Firms that offer loans to small-time landlords have been slow to tap the securitization market. So far there has only been one transaction with a public credit rating, in December 2016. Yet bundling these loans into collateral for bonds provides attractive financing.
Lima One Capital, which originated much of the mortgages backing the $114 million RCO 2016-SFR1 Trust, is passing the lower funding costs along to borrowers. The company is cutting the base rate on its rental product by 2.41 basis points, to 4.99% from 7.4%
Chief Executive John Warren expects that this will allow the company to boost its origination volume considerably. Over the past year, it has originated over $100 million of its Rental30 product, which finances single-family rentals, one-to-four unit properties, and condos, at an average coupon of 7.7%, largely based on a forward flow agreement with a single investor. Warren said that the success of the deal should allow the company to negotiate additional future flow agreements with a variety of purchasers.
"I'm anticipating we'll originate $500 million in the next year," the CEO said in a telephone interview this week.
RCO 2016-SFRI was sponsored by Residential Credit Opportunities II, an investment fund controlled by American Homes 4 Rent. The senior notes issued by the trust, which benefited from credit support of 43.5%, were rated AAA by Morningstar Credit Ratings. These notes are backed by 948 30-year mortgages originated by Lima One and Visio Financial Services. Most of these loans are backed by a single rental property. By comparison, other rated offerings of rental bonds have been primarily backed by loans on portfolios of rental properties.
Lima One, based in Greenville, S.C., is majority owned by Warren and backed by a private equity firm. The company got its start in 2010 lending to investors who purchase a property, make improvements, and quickly resell it. It keeps these "fix and flip" loans, which have terms of just 13 months and pay much higher rates of interest, on its books.
Lima One started offering longer-term financing to landlords in 2015. These loans range in size from $45,000 to over $1.5 million and are underwritten to the property's loan-to-value ratio and debt service coverage ratio as well as the credit score of the landlord. They are available across the U.S.
"Now we have a little more of a track record, we've proven our business model," Warren said. He noted that 99.5% of Rental30 loans are performing, and there have been no foreclosures to date. "Ultimately, that's what investors care about."
There are plenty of other players lending to small-time landlords, including Finance of America Commercial, formerly B2R0, backed by The Blackstone Group; and Colony American Finance, backed by Colony Capital. Warren said that Lima One sets itself apart with its focus on this segment of the market, whereas its bigger competitors primarily finance large portfolios of rental properties.
There is a potential downside to offering sharply lower interest rates, if existing borrowers try to refinance. This is already happening in the nascent market for mortgage to weaker borrowers; some of the earliest offerings of nonprime mortgage bonds are experiencing very high rates of prepayment.
However this risk is not as great for landlord loans. All of mortgages in RCO 2016-SFR1 are subject to a prepayment penalty for up to five years, according to Morningstar.