Private lending is nothing new. It’s been around a long time. In fact, it can be traced back to Macedonia around 3,000 years ago. In the U.S., the fix-and-flip segment of real estate investing has relied on private money for almost as long as pros have been rehabilitating properties. However, since the financial crisis of 2008-2009, private debt has grown in virtually every real estate investing sector. In the fix-and-flip sector, it has skyrocketed.

As an asset class, private lending emerged in the late 1980s. It started as a unique funding mechanism for mezzanine loans or special situation financing. Today, it’s a common method of funding fix-and-flip property deals with no signs of reduction any time soon. 

The Advent of Fix-and-Flip Private Lending

In 2012, President Barack Obama signed the JOBS Act, which made it possible for lenders of all types to directly market their offerings to borrowers. As a result, hundreds of marketplace lending (MPL) platforms sprung up in the years that followed. The first of these was established in 2010 and paved the path for others to follow. Many of these platforms specialized in real estate lending.

There is a lot of overlap between the MPL sector, which encompasses real estate crowdfunding (RECF), and private lending. Private lenders may seek out borrowers through MPL or RECF platforms, but they may also conduct themselves through direct lending models. Either way, the industry has seen tremendous growth since the financial crisis. Lenders leverage the internet to find borrowers and use traditional offline marketing methods, as well. One of the areas where private lenders have found a foothold is in the area of fix-and-flips.

Following the tradition of hard money lending, fix-and-flip financiers issue short-term loans with high interest and fast closings. They also typically have lower credit risk standards than traditional loans, which is why borrowers favor them.

Investors have enjoyed great returns ranging from 8 to 12 percent interest. Lately, however, fix-and-flip real estate investing has come under scrutiny by state regulators and faces a few challenges. It will still continue to be a prominent part of the real estate ecosystem, and private funding of fix-and-flip properties is poised to grow even further as more online platforms offer more deals for investors.

The Current State of Fix-and-Flip Property Lending

In 2017, ATTOM Data Solutions estimated that flippers turned over 193,009 single-family homes and condos during the previous year. It’s possible the entire fix-and-flip industry saw a total of 300,000 properties turned over. Investors saw an average return of 51.9 percent on fix-and-flips that year. The following year was almost as good as investors saw an average return of 49.8 percent. These are the first and second highest averages since the year 2000.

Another event that happened in 2017 to create new opportunities for private lenders and investors in the fix-and-flip sector was the creation of opportunity zones. These zones allow investors to reinvest capital gains into property rehabilitation projects in predesignated neighborhoods or to invest those gains in qualified opportunity zone funds. For private lenders, they represent opportunities to fund projects in these areas targeted for revitalization.

This rise in fix-and-flip property investing has put the sector on state regulation radars. Last year, New York introduced legislation that could increase transfer taxes for investors by as much as 20 percent. If it passes, it could hamper house flipper in New York. Florida has also introduced legislation that could impact fix-and-flippers and other real estate investors.

On the technology front, private real estate lenders are beginning to underwrite loans and assess credit risk using artificial intelligence and machine learning. Deal analysis is also being impacted by new technologies.

While fighting regulation and the challenges of new technology, increased competition from banks is also beginning to impact the fix-and-flip sector. While some banks are referring borrowers to private digital lenders and some are finding unique ways to partner with real estate technology firms, others are developing their own digital lending platforms.

The Future Looks Bright

Since the financial crisis of 2008-2009, traditional lending institutions have tightened their credit standards and shut out millions of would-be home buyers. The situation for flippers is even bleaker. Those without good credit, or wealth to finance their own deals, lose out on lucrative real estate deals. That’s why many of them have turned to private lenders for capital.

In a white paper titled “Private Lending Goes Public” published in April 2018, ATTOM Data Solutions reports that 207,088 single-family homes and condos were flipped in 2017 and that 34.8 percent of them were financed. The dollar volume for financed flips hit a 10-year high of $16.1 billion. Much of this growth is fueled by online lending.

Besides ease of access to needed capital, one other advantage to funding fix-and-flips through private lenders is a path to a quick closing. Borrowers can get their money in 10 days compared to 10 weeks through a bank.

As the volume of fix-and-flip loans has grown, so too has its diversity. What was once relegated to accredited investors has now been opened up to non-accredited investors. And it isn’t just individuals funding the loans. Many fix-and-flips are funded by institutional investors. In some cases, even banks are funding fix-and-flip investors through marketplace lending platforms or other online channels. And the introduction of real estate investment funds gives investors opportunities to invest in fix-and-flip properties by pooling their money to leverage greater returns and lower risk along with other investors. These opportunities will only increase as the market matures.

Securitizations are another area of potential for the fix-and-flip sector. SoFi and Marlette Funding have led the way in asset-based securities (ABS) in the marketplace lending sector. In late 2017, LendingHome funded its second Opportunity Fund with a $300 million credit facility. Last year, Angel Oak Capital Advisors, LLC obtained $90 million with a securitization backed by fix-and-flip loans. There is plenty of potential for such ABS products to grow in size and number within the next five years.

In a sense, ABS aside, all fix-and-flip deals are asset-backed. Where traditional lenders assess credit risk on Fair Isaac (FICO) scores and property values, private lenders care more about deal structure, loan-to-value ratios, and after repair values. Still, there is a tremendous risk to fix-and-flip investing.

How Private Lenders Manage Risk

Fix-and-flip investors are subject to a number of risks associated with property investing. They can pay too much for a property and not leave enough on the back end for profit. New investors typically fail to include fees and holding costs in their equations. Another common mistake investors make is underestimating the cost of repairs or other expenses. Outside of investor control, the market could turn while rehab is taking place, causing the investor to lose on a deal that a few weeks earlier looked like a sure win.

In these cases, a private lender can serve as a check and balance against the fix-and-flip investor’s judgment. By taking a keen interest in the financials of a proposed flip, the lender can spot challenges the investor might overlook. Any red flags can be a cause for rejecting the proposal.

The best private lenders are not just interested in the deal. They’re also interested in the investor. They may look at the credit score, but they also want to know the investor’s overall experience in real estate, his experience in the specific type of real estate deal being proposed, whether or not the investor can back his own project, and the number of successes the investor has.

Private lenders are more than silent financiers. They are partners with a stake in the fix-and-flip investor’s success.