A brief, high-level look at the US residential investment loans market and why institutional investors see so much value in the space.
What are residential investment loans?
A residential investment loans (RIL) is a business purpose loan, usually secured by rental or rehab properties, and right now, RILs are having a moment in the sun. Institutional investors, in particular, are flocking to these loans for several reasons, including the unique resilience presented by the Single Family Home space, reduced risk due to lender position, and the premium paid by residential investment loans over other real estate debt and fixed-income investments.
Institutional investors have long overlooked the RIL market for for several reasons, including the tendency for institutions to follow trends, as well as the unique structural factors present in the RIL space.
Traditionally, it’s been hard for institutional investors, large banks, and other heavy hitters to originate and process RILs. The combination of operational intensity, small loan balances, shorter loan duration, and scaling difficulties often exceeded the origination and operational capabilities of many lenders.
Additionally, the fact that the RIL market possesses the qualities of commercial loans with residential collateral requirements meant that playing in the RIL space was the natural province of traders and not institutional investors.
RIL qualifications also played a big role in dampening institutional interest, as residential investment loans are not eligible to be included in Freddie Mac or Fannie Mae pools. In the past, GSEs, or “Government-Sponsored Enterprises,” typically focused on the DTI (debt-to-income) ratio of a prospective borrower. This reduces the total amount one is eligible to borrow, in contrast to the asset-based strategy that most non-bank lenders in the space employ.
As a result of these immutable characteristics, the RIL market was primarily populated with small, local, and regional lenders. This kept the residential investment loan market small, with low leverage and high rates- sometimes hitting double-digits for bridge loans, at a time of record-low interest rates. The makeup of borrowers, primarily veteran property investors, gave strength to underlying credits and a level of security that eventually caught the eye of bigger fish.
Fast forward to the mid-2010s, and institutional investors are beginning to take notice. Their entrance into the space in the middle of the decade, particularly in 2015, led to the creation of a healthy secondary market alongside enhanced originator access to institutional financing. By the time COVID-19 hit in 2019, RILs began to come into their own and reached the status of a mature market.
We believe that there is significant value still to be found in the RIL space. Institutions on the hunt for the two-punch combo of portfolio diversification and yield should take a long look at residential investment loans. There are a few reasons why. Of particular interest to institutional investors is capital preservation in tough times- during the pandemic, residential investment loans had lower delinquency rates than non-agency mortgage asset classes.
In addition, RILs boast a premium over other real estate debt and fixed-income investments. The days of solid returns via indirect exposure through the use of residential, commercial, and single-family asset-backed securities may be over.
Institutional investors may also find tremendous value in structured mitigated risks due to the shorter maturities of bridge loans. Lenders get paid back fast, giving investors the ability to ride out storms in the market with minimal issues. Historically, loan-to-cost and loan-to-value ratios have offered up significant protection against declines in the market.
There’s also the fact that the underlying asset which secures a RIL, US single-family housing, is not only one of the largest real estate markets on the planet- it is also one of the most liquid. Combined with the current (and expected to continue) lack of inventory, you are painting a very pretty picture for institutional investors on the hunt for something safe(r).
This article does not constitute an offer to sell, or the solicitation of an offer to buy, any security interest in any jurisdiction. This material is distributed for informational purposes only and should not be construed as investment, legal, tax, regulatory, financial, or other advice. No assurance can be given that any investment objective will be achieved, or that an investor will avoid losses or obtain a return on an investment. While the information contained in this article is believed to be reliable, its accuracy is not guaranteed. Individuals should consult with their own professional advisors with respect to the legal, tax, regulatory, financial, and accounting consequences of any potential investment.