Even in a downturn, opportunities exist for private lenders.
The nation’s longest economic expansion in history is still underway, but eventually all good things must come to an end. When exactly the expansion will turn into a contraction is still anyone’s guess, but the housing and private lending markets are sure to be impacted when the next correction does occur.
While economic experts point to low imminent risk of recession over the next year, surveys have predicted it could arrive between 2020 and 2022. Any number of issues could potentially push the country into recession: an asset bubble, geopolitical issues, a trade war, energy price spikes, or a variety of unforeseen shocks to the U.S. economy or to an interconnected market abroad.
As a subset of the real estate market, a more appropriate question for private lenders might be “what?” not “when?”—as in “What will the private lending market do about the recession when it arrives?”
Lessons Learned From the last Housing Crisis
The mortgage market gained significant knowledge during the Great Recession, which should help inform it when the current real estate cycle wanes. The 2007 popping of the housing bubble—and the mortgage securities that backed questionable loans—got much of the blame for the 2008 financial crisis that dipped the country into a deep recession.
While the recession officially ended in June 2009, it took far more time, into 2012, before housing hit a price floor and began to rebound.
Mortgage credit tightened significantly during that time, as mortgage lenders and banks sought to shore up their finances and deal with the aftermath of delinquencies, defaults and foreclosures.
The financial system is less leveraged today than it was when MBS secured subprime mortgages of questionable value. Loan quality is far better, and borrowers’ ability to repay their mortgages is stronger.
The Office of the Comptroller of the Currency’s quarterly report on mortgages reports that 95.6 percent of mortgages were current and performing at the end of second quarter 2018, compared to 95.4 percent a year earlier. At the height of the foreclosure crisis, that number was between 86 and 87 percent.
If and when the market does correct, mortgage lenders likely won’t be so quick to foreclose. Using experience gained during the last recession, they’ll make a concerted effort to work with borrowers who are delinquent via modifications and other assistance that will keep their loans active and their borrowers in their homes.
Homeowners and real estate investors also have more equity in their residential properties today than they did when the Great Recession hit. That should provide a buffer if home valuations decline.
A CoreLogic analysis shows that 2.2 million homes, or 4.3 percent of mortgaged homes, were in negative equity in the second quarter of 2018. In comparison, negative equity peaked at 26 percent of mortgaged residential properties in the fourth quarter of 2009. The figure is based on CoreLogic equity analysis the firm initiated beginning in the third quarter of 2009.
Private Lender Opportunities Amid a Recession
While private lenders aren’t in a position to prevent a recession, they can and should adhere to sound financial business practices to lessen potential negative impacts.
While loan volume will likely drop if the economy contracts, lenders will also have the opportunity to lend in a contracting market.
One of the biggest opportunities will be to grow their client base of opportunistic real estate investors, who are increasingly using financing to buy and flip (or hold) homes.
Among home flips completed in the second quarter of 2018, 38.6 percent were purchased by the home flipper with financing, according to ATTOM Data Solutions. In some states—Rhode Island, Colorado, New Hampshire, Minnesota and Washington—more than 50 percent of flips were being purchased with financing, according to second quarter numbers.
Of homes flipped in the second quarter, 32.3 percent were distressed sales, down from
38.7 percent a year ago and down from a peak of 68.2 percent in the first quarter of 2010, which was in the middle of the housing crisis.
How to Survive and Grow in a Downturn
Savvy real estate investors have had a strong ride for about 10 years now as distressed housing provided ample opportunities to build their residential portfolios at discounted prices. Combine that with six years of rising home prices, strong home-buyer demand and increased single-family rental demand, these investors have toiled in a favorable market. Still, it certainly has become more challenging in recent years as home prices have risen and inventory has been in short supply.
The housing market continues to experience inventory shortages nationwide, and an economic slowdown may contribute to a more balanced housing market.
A balanced housing market where supply more adequately meets demand can be viewed
as a healthy development, which should temper concerns about affordability and asset bubbles. It will also provide the opportunity for millennials to become first-time homebuyers—or even purchase investment properties, especially in areas of the country where millennials are earning high wages and prefer to remain a renter but like the option of owning investment property.
If the market does contract, real estate investors likely will once again see an opportunity to buy real estate at more reasonable prices. Additionally, they will be able to make their cash go further by using leverage that can be achieved via a partnership with a private lender.
While certain players may view housing acquisitions during a recession as capitalizing on someone else’s misery, especially if the deal involved a foreclosure, real estate investors were credited with lifting housing off the floor and turning it around in 2012. Investors—and financing from private lenders—can come into distressed neighborhoods and turn them into the thriving communities.
Private lenders could play a large part in a future turnaround once a market correction does hit. The lenders who will benefit the most, however, are those who begin preparing now to take advantage of that opportunity. ∞