Making Rental Loans in the New Normal

Nema Daghbandan:

Good morning or afternoon or wherever you are in this country. Thank you for joining us here today. Geraci is kind of kicking off our new series. We were very covid related previously and trying to navigate the kind of daily momentum and changes that were happening during the Covid crisis. And obviously we're still very much in the covid crisis, but I think for ourselves and for a lot of other businesses, it's now adjusting to what we would call the new normal. So we're now back in the marketplace and adjusting to that, understanding what that looks like. And so really this is the first webinar of many that we will be having about how to transact in this new normal. The virus is still very much around you have case counts going up but how are businesses operating and adjusting to this new environment?

And I'm really excited because one of the first casualties when Covid first struck was rental loans. And had a good question come by earlier this morning to my email asking, well, isn't a rental loan just a non-owner occupied loan? Aren't they one in the same thing? And that's true a rental loan is necessarily a non-owner occupied loan. But what was a kind of change in momentum, particularly in the past couple years is that most private lenders, when they were issuing rental loans, they were only issuing bridge rental loans. So these short-term one or two year type loans to help transition a rental asset, which were usually taken out by some sort of bank financing down the road once they had a significant DSCR. And what changed in the past few years was that the many, many private lending institutions, Constructive probably leading the charge on this, started issuing rental loans that were a 30 year paper and we've got securitization and capital markets and this whole system and ecosystem of financial ecosystem that was built around this product.

And then obviously covid hit and as all of you know the capital markets immediately froze up as they typically do in these situations. And so it was a really interesting question whether rental loans could or would survive particularly this longer term paper whether it could survive and what it was going to look like. And so Constructive really is leading the charge I would say on this and was one of the first companies to figure out how to get new capital sources and negotiate with capital sources and figure out quickly how to get this machinery up and running. And that's a lot of what we'll talk about today but that's very much the purpose of today's webinar is really to talk about what does the product type look like today, how does it differ from what it was before and really to realign expectations of what this product looks like.

Before we dive into that a little bit about myself and the firm. My name's Nema hopefully many of you know both Ben and myself. I'm a partner here with Geraci LLP. Big picture wise about Geraci itself is we're a vertically integrated model built around private lenders. What that means is we try to be a full service law firm that can serve all needs that a private lender would run into. So we've got a corporate securities practice that prepares private placement memorandums and helps on the capital raising side of a private lender's business particularly mortgage funds. I'm on the lending and compliance side of the business. So we're typically involved with the preparation of loan documents and providing compliance advice for multi-state lenders who are going to be making loans and making sure they can stay within their guardrails. We also have a foreclosure practice here in California where we handle foreclosures and then we also have a litigation and bankruptcy practice helping lenders who are stuck in those situations navigate through them. In a normal pre covid market, we were very focused on loan origination. In the past few months we've been much more on the work out side, forbearances, modifications, and foreclosures. It's probably currently an even 50 50 split between new loan origination and then the work out side of the business for us here at Geraci. And then Ben, why don't you tell us a little bit about yourself and Constructive?

Ben Fertig:

Yeah, no thanks Nema and certainly thanks for the opportunity Ben Fertig, I'm the president of Constructive Loans. Little bit about my background this September to the extent that the world gets there we'll mark my 24th anniversary, 24 year anniversary as a mortgage banker and the last eight of those have been exclusively in the residential investor loan market and that started with the inception of a company by the name of Jordan Capital Finance. It is a platform that we actually sold twice, the second time of which was to the Blackstone Group in February of '17 where it effectively became half of what is now Finance of America Commercial, which most of you probably have heard of. And then in the fourth quarter of the same year I started Constructive Loans in partnership with what is the largest specialty servicer of residential mortgage assets in the country. Now, Constructive originates both well fix and flip loans and both portfolio and single asset rental loans. 80% of our historical origination population and about 95% of our current origination population has been single asset rental loans. And then 90% of those have been originated through some type of a third party partner, whether that be a broker partner or a correspondent relationship. So Nema, hopefully we should be on point here.

Nema Daghbandan:

Yeah, absolutely. And one thing to note really about Ben is we get the fortunate opportunity to meet lots of new clients here and I remember distinctly when we started talking initially and I candidly did not think he would be able to perform in the way he did <laugh> when I first first met you guys. And so I've never seen a company move at the velocity of what Constructive has ever in our history as a law firm. And it's a real testament to you, Ben, in terms of an ability to scale and grow a business. I've truly never seen on the scale and scope of what you were able to do in the short window. So I know we've got a setback going on in our world right now, but very excited to see where that heads back for you guys. So a little bit about the agenda today we've, we're going to talk a little bit about the programs that were available pre covid and what that looked like what rental programs we are seeing now in the marketplace how the sourcing process works, what are the underwriting requirements typically associated in the current marketplace related to rental loans, how do you document them, how does the documentation differ?

