Re:A Yale Graduate Leaves a Trail of Ventures and Debts
by chatmasta on Thursday April 16, 2015 @11:11PM
(#9392071)
Again, I am uninformed and this entire system is very complicated, and not documented in any authoritative legislation that I can find. In fact the Wikipedia page on "hard money loan" has one citation, a 404'ed Fannie Mae page. It's possible the entire idea of "hard money lending" is a bullshit concept executed differently by every investor. This may contribute to its apparently shady reputation. Because of its undocumented nature, it's difficult to discuss these loans and I am having trouble understanding the system. Despite that, let me try to respond to you:
Your examples make sense when the loans are targeted at individuals who live in the home the loan is paying for. In that case the incentives can frequently align to decrease overall risk.
However what I am hearing from mid level investors on the "ground level" is that most of these loans are not going to people living in the houses. They go to people renting or flipping the houses. This is creating misaligned incentives.
Because flippers/landlords work at scale (more than one house) they naturally treat the loan as an investment vehicle and therefore need to create positive ROI. A single homeowner doesn't care about high interest rates because presumably they were the best, or the only, option to buy a house. However flippers/landlords need to "cash out" of the loan for the high interest rates to be viable. They can also use the equity in one house financed with a loan as the collateral for a second loan.
A single default can have cascading consequences on multiple parties as it can lead to the foreclosure of multiple properties and a liquidity crunch for the lender who needs to then dump the properties. If suddenly twenty 3br houses within the same area foreclose and go up for sale, then the surplus of housing supply drives down the price.
The increased risk of lending to landlords creates an incentive to consolidate funds to cover a larger risk pool. That is why blackstone and other PE firms are investing in large funds. The problem is that by investing in many landlords, black stone cannot properly assess the risk of every loan. If this sounds familiar it's because the exact same thing happened in subprime mortgage.
Ultimately the problem is large funds are consolidating risk while decreasing the accuracy of risk measurement. This combines with the sudden influx of funding to create incentives for reckless lending.
Put another way, multiple parties are making money without providing any service other than consolidating funds and passing risk tolerance onto the next lender. The system of banks > PE funds > brokers > landlords has too much exposure. Too many people lend the money without knowing the risk.
As for why black stone would securitize into bonds, it is the economically rational thing to do. Unfortunately in this system the loser is the one left holding the check when real estate plummets and interest rates rise.
There are many parallels to subprime 1.0, most notably the middle class lenders authorizing the loans with "someone else's money." Landlords are not funding the investment but they are assessing the risk.
(Sorry for long reply. I have been thinking about this a lot.Also p.s. My original comment was wrong about Josh Adler head of b2r. I mixed up two people with names josh and Adler.)
Your examples make sense when the loans are targeted at individuals who live in the home the loan is paying for. In that case the incentives can frequently align to decrease overall risk.
However what I am hearing from mid level investors on the "ground level" is that most of these loans are not going to people living in the houses. They go to people renting or flipping the houses. This is creating misaligned incentives.
Because flippers/landlords work at scale (more than one house) they naturally treat the loan as an investment vehicle and therefore need to create positive ROI. A single homeowner doesn't care about high interest rates because presumably they were the best, or the only, option to buy a house. However flippers/landlords need to "cash out" of the loan for the high interest rates to be viable. They can also use the equity in one house financed with a loan as the collateral for a second loan.
A single default can have cascading consequences on multiple parties as it can lead to the foreclosure of multiple properties and a liquidity crunch for the lender who needs to then dump the properties. If suddenly twenty 3br houses within the same area foreclose and go up for sale, then the surplus of housing supply drives down the price.
The increased risk of lending to landlords creates an incentive to consolidate funds to cover a larger risk pool. That is why blackstone and other PE firms are investing in large funds. The problem is that by investing in many landlords, black stone cannot properly assess the risk of every loan. If this sounds familiar it's because the exact same thing happened in subprime mortgage.
Ultimately the problem is large funds are consolidating risk while decreasing the accuracy of risk measurement. This combines with the sudden influx of funding to create incentives for reckless lending.
Put another way, multiple parties are making money without providing any service other than consolidating funds and passing risk tolerance onto the next lender. The system of banks > PE funds > brokers > landlords has too much exposure. Too many people lend the money without knowing the risk.
As for why black stone would securitize into bonds, it is the economically rational thing to do. Unfortunately in this system the loser is the one left holding the check when real estate plummets and interest rates rise.
There are many parallels to subprime 1.0, most notably the middle class lenders authorizing the loans with "someone else's money." Landlords are not funding the investment but they are assessing the risk.
(Sorry for long reply. I have been thinking about this a lot.Also p.s. My original comment was wrong about Josh Adler head of b2r. I mixed up two people with names josh and Adler.)