Single Family Rental Lender B2R Goes with the Cash Flow
Buy-to-rent mortgage specialist B2R behaves like a commercial lender when underwriting loans to small-to-medium landlords, an approach that differs from the residential lens the GSEs use for individuals looking to buy rental properties.
In a Q&A with ASR, the firm’s president John Beacham and newly appointed CFO Evan Lorch discuss the metrics B2R uses in assessing a prospective customer, from property cash flows to appraisals. They also hold forth on the sources of competition and the traits of their target audience.
Established in November 2013 by private equity giant Blackstone via its Blackstone Tactical Opportunities unit, B2R targets those who are looking to purchase anywhere between five and 1,000 properties, which includes single-family homes as well as two-four family homes, townhouses, condominiums and multifamily apartment buildings. Loans run from $5 million to $50 million and are five-year floating- or fixed-rate or ten-year fixed.
With more than 65 employees, the company has quoted loans in 35 states and offers them in 45.
Securitization players are watching B2R and its peers Colony American Finance and FirstKey Lending as potential issuers of multi-borrower, single-family securitizations. This would be akin to conduit versions of the single-borrower, single-family rental deals that have been hitting the market since late last year. There’s one big difference though: the small landlord market covered by the B2Rs of the world is estimated at 14 million homes, the market the large institutional investors operate is about a quarter of a million. And no one expects the ratio to change much in the foreseeable future.
B2R has said it is evaluating securitization as one of its funding options. For now, Blackstone Tactical Opportunities Fund is providing equity financing and a national bank provides warehouse funding.
Q: Your background in M&A and startups, Evan, would indicate that B2R is still very much in a strong growth phase. Is this the case?
Lorch: We’re trying to build a scalable operation and if there’s an asset we’d like to acquire that could get us there quicker, [we’ll buy it]. It could be a system, an operation, a platform, people. At my last company [CoreOne Technologies] we wanted to get into cloud-based hosting and we bought something that could get us there quickly. As we continue to grow, I’m working on currently evaluating a number of strategic expansion opportunities with the company that will meet the demand that we’re currently seeing.
Beacham: We’re seeing a huge amount of demand for our product from customers across the country [and] we don’t feel like we’re even beginning to address the opportunity here in the market. We’ve quoted closing loans in upwards of 35 states. Pretty regularly we’re getting more than 1,000 inquiries per month. We have more than 65 employees currently [and] we’re actively hiring more people.
Q: Could you describe your typical borrower?
Beacham: They could be doctors, dentists, real estate agents, developers. Our first customer was a CPA. They tend to be successful entrepreneurs, buying homes where they live. The minimum number of homes [we fund] is five; the median is 10-20 homes. Big states for us include Georgia, Florida, Texas and Illinois.
Q: What motivates them to invest in rental properties?
Beacham: It’s a pension substitute product for many of our customers. Our typical borrower is between 30 and 60 years old and is looking for a retirement asset. Right now you can get a 6% net yield on a typical home, plus tax benefits. Compare that with bond yields, and it’s much more attractive. [Also] rents tend to increase with inflation over time. This asset class is not new. From at least the early 70s until today, somewhere between 10-15% of the housing stock has been single family rental homes. This asset class has proven to be appealing to investors in different economic environments over long periods of time.
Q: Who are your main competitors in this business?
Beacham: In order — cash, the GSEs and community banks.
Q: Let’s start with cash.
Beacham: These are people who have bought their houses and are unencumbered. There are customers who don’t even know that financing is available for this asset class. And there’s a portion of this market, maybe they’re older and in a different phase of their life, and they’re not in an accumulation phase, they’re in a harvesting phase. But others are unencumbered even in their 30s, 40s, 50s, who really should be borrowing to buy more assets.
Q: How about the GSEs? Both Fannie and Freddie purchase conforming mortgages to rental property investors and there’s the view that the market of small landlords is amply covered by this product.
Beacham: The GSEs are primarily focused on doing residential owner-occupied loans. They treat [the rental property market] exactly the same way they treat owner-occupied loans — they underwrite it the same way and have the same criteria around it. The product doesn’t work for many customers. First of all there’s a cap on the number of investment properties that can be financed, four at Freddie and ten at Fannie. That limits the number of non-owner occupied properties you can get. The GSEs also require a separate loan for each property which increases closing costs and they also will only lend to individuals. Many sophisticated investors prefer to buy homes in LLCs in order to benefit from liability protection. On the other hand, the appeal of the GSEs is you can get a 30-year non-call protected product that’s pretty efficiently priced.
Q: So how does B2R’s underwriting approach differ? Does it have more of a commercial bent?
Beacham: We don’t look at your personal income. We look at the property cash flow like a commercial lender.
The GSEs look at all your personal income and make sure it covers your debt service. The debt-to-income number for residential loans, including investment properties that [they apply] is 45%. Why 45%? The science is that for the average American you can’t afford to spend more than 45% of income on housing because you need the 55% for food, clothing, gas and all the other expenses you might have. This approach requires the lender to re-underwrite every property owned by a borrower each time the borrower adds another loan which results in a significant documentation burden once investors accumulate a number of properties. In addition, because they apply a global income calculation, GSE lenders do not require that the individual property covers its associated debt service which we believe increases loan default risk.
We look at the individual’s credit characteristics — do they pay bills on time, past bankruptcies, etc. — but we’re primarily interested in in the cash flow of the underlying property minus the expenses that go into managing the property. We look for a 1.2x debt service coverage ratio, the standard for commercial real estate lending. It makes it easier for certain people to qualify to build up their portfolios of property.
Q: And your final competitor would be the community banks…
Beacham: There are local regional banks who’ll offer this type of product [but] it’s not usually considered a core asset for them. It doesn’t fit well into how most community banks are set up. They tend to have their residential lending group lenders and their commercial real estate group. This fits in the middle. It’s not something they do consistently. How do we compete [with them]? On pricing and leverage but probably more importantly we compete on stability. We’re here not only to finance your first portfolio but [also] your second and third. We also offer non-recourse financing alternatives that many banks do not offer.
Q: Properties backing the single borrower rental securitizations are valued through broker price opinions (BPOs), how do you value the properties that you finance?
We get an appraisal for all of our properties. Appraisals are more expensive than broker price opinions. They’re done by a licensed appraiser, who has a certain level of training and certification.
Q: How do you arrive at the expected cash flow on the property?
We get copies of the leases on every single property. And then we do a market check to figure out what that market rent is for that particular house. We make sure the rent is not only correct for the current tenant but also correct for the next tenant. We’ll only give credit for what the market will bear in rent.
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