And then really explaining the ecosystem on the capital market side. Again, what makes these loans unique is they are rarely going to be held on a balance sheet of any lender and so there tends to be a lot of trading and securitization involved. And so knowing how each party either the end buyers or issuers of the securities are thinking about these is very helpful to understand the underwriting side and how you can think about this product differently. A little point from a housekeeping perspective if at the bottom of all of your screens right now you should have a box that says Q and A and chat and raise hand. The best way to communicate to us at any point in this presentation is use that Q and A box. Ben and I can see the Q and A box at all times. So feel free to ask a question at any time.

We've designated time at the end of this presentation to answer any of the questions they may have, but feel free to ask them at any point in the process and we'll be able to go through the questions at the end. Other housekeeping items which are typically asked one is this presentation is being recorded it'll be available to all of you after the presentation. We usually send that follow up email which includes a copy of the slides for the presentation for those of you that want the slides. And then also an ability to a video link where you can watch it later. So if you want to share this with people after the fact, you're more than welcome to so know that you will be able to get a copy of the slides. We wrote an article similarly associated with this webinar that'll be distributed there about how to understand and view rental loans. And so all of that will be sent in a follow-up email after this webinar. So kind of go diving right into it. The first thing is really understand and discuss what was a typical or what really available and what did the marketplace look like February, 2020. Ben, you know guys are under literally writing hundreds of these a month. So kind of talk to us a little bit about what a typical loan looked like in February, January.

Ben Fertig:

Yeah, sure mean, first of all, we talked a little bit about possibly defining what we mean by pre covid and post covid covid obviously these days is a broad term used in a lot of different contexts but I think what we're referring to when we say pre covid and post covid referring to Covid as the historic market disruption that occurred in the non-agency mortgage market the week of March 19th. I'm sure many of you remember it, the 19th was actually a Friday, but it was that third week of March. And what effectively happened was that there were two mortgage rates, both of them, them were publicly traded that couldn't post collateral on their short term repo facilities and that collateral was reclaimed in the case of one of the REITs. It was sold almost immediately for 85 cents on the dollar to recover the 85% advanced rate given the way that the facility was structured. And in the case of the other rate it happened to be mortgage secur, it happened to be mortgage securities.

And effectively anybody who was exposed to any type of mark to market had to sit back and take a pause on a number of levels not the least of which was everybody else's facility is going to mark paper to 85 cents on the dollar causing the residual reaction that you saw back at the 2008, 2009 financial crisis. But the other thing from our standpoint, for instance, wasn't super exciting to us to originate alone where when we pushed the button on the wire we were going to lose 15 points immediately. So you saw effectively a cessation in lending and the market did trade around 85 cents for a short period of time. It moved up into the low to mid nineties, probably within 30 days of that happening. And just for full disclosure, we did sell a pool at that level but it put the market in a situation where it had to make up five to 700 basis points and relative to what was going on pre covid. And two most common ways that you see that happen is number one, higher interest rates and then secondly tighter credit policy. So I think that's what we're talking about. But when we say pre covid and post covid, yeah it was January, February the market post covid market came back early May, but it's just not something that Neiman and I are just kind of arbitrarily defining. It was based on that third week and what had happened in the capital markets.

Nema Daghbandan:

Absolutely. And I talked about this as well is what really I think marked this period and that was interesting and I think we'll likely probably start seeing a return as the investor appetite changes over time and this product starts really ramping up again. But what was a lot of these loans had a initial interest only period and that made them very attractive for the rental investors because they were able to just get their cash flow kind of juiced between the arm and the IO period. They had a really great opportunity to have a low debt service payment and these things were flying off the shelves pretty quickly. And that's obviously one of the things we'll discuss kind of from a change perspective. So March 19th happens and we've got kind of a market disruption and again, we kind of watched from our lens here at the firms, we have a loan document generation system that a lot of our clients use where they can generate our docs through the system and we just watched the traffic just immediately dissipate overnight and you got kind of got to see in real time wait an actual product just disappear.

So obviously the interesting thing, I think I was probably much more skeptical of the return because the reliance on a robust capital market system seemed to be the necessary precondition for this to come back into play. And to my surprise these products actually have made a comeback and we're to see the repopulation. So let's start talking about what you now see today and what the investors are looking at in terms of the product that they want originated.

