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2020: The Year Investors Start Paying Attention to Residential Bridge Lending

Updated: Mar 24

By John Beacham, CEO of Toorak Capital Partners


Institutional investors, starved for yield in the current low interest rate environment, which persists with no end in sight, have come back to the RMBS space in a big way. Investors have poured into mortgage backed securities, including non-qualified (non-QM) and non-prime securitizations – the rebranded versions of subprime lending that sparked the housing crisis. In fact, senior tranches of such securitizations have consistently received AAA ratings and issuance is routinely oversubscribed. This renewed interest, despite the pain of the subprime crisis that still roils public discourse ten years later, has bolstered the non-QM and non-prime securitization market from effectively zero to tens of billions of dollars in annual issuance in the span of about five years.


Make no mistake, it is not just low yields fueling the rapid resurgence of non-agency MBS, it is also the fact that credit quality, regulatory oversight and risk retention have dramatically improved in the post-crisis period.


Now there’s another burgeoning asset class catching the attention of investors that offers higher yields and a lower risk profile than non-QM lending – residential bridge loan securitizations. Residential bridge loan securitizations, sometimes called “fix and flip,” have only been in existence for about three years, but the performance has been outstanding with negligible losses, and the unique characteristics of the underlying loans creates the potential for extremely attractive risk-adjusted returns. Many investors are quickly realizing that residential bridge securitizations pay off more quickly, have lower LTVs and higher average FICO scores than non-QM issuance. But because the asset class is so new, rating agencies haven’t caught up to develop a rating criterion. As a result, investors in unrated residential bridge securitizations are being paid a premium. But before expanding on the credit characteristics of residential bridge securitizations, it’s important to highlight the structural differences of residential bridge loans and how they benefit investors.


Drawing down risk

First, the draw process, by which a portion of residential bridge loans are funded, helps ensure loan performance. Beyond credit checks and related due diligence performed at the time of initial loan funding, residential bridge borrowers are required to substantiate renovation progress of their investment property before they can draw on the full amount of the loan in lock-step of value creation. The loan is de-levered through value creation upon completion of work (see Figure 1). For example, a bridge borrower that purchased a $300,000 home and intend to increase the home value to $450,000 by upgrading the bathroom and kitchen (i.e. business plan), will only get $225,000 at initial funding and upon substantiation of rehabilitation completion and professional inspection to ensure progress as intended, will be able to draw on the additional $67,500 of the maximum loan amount.


The draw process provides for the additional borrower touch point during the loan term and is a canary in the coal mine as it provides early signs of distress that enable early loss mitigation ahead of potential repayment issues. Segmented draws also ensure that borrower’s capital contribution is in line with the approved construction budget and business plan. Furthermore, the loan structures encourage borrowers to complete their projects on time – which in turn leads to a successful repayment of the loan and new housing product being made available to the market.

Figure 1:


A bridge loan is a short-term loan, typically taken out for a period of 6 to 24 months pending the arrangement of larger or longer-term financing. Many of the Toorak bridge loans have a feature that allows the borrower to draw upon additional loan funds for property renovation, as demonstrated above.


De minimis defaults

For residential bridge loans, incentives are aligned in a way that significantly reduces the likelihood of a loss after experiencing a payment delinquency. Unlike the 30-year conventional loans, which are usually owner-occupied, once the loan enters default status, a long, drawn out process begins that rarely ends with a successful modification or return to good standing. First and foremost, borrowers of residential bridge loans are motivated to sell the finished property quickly so they can free up liquidity and move on to their next project, as opposed to a homeowner whose main goal is to stay in the property as long as possible. Moreover, residential bridge loans are structured with terms that range from 5 to 24 months and are 10 months on average. Because of the shorter term of these loans, borrowers are also much less sensitive to higher interest rates and can easily absorb a few months at a higher default rate. If borrowers do become delinquent, the sale of the property creates a liquidity event that helps prevent the loan from going into default. To be sure, the data bears this out -- since the first residential bridge loan was issued by Toorak in 2016, approximately 80 percent of the bridge loans entering default status were cured, compared to only 40 percent for traditional home mortgages.

Higher caliber credit

As demonstrated, the structure of residential bridge loans has significant advantages over owner-occupied residential lending when it comes to repayment and alignment of incentives. Yet the credit quality of residential bridge loans is also more attractive than what can be found in non-QM. First, residential bridge loan-to-value ratios (LTV) tend to be substantially lower than non-QM LTVs. Toorak Capital Partner’s portfolio has an average LTV of 64%, well below industry averages for most every type of RMBS. The average FICO score for borrowers in Toorak Capital Partners’ portfolio is 712, which is also a significant improvement over non-QM credit profiles.


Paying a premium

Aside from structural benefits and credit enhancements, the residential bridge securitization market has gained traction with investors for an obvious reason – it carries a higher yield. We all know that a higher return only comes with higher risk, but the in the case of residential bridge lending, we are not talking about interest rate risk or credit risk; rather, the risk premium comes from the low liquidity of the asset class and the fact that it remains unrated.


For example, senior tranches of non-QM securitizations typically yield in the high twos, with LTVs near 70%, average FICO scores in 690-700 range and four-year repayment rates. Compare that to residential bridge securitizations that have yields in low fours, LTVs in the mid 60s, average FICO scores over 710 and two-and-a-half-year repayment periods. This means investors are actually getting higher yields for an asset with lower credit risk and less exposure to long-term housing cycles. The trade off is that because the asset class is still in its infancy, there’s less liquidity and the assets are not rated -- but that is changing.


Figure 2


Toorak Capital Partners expects to complete a rated transaction in 2020. Once the asset class starts receiving ratings, it will open the door to a far larger pool of investors, which will increase liquidity almost immediately.


2020 is the inflection point

To date, Toorak Capital Partners has been responsible for over 30% of the total issuance of residential bridge loan securitizations, including the three largest transactions. This market dominance is due to first mover advantage, deep institutional expertise and the fact that Toorak Capital Partners has experienced deminimus, single digit basis point principal and regular interest loss through approximately $2 billion in payoffs.

Once rated transactions become the norm in residential bridge securitizations, the market should expect both demand and supply to increase dramatically. However, residential bridge lending will remain a highly specialized asset class that requires a high degree of oversight from a skilled investment manager. Investors should demand stringent underwriting and high credit standards from any issuers, as well as a voluntarily commitment to exceeding first-loss risk retention mandates.


2020 is setting up to be an exciting year for residential bridge securitizations. Structure credit investors would be wise to keep a careful eye on this rapidly maturing asset class.

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Toorak Capital Partners is a leading real estate investment manager dedicated to investing in small balance business purpose residential, multifamily and mixed-use loans throughout the U.S. and the United Kingdom. Headquartered in Summit, N.J., Toorak acquires loans from leading loan originators and manages all aspects of its investment portfolio, including loan sourcing, pricing, underwriting, acquisition, and asset management.

If you’d like to learn more about Toorak’s securitizations platform, please contact Aleksandra Simanovsky at asimanovsky@toorakcapital.com.


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