The Future of DSCR and Fix and Flip Lending?

Question

I have been seeing a whole bunch of lenders get super aggressive on the rate and terms for both Fix and Flip and DSCR Loans. I wonder if any lenders have insight as to why that is? I am seeing DSCR rates near conventional lending rates and Fix and Flip Lenders doing some pretty aggressive loans...

It makes me wonder, what's really going behind the scenes?

Doug Smith · Answer

The positive thing about being old is that I've seen a lot...including several crashes. Our industry is cyclical. As each cycle ends and nears a correction, I've noticed high LTVs, aggressive pricing, and loosening underwriting guidelines. I think we're seeing that play out now. I'm not saying we're facing a crash, but a lot of the reason you see a lot of foreclosures at a point in each cycle is due to those three factors as much as market forces. I would contend that's starting to happen for this cycle. Good discussion.

Patrick Roberts · Answer

I feel like every day, I hear about a new REIT/PE Fund/Private Credit Fund entering the space and offering to buy/hold this paper. On the surface, it seems very promising: highly secured, risk adjusted yields that should be 300+ bps over treasuries, especially in the face of an equities market that's getting riskier by the day.

That being said, for about a year now Ive been seeing riskier and riskier loan products: 85% LTV DSCRs, 90-95% LTC fix and flip, lax experience requirements, etc. When the market eventually corrects and a lot of these overly-aggressive loans go sideways, we will see a pullback from this. Especially after the equities market eventually corrects and becomes a much better buying opportunity - a lot of this private capital will flow out of fixed income and into equities.

Who knows when this will happen, though. Could be 20 years

Jay Hurst · Answer

The same reason sub prime went from a niche business to everywhere in the earky 2000's: Creative financial enegineering in the form of securtization.  Up until a few years ago, Fix and flip (Resendiatial transition loans, or RTL in Wall street parlance) was not able to be done on scale for a lot of reasons. Big data has "solved" some of these, and solved is in quotes because time will tell, but the biggest issue was short term nature of RTL business with expensive and tricky servcing with draws required etc. How do you securtize that kind of loan when investors want certainty and standardization, and the production is non standard and prodced by mom and pop.

Deep pocketed asset managers saw the hole, and funded orginators with a national footprint and were able to standardize the business, warehouse and service the loans until there was a enough secondary market demand and create the MBS market for RTL. That was about 2018-2019. Now those securities have good track records (all be in it a real estate market that has gone straight up until recently. sound familar?) so more and more asset managers are eager to sell securties, and of course, bringing down price as they compete for the business. It is still a tiny business and is not at all systematic like subprime MBS was, but I am worried a bit that taking mom and pop out of the loop who really care about their money has reduced standards and deals are getting done that should not be and there might be  touble in that securtization market. Seems to happen late in the cycle often.

Patrick Roberts · Answer

Yep. The fixed income resurgence has everyone jumping on the bandwagon. The fixed income world was so yield starved for almost 20 years that now everyone thinks secured lending at 6% is the deal of a lifetime. Yields in the mid 6's for insurance companies and pension funds make sense to some extent- it's the inherent credit risk that's a problem. Like you said, the race to the bottom means making riskier loans in order to win deals.

I think it's a bifurcated problem. DSCR loans are likely appropriately priced at mid 6s to low 7s for long run solvency and sustainability. Credit risk is the wild card - these loans should be incredibly safe at these yields - DSCRs greated than 1.10x, downpayments of 25%, documentable operating skill from the owners, high credit scores, etc. Fix and flip, on the other hand, is and always has been a high risk product. Yields on these should never be below 10%, and even that is on the low side. 12%+ is very realistic given the expected defaults and workouts on these. Just my $0.02.

I suspect we will get back to some place of sanity and reasonableness on all of this over the next few years. A significant fraction of the loans and deals I've been seeing are ticking time bombs. Just a matter of when, not if, they blow up.

Jeff S. · Answer

It's happening right before our eyes, Patrick. I sat on a panel a few weeks ago where one participant, who specializes in DSCR loans, discussed originations at rates lower than recent conventional loans. Others had DSCR requirements as low as .7 (!!!).

The race to the bottom isn’t coming—it’s already here.

Chris Seveney · Answer

Lots of cash on sidelines.

Mike Grudzien · Answer

Lenders are responding to pent up demand from several years of high interest rates.

Deborah Wodell · Answer

Really solid points in this thread. From what I’m seeing, a lot of this “race to the bottom” is being driven by competition for deal flow and secondary market appetite. DSCR and fix-and-flip loans look attractive when there’s cash on the sidelines and investors chasing yield, but at the same time, it’s easy to see underwriting loosening in ways that don’t line up with long-term sustainability.

I think the bigger question is how long this kind of pricing can realistically hold before credit risk forces a correction. Like Doug mentioned, cycles always repeat themselves, high LTVs and aggressive terms feel great until the market shifts. DSCR at mid-6s makes sense if the fundamentals are there, but fix-and-flip under 10% just feels like a mismatch to the risk.

Patrick Roberts · Answer

Late in the cycle was my exact thought, also.

Patrick Roberts · Answer

Admittedly, I should probably pay more attention to the strength of the dollar. Forex was never my specialty. I remember hearing recently that gold has been surging as well, so there may be something to this.

The Future of DSCR and Fix and Flip Lending?

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