\/www.biggerpockets.com\/blog\/wp-json\/wp\/v2\/types\/post"}],"author":[{"embeddable":true,"href":"https:\/\/www.biggerpockets.com\/blog\/wp-json\/wp\/v2\/users\/613620"}],"replies":[{"embeddable":true,"href":"https:\/\/www.biggerpockets.com\/blog\/wp-json\/wp\/v2\/comments?post=144268"}],"version-history":[{"count":0,"href":"https:\/\/www.biggerpockets.com\/blog\/wp-json\/wp\/v2\/posts\/144268\/revisions"}],"wp:featuredmedia":[{"embeddable":true,"href":"https:\/\/www.biggerpockets.com\/blog\/wp-json\/wp\/v2\/media\/144271"}],"wp:attachment":[{"href":"https:\/\/www.biggerpockets.com\/blog\/wp-json\/wp\/v2\/media?parent=144268"}],"wp:term":[{"taxonomy":"category","embeddable":true,"href":"https:\/\/www.biggerpockets.com\/blog\/wp-json\/wp\/v2\/categories?post=144268"},{"taxonomy":"post_tag","embeddable":true,"href":"https:\/\/www.biggerpockets.com\/blog\/wp-json\/wp\/v2\/tags?post=144268"}],"curies":[{"name":"wp","href":"https:\/\/api.w.org\/{rel}","templated":true}]}}