Rethinking Private Loans as a Financial Solution to the Affordable Housing Crisis
Updated: Mar 16, 2022
Facing the Challenges in Housing Demand and Funding
By John Beacham
The U.S. is experiencing a severe shortage of quality, affordable housing and new construction developments are unable to sustainably meet demand. However, renovation, repositioning and rental of residential properties, fueled by private loans made to local borrowers, is contributing to the improvement of the situation.
Increased Housing Demand
A recent report from the National Association of Realtors shows new housing construction in the U.S. over the past 20 years fell 5.5 million units below historical levels. Within that shortfall, a total of 5.5 million are in properties of five or less units. In addition, new home construction in the past decade fell 6.8 million units short of what is needed to meet household formation growth and normal reductions to housing inventory. For every 100 low-income households, there are only 37 affordable and available rental homes.
Compounding the lack of new housing construction, COVID migration patterns have exposed many shortcomings in the U.S. housing market – most notably the lack of sufficient housing supply in suburban locations, where new construction lagged behind city centers. While the COVID-19 pandemic may be easing, companies and workers are realizing that remote work is sustainable over the long term. This means that movement from city centers to suburban areas is expected to increase, placing a priority on the production of new inventory in such areas.
Many of those leaving city centers (and not returning) cannot afford to purchase a home and prefer the convenience of rentals. Such rentals are usually offered by local landlords of residential homes, who generally finance their properties with private loans.
Challenges in Meeting Increased Housing Demand
While it will take years for new construction to make a measurable difference in meeting demand, renovation has the proven ability to provide more immediate relief for the affordable housing market. Opportunity is not the issue – there is a pressing need for updates to outdated housing stock and conversions of single-family properties into multifamily properties. However, despite this increased demand, developers and property investors looking to build, reposition or stabilize occupancy within smaller scale properties with loan needs under $10 million are experiencing a scarcity of reliable capital.
Challenges with Funding from Existing Institutions
Traditional lenders and government agencies have limited structure to finance business purpose loans for the rehabilitation, stabilization or rental properties . Financing for rehabilitation and stabilization loans is limited due in part to the lengthy and complex loan approval processes , as these deals usually involve additional layers of approval, including loan committees that involve a consortium of partners that must reach a consensus. Financing for rental loans is limited, due in part to the lack of focus on the income generated from the property, but rather on the borrowers’ financials. Additionally, traditional lenders and capital providers typically do not have the local knowledge or in-place infrastructure needed to process such loans. Today’s market moves faster and needs to address the urgent demand for inventory that did not exist pre-pandemic.
Since banks and government programs do not typically offer these loans, real estate investors and house flippers have historically relied on private money also known as "hard money loans," which are loans that are backed by a “hard” asset, such as real estate. However, financing choices were limited to local lenders, private individuals, and companies offering non-standardized, non-institutional, underwriting loan programs with interest rates upwards of 10% and varied credit standards. Many rehabilitation projects went unfunded due to a lack of capital, which only worsened the housing shortage.
Rethinking “Hard Money” Financial Arrangements
Toorak’s solution was to create an ecosystem that linked small balance real estate lenders to institutional capital – enabling growth along the supply chain while feeding capital back into the system to fund future projects.
Toorak provides capital to local and regional lenders that it partners with nationwide, who in turn work directly with the borrowers who are conducting the actual rehabilitation work. The capital Toorak provides enables its network of lenders to fund and close more small balance multifamily loans without locking up their capital.
Since its first deal in 2016, Toorak has funded more than 15,000 loans, which are expected to provide renovated and/or stabilized housing to 17,000 families (including more than 9,000 units completed to date) at a rate of approximately 500 units per month.
For each loan, Toorak conducts a thorough review of the borrower and the property – underwritten by strict credit standards, property value and the borrower’s ability to successfully complete the project itself.
After capital has been deployed and projects are complete, there is an attractive market for private capital providers like Toorak to purchase these residential bridge loans from the local loan originators. This allows for greater turnover in capital available for loans, and in turn, for increased housing inventory to be introduced. This equates to more engagement in disadvantaged areas, more home ownership, and improvement in overall quality of life based on organic, community-focused growth rather than gentrification.
Toorak’s established infrastructure offers an institutional, homogenized product, with rapid loan acquisition cycles, an efficient draw and payment process, and consistent and transparent due-diligence, enabling lower fees and fastest closings because of its access to capital markets.
This new process should dispel the negative and unreliable connotations of “hard money.”
The key to keeping this type of financing available and self-sustaining is to package the loans in ways that would be appealing to institutional fixed income investors. Toorak has now issued six securitizations to date totaling over $2.0B. There is high institutional interest in these securities. The strict underwriting standards and due diligence on each loan, paired with the fact that additional loan funds are released to borrowers only with proof of project completion, means the underlying assets are of very high quality. In addition, institutional investors have full transparency into the quality and credit worthiness of each project. This capital is used to finance more loans, which in turn leads to additional rehab projects and more housing inventory being released to the market.
This approach democratizes real estate investment opportunities, allowing hardworking entrepreneurs the opportunity for wealth creation regardless of education or background. In the process, these entrepreneurs transform outdated housing stock into newly renovated, affordable housing. In fact, more than 85 percent of the units Toorak has financed are affordable to families earning the median income or less in their neighborhoods. This process also creates jobs for local contractors and laborers, increasing economic activity within communities.