Ben Fertig:

Sure, I mean if you want to go back quickly, we could touch upon the pre covid covid programs. I mean you mentioned the 30 year amortization, that's the most common structure you saw. Most of what we did quite honestly was interest only arms. I don't think there were more than a handful of arm loans that we did that weren't interest only. To your point, investors not priority was generally cash flow five and a half to seven. I mean quite honestly there were rates back in the first quarter trading lower than that. We wrote some rates with four handles. It wasn't uncommon for the cores product or the portfolio products to trade in the four S average, our weighted average LTV at Constructive was 71 and a half. That was driven by a max loan to value on purchase and rate term refinances of 80 and a max cashed out LTV of 75.

One of the key differences was those max LTVs at the time were achievable with a six 40 fico. As we go to what's going on now, we'll see where that's, that's changed. And then you would mention Nema, the sliding scale of prepayment penalties with preferential pricing. Another thing as you start talking about what's going on with the capital markets was prior to all this happening bond investors rating agencies had good visibility on what prepaid speeds were going to be. They were able to be reliably modeled. So you could effectively calculate how much more rate you would need in the near term to cover your prepayment speed risk. I mean that's not so easy. That's not so easy now. And then the other thing that I think is probably worth mentioning pre covid is that there were some fringe products out there, meaning there was a no ratio dftr product that was not uncommon. Some of the non QM platforms there were dfcr below 1% and some of those things right now we're writing everything to a 1.15 minimum. Do those fringe products come back? I don't know. I mean I'm not sure that Constructive would want to lend to somebody who's willing to go underwater on a property to kind of bend on home appreciation. So we'll see how greedy the market gets. But as of right now those are not commonly trading.

Nema Daghbandan:

So then obviously that's what was being offered then What are you seeing from an investor appetite perspective of what the expectation is today?

Ben Fertig:

Yeah, so right now we've got full operating again of both fixed and arms and we just brought IO back early on Monday and you've seen LTVs get back up to five points of attachment less than they were now when we went into our first M L P A mortgage loan purchase agreement that was effective after covid in early May, everything started at 65 ltv, 60 cash out. We've seen that come up five and then come up 10 since then there's a difference. The FICOs have tightened right now we will go down to a six 80. We had kind of toggled over the years between generally a 606 20 is a minimum fico but in order to achieve the highest LTVs got to have a seven 20 that was a six 40 as of the first half of March. So you're seeing that as what I would call a meaningful difference from a prepay standpoint.

You're going to see it on all products, right? I mean anything based on rates that have jumped the way that they have LTVs are alleviated from what they were. It's very difficult, if not impossible to model what prepaid speeds you're going to be. See investors generally want that protection and to the extent that they don't get that protection, it's going to be expensive to buy it out versus what it was. We've got nine months reserve requirement. Now we do have a more relaxed product that we'll probably touch on in a second that's six months. It was three months generally prior to covid. So I think that makes sense, right? I mean it's logical. There was eviction moratoriums, you don't know if unemployment's 20% or 20% of the tendency the underlying tendency that's supporting these loans going to be unemployed makes more sense that you're want your borrower to be more liquid. And then our loan size has always been about anywheres between 170 to 200,000. As Nema knows as we're a legal doc client we do a lot of loans at Constructive, a lot of units before this we were doing just about 300 single asset rental loans a month.

We're not that heavily weighted in the coastal areas. It's not necessarily something that's strategic. I'd like to be there's probably a lot of good California loans out there that we're not doing. I mean it's probably more of a function of our better sales people may have been in better areas but our sweet spot seems to be one 70 to 200. And the one thing that we've always had historically is good loan performance. Not that that's specifically correlated to loan size, but kind of figured out what we've done well and tried to do a lot of it.

Nema Daghbandan:

And that's actually an interesting point you made as well, which was the, you and I talked about this a few months ago, which I think also probably helped speed up the acceleration of capital market's interest again was actually there was a fairly low default rate on these loans even with the looser credit standards. I don't know if there's any kind of statistics or window you've got into, what was the default or portfolio rate or if there's anything you could share on that, but I know it was actually surprisingly low.

Ben Fertig:

So we had always had a default rate at about 1.75% by unit on the single asset rental product. So what you saw when from the second half of March on was you know, started to see forbearance requests come in, forgiveness requests come in. And with our own portfolio, if you took any loan that was not cash flowing to the owner and we had visibility on it cause we're affiliated with the servicer that services all of this. It was in April and May, it was just about six and a quarter percent. We saw that drop in June to just over four. So performance actually came back.

