Even in a tight deal market, there are opportunities you can take advantage of; however, you must also be aware of their associated risks.

Lenders, especially new and small lenders, must keep their eyes open for both opportunities and threats. Changing market conditions can bring good deals that nimble and niche lenders can take advantage of—as long as they are aware of the pitfalls to avoid.

Let’s take a look at five current opportunities as well as their corresponding threats.

1. Opportunity: Non-Local Markets

As private lenders, we aren’t necessarily constrained by geography. If your local market is experiencing a correction, chances are there are other areas of the country that are maintaining or expanding economically.

A city or county’s economic development website will often provide solid baseline information about the population, industries, and projected plans for community development. Paid data website services that break down economic data for a chosen area are also available. The Milken Institute also has a wide variety of data-driven reports on their website, including information about the best-performing markets at the current time.

Threat: Compliance Requirements. Since private lending laws are state specific, if you do jump to a new state, make sure you are aware of the requirements for licensing and usury compliance.

2. Opportunity: Value-Adds

The market rates for smaller lenders are not usually held against some benchmark index. If interest rates do fall in the future, smaller balance sheet private lenders likely won’t see a significant rate reduction for their loan products compared to current interest rates.

Smaller lenders can offer additional value adds to their borrowers (e.g., flexibility on some loan terms, connections to vendors in their market, referrals to permanent financing if the lender only offers short-term debt options). Leaning into the value a small lender can bring to a deal other than rate and terms will create repeat business from borrowers who appreciate those additional services and connections.

Threat: Interest Rate Races. Larger lenders may use capital tied to a floating index rate. When their cost of capital gets cheaper as interest rates decrease, they may lower rates to attract borrowers. If smaller lenders want to remain competitive without being involved in a race to the bottom on rates and fees, value-adds help differentiate your lending business from others.

3. Opportunity: Second Lien Products

Many homeowners and investors have locked in historically low rates that they see significant value in keeping. Refinancing that low-rate debt is usually the last thing they want to do because they know they cannot get a rate anywhere close to their existing one.

This has created a significant demand for second-lien loans. Investors taking properties “subject to” from distressed homeowners are actively seeking out private lenders to provide funds for the transaction (e.g., closing costs, catching up the mortgage, repairs, or cash to give the seller to walk away). Many new lenders may be approached or drawn into these opportunities because they usually offer a very attractive interest rate and have a lower loan amount, sometimes as low as $20,000.

Threat: Greater Risk. This type of loan in the current economic climate can be very risky! Lending as a second-lien lender requires extensive lending knowledge to mitigate your risk and properly assess the opportunity.

Make sure a few things are in place before you agree to fund such a loan. Lending in the second-lien position may have additional underwriting criteria that may not be present with a first-lien loan. For example, make sure the first lien is current and the combined loan to value still allows for a healthy equity buffer, generally below 75% CLTV. Using a conservative valuation and having multiple strong and suitable exit strategies for the borrower are also crucial when lending in the second-lien position. Involving a knowledgeable lending attorney to review the deal and the loan documents can help secure a stronger position in the loan.

4. Opportunity: Permanent Debt Lenders as a Barometer

A typical private loan is for a short duration, often measured in terms of months, not years. This leaves the borrower with a deadline to either sell or refinance the property. Usually, one of those scenarios will involve new debt on the property.

As the economy deteriorates or improves, underwriting standards for more traditional loan products will fluctuate. Our industry saw this in the early stages of the pandemic when underwriting was changing weekly. A smaller lender needs to pay attention to these changes. Having a relationship with local permanent debt lenders and regional banks can be very helpful. Checking in periodically to make sure there haven’t been any significant changes to their loan terms or underwriting criteria can help shape your choices for lending moving forward.

Threat: Changing Terms. Discerning which direction things are moving is invaluable for avoiding a borrower being stuck in your loan. For example, if your local debt connections repeatedly say they will only do a rate and term refinance up to 70% of the value of the property, lending at 75% may mean your borrower has to bring significant money to the closing table just to get out of your loan. A borrower may not have that capital available to even close the loan, especially including any reserve requirements.

5. Opportunity: Partnerships

When deal flow is down, there may be opportunities to partner on deals you don’t have experience with. A well-thought-out pivot can be helpful to a business, but trying to do too many things at once is detrimental. Lending on traditional construction fix-and-flips is different from ground-up construction or raw land purchases. There are significant underwriting differences, title considerations, and potential unique loan terms that may not fit within your current business model. Or, you may have the opportunity to open up your buy box to atypical construction (e.g., tiny homes or container homes).

Threat: Impulse to Pivot. Work with a more knowledgeable lender if you do want to make a jump to an unfamiliar loan product or property type. That lender should understand the parameters of the new loan product and borrower.

As you can see, being able to look ahead and see where the lending landscape is moving is crucial. There have been, and likely continue to be, significant capital inflows into our industry. Knowing what you do, how you do it, and executing it well is critical, especially in times where valuations may be falling or deal flow is low. Talk to other lenders and network with vendors and borrowers to gain insights about what’s happening in your market. Remember what makes your business an advantage to borrowers—and use that as your superpower.