Private debt is one of the brighter spots for individuals looking for relative safety and security when the overall investment market is uncertain. Some private lenders may provide their investors with consistent cash flow while their assets are invested hard assets with a senior secured position. Private real estate lenders serving the residential sector can offer especially attractive risk-adjusted returns with downside protection.
Individuals can invest with certain private lenders and may receive the following benefits:
- Asset preservation and downside protection backed by first mortgage collateral
- Monthly cash flow distributions or dividends
- Continuous adjustment to market conditions
- Diversification in a loan portfolio across multiple properties, borrowers and markets
- Additional security through personal guarantees from individuals with credit
Private Real Estate Lenders
Private real estate lenders, such as Trueline Capital, provide loans for construction and renovation of desperately needed residential housing including single-family and also multi-family homes and townhomes. Builders choose to borrow from private lenders to obtain a bit more leverage and a lot more flexibility compared to traditional banks. A bank might provide 50%-65% loan-to-cost financing at 6.0%-6.5% annual interest rate whereas a private lender might provide 75%-90% loan-to-cost financing with 10%-12% rate. The interest rate may seem much higher on the surface, but the cost difference measured in actual dollars may be marginal, especially when factoring in potential timing delays that a more flexible lender may help avoid. Time can be more of an enemy than interest rates for borrowers. One extra month of term could completely eliminate anticipated interest savings.
Investing With Private Lenders
Certain private lenders are set up as open-ended vehicles, meaning investors can invest anytime throughout the year. Investors typically receive a return on their investment in the form of cash distributions periodically, usually monthly or quarterly. While the investment returns tend to be relatively consistent, they should not be confused with bonds or fixed income securities. Each month loans may pay off and new loans may be made. This continuous cycle of capital results in a continuous adjustment to market conditions. During a rising rate environment, the value of a bond with a fixed payment stream may go down, whereas the value of an investment in a private lender may remain protected and the cash flow available to that investment may rise as interest rates rise. This is a simplification for illustrative purposes; other factors may impact investment cash flows and performance.
Inflation Impact
Rising home prices is a significant factor contributing to the current inflationary pressures. The Federal Reserve recently released data showing that U.S. home equity increased in the first quarter of 2021 to a record high of $27.8 trillion. In one sense, this is welcomed news as the value of the collateral securing loans may be trending higher making current loans more secure. The rising interest rates may eventually have a negative impact on value as home buyers may not be able to afford the mortgage, which would push them to either buy less expensive homes or pay less for a home or remove them from the buyer pool altogether. Builders and sellers may be immediately impacted by that pricing pressure and see a slowdown in the pace of sales, while private lenders are invested in secured, first mortgage positions on brand new housing inventory in desirable in-fill markets.
Housing Industry Performance Illustration
As a nation we need to get housing affordability from A to B on this chart. Which is to say, we need to add more units to help make housing more affordable. This graphic is not to scale and not based on any data – it is intended to illustrate the relationship and relative performance of the housing industry and its participants.
Historically, the housing industry (blue line) has ebbed and flowed through economic cycles and it will likely continue to do that. Generally, builder and owner profits tend to swing more widely and make news headlines. During such time, lenders including private lenders may expect to see relatively steady profitability with some fluctuation. Developer profits may get squeezed from inventory taking longer to clear, while lenders remain in senior secured position earning its expected return through interest.
John Churchward is Director of Capital Markets for Trueline Capital, a private-lender to the home building industry in the Pacific Northwest. John’s role with Trueline is to expand the company’s capitalization which includes broadening investor relationships. Trueline Capital distributes cash flow to investors, backed by senior, secured positions in brand new residential real estate projects in growing markets. John’s professional real estate career spans 25 years as lender, developer and advisor in the northeast and the western United Sates.