But probably more importantly, some of the consumer non QM portfolios and if you're not familiar with what they do from a product perspective it's like the bank statement loans, the asset depletion loans, but just generally your owner occupied non QM loans in some cases were between delinquency and forbearance and forgiveness plans were close to 30%. So what you saw was a diversion in the performance of these non dscr loans who had always been included in these non QM securitizations and some of the owner occupied stuff. So of course you know had the capital markets assume that the performance was going to be much worse as the underlying investor borrowers continue to perform, you saw capital start coming back pretty quickly.

Nema Daghbandan:

And by way of example, when you look at the MBA surveys still, I think they've peaked out at about 9% forbearance rates and kind of toggle back down to closer to 8% now. But interesting enough is that these products have actually performed better than pretty much all the markets which is real a true

Ben Fertig:

They perform better than agency and they've performed better than certainly goy, FHA and va. And to the extent that they continue to, you'll see more capital coming to the market.

Nema Daghbandan:

And so what's interesting is this has been a very rapidly evolving situation as well, which was I remember, gosh, maybe it was short better than I do either, it was May or June, but pretty shortly thereafter we'd started hearing the inklings of investors interested in the fixed rate product this 30 year full am product. And it seemed like that would be the only name in town. But you've already been starting to talk to others. So let's talk about other than this fully advertised product, what else is really out there and what's the appetite outside of the fully M products?

Ben Fertig:

Yeah, so we've got a 30 year fixed now we're offering five seven and I think we just added a ten one arm. All of those have an interest only option. Now we've got with the relaxed lease requirements I think came from some of the stuff that we did in preparation where in the beginning we were getting some kind of goofy provisions in the guidelines where we were being asked to, if there was a lease that had less than six months remaining, we had to get it extended. It was a bit of, was difficult to operationalize to some extent. And the other thing that was out there was that a tenant voe was required, which just was virtually impossible to operationalize with privacy and fair credit reporting, those types of things. So we got past all that, we relaxed most of that. We talked our capital partners into getting rid of that and trying to explain how we didn't think there was very effective against, relative to how difficult it would be to try to originate a loan like that.

And I think that a lot of what we're doing will less the fact that you need a higher FICO to get to some of your maximum attachment point. There's a little bit of a more buffer reserve requirement but a lot of it is the same. I think we've been able to have some good conversations with the partners that provide us capital. And by the way, I mean we had four main partners prior to this and we've got three now, so we're effectively capitalized the same as we were. But I think case in point is you're finding that when it comes to risk they're listening Well, and to the earlier point that the performance obviously has certainly helped support that.

Nema Daghbandan:

And by way of example I would say is I, 95% of the law firm's clients originate and continue to originate, fix and flip loans. And so we started seeing that dynamic change a couple years ago was we started seeing a little bit of diversification of project of products. So initially, if I take you back seven years or so, it was all mostly here in California, then it started branching outside of the state. That was kind of the first movement for a lot of our clients then in as yields compressed and as yields compressed that you started seeing this branch outside of their typical product. So first it was lending outside of the state, then it was starting to expand into other lending verticals. So it was commercial real estate or it was some had switched into consumer purpose non qm, particularly on the bridge side and really trying to diversify.

And so one of the things that as clients start pivoting into these other products and in the last couple years it really was the movement towards rental. And at probably the fastest rate when I would traditional fixed and flip originator I think the riding on was on the wall that you would have these large powerhouse organizations that were just going to undercut on the rate side over and over again and it was going to be a race to the bottom on fix and flip. And so it seemed like the smart play at the time was to really pivot into rental where there was a lot of different offload options that you could handle. And so why don't you just explain, cause a lot of the audience that is listening to probably have never really, neither may have this quote coming into 'em, but why don't you explain the origination side of this and how it differs and how people think about the origination side of this.

Ben Fertig:

Sure. Yeah. So look, I mean 90% of what we do is third party. So we do do some of this relative to our direct investor direct originations. But certainly it's not anything that I would consider trade secret. But your existing fix and flip borrower base should be your top priority. Most of our client base has some type of a bifurcated model where they buy to flip and they buy to hold. If you don't have access to a rental loan, you really have to get one. And the reason for that is you've got to keep that borrower in your ecosystem. So if that borrower is a good bridge borrower of yours, let's say and he needs rental financing, and we've seen in the Constructive portfolio about 35% of our bridge portfolio exits into some type of a longer term credit instrument. So in other words, the borrower's not selling the top keeping it.

