Making Good Loans as LTVs Creep Up

In funding real estate loans with my partners over the last year, it’s been interesting to talk with hard money lenders around the country.  They have different models and very different costs of capital.  

One broad trend that I’ve observed is that most hard money lenders that are putting a lot of money on the street, are lending at 75% of after repaired value on single-family fix and flips.  Obviously, a good loan to value is very market-specific.  For example, I’d need to be at a lower loan to value in markets where there’s no lot value, or where foreclosures take longer/cost more.  Even ignoring very low-cost markets where houses trade below replacement cost, 75% makes me uneasy.

I’m also seeing a lot of hard money lenders making construction loans. Though I can’t get my head around taking on the incremental risk of a construction loan for another 200 basis points of yield, maybe I’m missing something.  Or maybe it is because I have built houses and understand what can go wrong in the process.

If I continue to ramp up making loans, I worry that this time next year I’ll struggle to find sufficient loans originated by other brokers, that meet my buying criteria:

1. Lower LTV
2. Low double digit yield
3. If value add a borrower with some previous experience with this type of value add

At that point, I will likely need to either lend money to the hard money lender, with the loans she then makes acting as collateral for our loan OR find a few hard money lenders willing to co-invest and subordinate their co-investment to get me to a lower effective loan to value.

For example, here’s a loan that’s an instant “no” for me today, despite meeting two of my three criteria.

1. Interest Rate: 10%
2. Experience: Borrower has flipped four previous houses fully cycle
3. Loan to Value: 75% After Repaired Value.  Purchase Price $165K. Renovation cost $40K.  After Repair Value of house $250K.  Loan amount $187K (Initial loan amount $147K, Construction Holdback $40K)

But if a hard money lender was willing to invest $15K and subordinate this investment to the $172K my partners and I lend, suddenly it would be at a loan to after repaired value of less than 70% and it would fit within my buy box.