Financing a Fix ‘n Flip During a Pandemic
October 6, 2020
CEO/Owner, B.E. Lending
The last six-plus months have been filled with all kinds of challenges in the world including a worldwide pandemic, market volatility, and historic job losses not seen since the Great Depression, followed by a swift bull market and massive job recoveries at unprecedented speed. And there is likely more volatility to continue as a truly historic election is rapidly approaching. Most real estate lenders by nature are risk adverse, so the extreme volatility and unknown in the greater marketplace initially led to credit markets seizing. Many lenders, especially in the fix ‘n flip space, receive their capital from either high net worth individuals or a combination of private capital and conventional debt. Lenders also circulate their capital when loans payoff due to maturity, refinance, or sales, thus recapitalizing their available funds to re-deploy.
However, when the madness surrounding Covid-19 hit our shores, new transactions and refinances largely halted as buyers and lenders alike hit the pause button on new originations as risk profiles changed in various markets and asset classes seemingly overnight. According to the Scottsman’s Guide, some 30%+ private lenders temporarily vacated this lending space between March and April. Private lenders pulled back hard, increasing rates and decreasing leverage to accommodate for changing perceived risk. Then the surge of $2.5 trillion+ dollars came, which is a truly astounding figure, and it may increase substantially over the coming weeks. This helped quell the short-term economic markets, but then came the executive orders halting foreclosure of virtually all government-backed securities in residential real estate. A borrower with a FANNIE MAE or FREDDIE MAC owned mortgage, which represent over half of all residential loans, merely needs to request relief for their mortgage payments and they are virtually guaranteed a 6-month forbearance which can be extended for another 6 months upon request. The qualifications are fairly simple if you have been negatively impacted economically by COVID-19, and virtually everyone can make that claim. Coupled even further with historically high unemployment benefits where more than half of the recipients began making more income than when they were working full-time and you have the makings of a temporarily stabilized market that may even appear robust.
It is still, however, unknown how long until the virus abates, or saner minds prevail (depending on your political persuasion or understanding of the virus), and business can resume its normal course hopefully absorbing the remaining jobs lost. The Federal Reserve’s recent comments about pursuing a “long-term average” 2% inflation rate target verses a consistent short-term inflationary target rate at or below 2% certainly indicate a longer horizon of low conventional interest rates which is great for refinancing and new home buyers. This all helps support the disposition side of the fix ‘n flip industry for the moment, but due to our sustained lack of available re-sale and new home inventory, prices have continued to rise making certain opportunities more scarce while opening up new opportunities for more substantial improvements or new development.
Generally speaking, fix n’ flip financing is most commonly obtained from private capital or hard money lenders that have the flexibility and creativity to close quickly on opportunistic situations for investors. The annualized rates are still typically double digits in the 10-15% range at par pricing (no origination fee), but since most of these loans are only used for months, not years, the effective interest paid is typically only 4-9% of the loan amount provided. Likewise, these bridge loans typically permit a construction allowance to cover the bulk of construction related expenses. Bridge loan terms as of September 2020 are most consistently 6-month long terms with extension options available, up to 80% LTC, plus up to 80% of the construction budget, interest only payments, and non- recourse. Some lenders will lend up to 85%+ of cost, but the rates are typically even higher. Some lenders will even lend up to 100% by cross collateralizing one or more properties with a new acquisition if the equity in the existing cross-collateralized property is substantial enough, avoiding any need for down payment or new capital contributions. Because of all the recent appreciation, this is a great option for fix ‘n flippers with equity in an existing investment property owned free & clear or with minimal outstanding debt. There are good opportunities out there, but a fix ‘n flipper generally needs either all cash or access to bridge lending capital in order to acquire the best opportunities with the flexibility and quick timing required to close.