Mortgage Loans and MBS

What to Watch in Real Estate Alternative Financing

Nov 02, 2021 | By JOSEPH CIOFFI

Inflation forecasts have piqued investors’ interests in adding more real estate to their portfolios, while new technologies and geographic, climate and consumer trends are driving the need for creative and alternative financing structures. Now is the time to get familiar with these arrangements as it won’t be long before they have a significant impact on the credit markets, either through securitizations or competition with traditional pooled assets.

An Alternative Focus

As travel was interrupted and leisure activities curtailed, some investors have moved away from hotels and luxury. Instead, some have favored investments in more practical markets with a new focus on data centers, cold storage, self-storage, life sciences, medical facilities, parking lots and student housing.

While the trend of institutional investors buying single family homes is not new, 2021 brought a marked uptick in this activity. A 2021 report identified one in seven U.S. homes in the first quarter of 2021 were purchased by institutional investors. By June, another report said it was nearly one in four homes.

To find opportunities other investors have missed, there has been more reliance on technology and data analytics to crunch numbers and target real estate with the best investment value.

Preferred equity deals have been growing over time and more recently as investors are trying to gain yield.

Alternatives in Real Estate Financing

For the small investor or home buyer, they are now facing steeper competition with big institutional investors. So technology start-ups have found ways to assist smaller investors and even some home buyers in this overheated market to help compete by financing all cash offers.

Pandemic competition for houses has meant all-cash offers frequently control. One iBuyer’s approach is to buy the house the customer is targeting and then lease it to the customer until that customer gets a mortgage or sells their current house and then the customer buys their target house from the iBuyer. This frees up a home seller to wait for the best offer on their current home while assuring them the target home they wanted is held for them to purchase. It also keeps agents happy because it does not interfere with their practices.

As one investor has noted, there is more comfort in residential real estate with “home-equity-based financing models (where the owner sells a stake in their home, or acquires full ownership in a home over time).”

These shared appreciation agreements are often for borrowers who might struggle to access a home-equity loan and are in need of liquidity, with investors offering a contract for cash in exchange for some of the equity in the borrower’s house. The borrower must pay off the contract with the investor and the investor gets a percentage of the home’s appreciation during the term of the contract (plus up front fees). But if the borrower can’t repay, the investors could foreclose, though they take a secondary position to the original mortgage.

While reverse-mortgages have been around for a while and focus on older borrowers who are looking to stay in their homes, other borrowers have started dabbling in sale-leasebacks. In these situations, borrowers who are currently strapped for cash sell their homes to a firm which leases it back to the borrower. When the borrower is in better financial shape, they hopefully can purchase the home back. But, of course, that is a risk and some groups are raising consumer protection concerns with these arrangements.

With the growing use of cryptocurrency everywhere, it was inevitable it would also crop up in real estate loans and investments. Some holders of cryptocurrencies are beginning to get loans to purchase tangible assets backed by their digital deposits. At least one company is establishing a pool where users can put their real world assets (including real estate) and then receive a loan paid out in stablecoin. These “credit lines” will be entirely structured through the blockchain network Ethereum.

We’ve even reached the point where three New York City retail condos are for sale but purchases can only be made in bitcoin.

Looking Ahead

For all these creative financing arrangements, the key is always to know the risks, understand priority of payouts and liens, and know competition is only getting stiffer as the range of products and services expands to the edge of the latest technologies and market trends.