Inside the 2023 playbook for real estate investor financing

November 17, 2022 7:00 AM

Headwinds that have sent residential lending volumes plunging in 2022 are leaving a mark on the investor real estate market but the economic environment still provides strategic opportunities for investors in both fix-and-flip properties and single-family rentals in addition to challenges.

"I think the super-prolific, seasoned, experienced folks are saying this is not necessarily a bad thing for me. It's back to the fundamentals and the basics of the math on buying right," said Stephanie Casper, chief revenue officer at investment property lender Kiavi.

Signs of pessimism have emerged among some buyers, though, especially when compared to the average consumer's views. In a recent survey conducted by Vontive, a lending solutions platform serving the real estate investment community, over half of investors — 59% — said they thought the housing market would become or remain weak or very weak over the next 12 months, compared to just under 40% among a cohort of general consumers.

Far more questions than answers hang over the heads of everyone involved in the mortgage industry, and businesses that provide loans to investors say the current trends will lead to more cautious and measured choices compared to recent history. While volume falloffs might not be as steep as what the residential lending market is seeing, changes can be expected.

Ty Wright/Bloomberg

Direction of home prices could lead to more focus on single-family rentals

A surprising amount of variation regarding home-price expectations over the next year leaves transitional or fix-and-flip investors in a quandary over the right price point to purchase and eventually resell to turn a profit.

"I think what we're starting to see is some of our really experienced customers, who might have a number of projects going, have said, 'Hey, I'm going to work through these projects, then regroup and get back,'" Casper said.

"They don't want to be over their skis by having too many projects going on with all the uncertainty on the exit."

More fix-and-flip investors might consider converting their purchases to a single-family rental instead if the math works in their favor given current interest rates, Casper said.

"Owning rentals when the cost of homeownership gets to the level that it is — it's a really good countercyclical play to selling to an owner," she said.

The market is also currently favorable toward more rentals, and — from a financial perspective — represents a stable outlet for investors, as rising interest rates lead some potential first-time buyers to abandon purchases for the time being.

"There's an undersupply of affordable rental housing, particularly single-family homes, which people prefer," said Charles McKinney, co-founder and CEO of Vontive.

"We think that investors who can convert transitional assets now into rentals are going to be fine," he said, adding that he was "bullish" regarding this type of pivot.

Charles McKinney, founder and CEO of Vontive

Deals will be available, but credit might not be

Funding of new purchases — as in the residential mortgage space — looks to be tight for the foreseeable future, no matter what type of investment the property is intended to become.

Investors that rely on debt to increase their portfolio or to purchase fix-and-flip projects will struggle in the next six months, said Brandon Lwowski, director of research at valuation data analytics provider and brokerage HouseCanary.

Data from Vontive's survey shows investor buyers have already anticipated a cut in available credit. Approximately 40% of investors predicted getting a mortgage for an investment property would be more difficult in 12 months.

While borrowing won't dry up, less liquidity means some lenders will be unable to originate at the same volume as they had in the past, McKinney said.

"That does trickle through to the borrower in terms of less overall liquidity or availability for mortgage credit." Buyers should expect to undergo "a more expensive, more laborious search" to find a funding source to match their needs, McKinney added.

On the other hand, those with funding already on hand should be able to capitalize on softening home prices to land deals, Llowski said.

"Those with the big pockets right now and can make cash deals or cash-like deals will still have a lot of potential to acquire property here in the next six months," he said.

Changes in the competitive landscape

As a slowing originations market has led to predictions of consolidation within residential lending, some of the same dynamics are playing out in the investor-funding space.

Smaller lenders with less capital are currently "having one heck of time" in the industry slowdown, according Andrew Pollock, CEO of Anchor Loans, which provides private loans to investors and builders.

"It's a competitive marketplace, both on rates, on leverage, and on just pure capitalization on liquidity," he said.

"We're seeing a lot of regional players that we go head to head with in certain markets go away. They've gotten small. They've converted into being a brokerage firm or shut the doors," he said.

Unlike the consumer mortgage market, the top leaders in business-purpose lending do not command nearly as large a share, with the top 25 accounting for less than 20%, based on Vontive's research. A highly segmented market leaves the smaller players less equipped to survive a slowing market.

"I do think you'll see small lenders get bought, merge or go out of business," McKinney said.

But a slowing consumer market is tempting other lenders to test the waters of investor financing, moves McKinney expects to occur. "If you think, 'I've had a great business lending to homeowners, but my volume is down 70%, I can either reduce expenses accordingly or I can look to diversify into an adjacent space,'" he said.

Pollock said he has seen emerging signs of the possible entry of new players into his sector, but warned that rules and policies not easily transferable between consumer and business-purpose lending, and choppy waters may await.

"The barriers to entry aren't that high.The barriers to success are very tall," he said.

Current headwinds, though, have likely spelled an end to the influx of new home-flipping businesses, brought on by the popularity of reality TV programming.

"I think for those early-stage developers, the market movement has clipped their wings. I do believe that they are reevaluating their career paths at this juncture," Pollock said.

Technology to serve investors continues to develop

New technology security developments and tools enabling virtual inspections of investor properties — many first introduced during the COVID-19 pandemic — look set to increase and should continue to streamline the financing process, according to Casper.

"As lenders release funds or are getting requests for the withdrawal of the renovation dollars, they want to make sure that the work has been done," she said. The latest apps now let the borrower show work that's been completed, and provide geocoding and timestamps to create a measure of security that images aren't being altered.

Improved capabilities in data analysis and artificial intelligence are also trends to look out for, as they give lenders like Kiavi the ability to be strategic and "almost surgical" when it comes to managing risk. The technology allows lenders to consider specific property characteristics rather than general guidelines when making financing decisions.

That same level of speed and detail made possible within apps can also assist clients when they weigh potential buying decisions, according to Casper.

"Even we have delivered one where you can put in an address and information about a property, play with the numbers and see what the value could be, what do rents look like, even calculate returns," she said.