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State of the private money industry

The fix-and-flip market tells investors everything they need to know

As the end of the year looms, now is the time to take a look back at what has occurred so far in private money lending. The private money industry’s success relies on the growth, and changes, reflected in the real estate market. With a large amount of private money lenders focusing on lending to residential investors looking to fix and flip, or acquire properties for short-term rental periods, the fix-and-flip market is a very important industry to look at in order to calculate the health of the private money industry.

FIX-AND-FLIP INVESTMENTS

The fix-and-flip industry has experienced steady growth through 2016 so far, as it had throughout most of 2015 as well, but at an increased rate this year. According to the RealtyTrac report for Q1 of 2016, 6.6% of all Single Family Residences and condominiums sales were flips in the U.S. 

This growth represents a two-year high for the industry, including a 20% increase for transactions over Q4 of 2015. This is a strong signal for investors who are monitoring the health and stability of the real estate industry as a whole as well as gives a positive forecast for possible continued growth. 

This portrays a positive outlook to both new investors looking to get into the fix-and-flip business, or the experienced investor looking to expand the business they already have. 

When it comes to the different markets in the U.S., there are definitely some that are better for investments than others, especially for fix and flips. 

The single largest market for fix and flips in the U.S. is Miami, with 8.6% of all SFR and condo transactions in 2015 being flips. This is much greater than the national percentage of 5.5% for the same time period of 2015. The number of all cash investment transactions are starting to decrease, and is below the national average of 71%. In Q1 2016, 71% of flips nationally were purchased in all cash, while Miami in the last 5 quarters has hovered around 55%. 

The lower amount of all-cash transactions is a signal to investors that the market is stable and healthy with room left to grow. This factor, perhaps more than others, shows the health of the overall financial market, rather than just that of the residential real estate market. 

This is incredibly beneficial to the investor who is not just in the real estate industry, but who invests in a diverse array of products. The decrease in cash transactions also shows that most investors are becoming increasingly more comfortable with taking on an a higher amount of debt in order to slowly increase the amount they are leveraged on investments, helping to increase, and in some cases maximize, their possible returns. 

THE LENDING INDUSTRY

This increase in amount of debt being used to finance investments will also force lenders to become more competitive with items such as lower rates, fees, etc. and raise the level LTV (loan-to-value) and/or ARV (after-rehab-value) that they are able to lend on. This will feed into the cycle more, but only to a certain point. 

While it will not escalate to the point of another bubble, due to more common sense lending tactics, it will allow more experienced investors to produce more, rather than causing large amounts of novice investors to be over leveraged with high interest loans. This will also increase the need for trusted and accurate valuations of subject properties, so that lenders aren’t lending on anything greater than the current market value.

The marketplace is full of hard and private money lenders — it will come down to who can best assist investors in completing their goals, whether that be by providing quicker close times, or with more accurate valuations. With how many options there are for borrowers, lenders will need to start competing for marketshare as borrowers shop their situations to multiple lenders, leveraging the offers against each other. This process will force lenders to update their guidelines, or be forced out of the market.

INVESTMENT MARKET

California in Q1 of 2016 also portrayed a very productive investment market for the residential real estate market according to the Realtytrac report. Markets such as Fresno and Porterville produced ratios, of flipping transactions to overall transactions, over 11%, which are high not just for California, but nationally too. These two markets had the highest ratios of all of the California markets. Some other strong markets in California through the first quarter of 2016 included Modesto, Bakersfield, LA – Long Beach, and San Diego, all producing ratios well over 7% which is still above the national average (RealtyTrac). Areas such as LA – Long Beach and San Diego are major metropolitan areas, while areas such as Fresno, Modesto and Bakersfield are growing cities that do not boast the same metropolitan market. 

The mix of these different type of markets all having high transactional numbers of fix and flips is evidence that there is a wide variety of investment inventory available in the marketplace, and investors are taking advantage of that. It also helps to show the health of the real estate market as a whole in California, that there is still growth occurring in both big cities as well as smaller sub-centers of the state. 

Gary McCarthy of HMC Assets sees California as a market with continued promise for real estate investment. “California is a market where I see there always being opportunity, the specific zip code may change but the California market as a whole is staying strong for both fix and flips as well as rental properties.”

 This signifies a promising market for your typical home buyer, not just an investor, showing to the general public that all real estate is on the rise as far as value and stability. 

With the increase in the number of flip transactions on a national scale, there are due to be a few over-saturated markets in which investments are harder to find and less profitable once found. According to RealtyTrac, markets such as San Antonio and Austin in Texas contain premiums on most flip purchases rather than discounts, which are typical for the industry. 

The simple, yet effective, investment strategy of buying properties at a discount is really the cornerstone of the fix-and-flip industry. This is evidence of a market where investors are having to bid up the price for properties, which in turn lowers the possible return on the investments. 

THE FUTURE

The state of the private money lending industry is very strong, with healthy recent growth along with stable forecasted growth for the coming quarters. As investors start to become more comfortable with debt financing for investments, this will allow for additional properties to be added to investor’s portfolios with the equity capital saved. 

Debt financing is key for freeing up cash on hand for down payments on other properties. It is usually bad practice as an investor to have all of one’s cash tied up in property due to the riskiness of a single holding. This process  will thereby increase the number of transactions done in the marketplace, adding to the health of the industry even more.

 With this cyclical pattern, the health of the industry should grow at a steady pace, even exponentially if current conditions grow at the same pace. This will be aided by a short-term increase in foreign investment, which should occur based off both historical patterns and Brexit. 

Brexit should spark a short-term influx of capital by foreign investors into the U.S. marketplace, and with where interest rates are, an investment in a piece of real estate is the logical choice. This increase will boost capital in private money lending by the default of investors needing to close quick, and at times foreign investors having a harder time obtaining conventional financing. 

While many still think private money is only for borrowers who cannot receive conventional financing, that isn’t completely true. More and more investors with good credit and substantial assets are choosing private money in order to close quickly. The ability for an investor to gain the capital to close quickly is becoming more of a necessity in order to stay competitive. 

There should not be much concern for over-saturation in more markets due to the way in which investors are looking to make decisions. There is no evidence at this point that investors are acting irrationally, which is a great sign for the industry. The slow progression of investors moving away from all-cash purchases is also a good sign for the same reason, that investors are being cautious and realistic about the market, and not taking any unneeded risks.

The biggest thing to be concerned with in a growing market is if the recent growth is inflated, and like a bubble, ready to pop. There has been no sign of this in any of the published data over the last year and a half (since 2014); instead there is evidence that the industry still has much room left to grow. 

2016 showed continued growth, but it would not be unexpected if the rate of growth slowed down comparably in 2017, although this would not be a signal of a slowdown as much as signs of industry growing pains. The industry took a massive hit just eight years ago, and with the recovery being a large and time-consuming one, it is just now that the industry is really getting its legs back and taking off. 

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