If that borrower goes to somebody else for a rental loan and oh by the way that somebody else also offers a bridge loan, you risk losing that borrower altogether, right? So I mean you work hard to develop these clients and you want to make sure that you're keeping them, that that's the first way and it doesn't really cost you anything. We also do some search engine optimization and search engine marketing. That's something that we do through a third party vendor. If I remember correctly. There were plans of about from about 4,000 to $13,000 a month depending on what you want to do with that. The search engine marketing is Google AdWords with somebody, Google's six foot loan or rental loan or whatever it is show up. I think we probably spend about 10 grand. I know that prior to all of this we would get between three and five is a day from that. Honestly, I probably should have the information now as to what we're getting, but I don't that's one thing. And then lead exchanges, the one that we used many of you probably heard of connected investors or cx they're kind of a lending tree that tailors that's tailored towards real estate investors.

And I think we pay 20 bucks maybe a lead. The cost that coincidentally as everything stopped, the cost of those did not go down. But what improved was I think that before all of this, that lead would go out to maybe four or five different parties and now maybe it's two.

Nema Daghbandan:

So

Ben Fertig:

We're hoping that cost we would get a better pull through. But I mean that's one way that you can kind of go out and generate leads and then some of your just general distribution strategies. One thing I liked about private lending was that it's a pretty pure sales game. I mean go out network those types of things. So you've got investor meetings, networking and all of that stuff is obviously impaired to some extent. You've, I mean what we're doing right now I know that you guys have canceled all your conferences for this year and hopefully we pick 'em up in 2021. I mean just got to whatever the virtual equivalent of that stuff is something that we do internally. We used to manage our salespeople really close to it right now we're trying to just figure out what the new normal is with some of that stuff. And then for us, the big one is third party origination. We want to do loans through third parties. We've got a very easy contract for people. We'll do it wholesale, do the correspondent. That's the way that all of our systems are set up. We've got technology and systems and processes in place to that specialize in that type of origination. And that's again, predominantly what we do.

Nema Daghbandan:

And I wanted to clarify this. So it's almost 90% of the rental product origination actually comes third party to you.

Ben Fertig:

90% of our single asset rental product comes third party. 80% of what we originate overall is a single asset rental product.

Nema Daghbandan:

Got it.

Ben Fertig:

So 90% of that 80, 72% of what we do is a third party single asset rental loan.

Nema Daghbandan:

And so kind of similar analysis too is your average listener is going to be well acquainted with the underwriting side of a fix and flip. So why don't we talk a little bit about switching the mindset so they understand what is the credit box, because you and I talked about this briefly before, which was fix and flip is a very story oriented analysis. What's the story? How does this person exit? Is it a believable story? Do I understand track record, all these things. There's a lot of discretion in a fixed and flip loan and this is a different product. This is, can I check a series of boxes to make this loan make sense? So why don't you just talk about some of the things that the mindset changed and what really is required to underwrite one of these

Ben Fertig:

Look, I mean I think you hit right on the point. It's much more objective, right? I mean good at least in my opinion. Good fix and flip credit policy cross references a lot of different subjective things. You obviously want to look at investor track record generally. Is the scope of the private project commensurate with that track record? Do you want that investor in specific geography that he's worked in the past? You're not doing a lot of that in a rental loan. I think the number one thing that you want to look at is whether or not the property cash flows. I mean if you're doing a loan through Constructive, look at that because if it does, where we have a tendency to be able to make some exceptions is maybe where the borrower has a shortfall or something. So look at what the G, look at the gross rents over the principle interest taxes and insurance and association if they're applicable.

We generally use the lesser of the actual lease versus what's on the 10 0 7 scheduler or the income and operating statement of the appraisal. There's some others out there that introduce like a mark to market rent, like a rent range used to be. But whatever it is, if the property cash flows, that's the best way to start. And then your box checking, fico, your box, checking credit events, is there a bankruptcy or foreclosure? And when did it happen? And then we talked a little bit about what the reserve requirement is on the Constructive products you could use. If it's cash out refi, you could use cash out to cover the reserves. So it's pretty easy. We've got some bullets on here about do. It is a securitized asset as we talked about. We want it to be non arm's length. We're generally repping that it's non arm's length.

You can't have a four unit with four units that are rented to family members and so forth. I mean those are the kind of things that we looked at before. And we look at 'em, we look at 'em now. We did just recently introduce individual borrowers when we first pulled out back in the beginning of May it was to LLCs only. That LLC would've been supported by a personal guarantee from one of the principles of that llc. We will do loans to individual borrowers. In my personal opinion, that's not really real estate inclined. You would probably be able to talk better to this than I real estate inclined to own the property in your own name. And then there are some jurisdictions, Georgia, New York, where we just can't do it. But to the extent that it comes along it's not something that we would've to disqualify at this point.

Nema Daghbandan:

And when you work with, let's say for example a correspondent originator, is there just a, Hey, here are the boxes we want to check? Or how are you managing that communication when you are working with a new originator?

Ben Fertig:

So we have call it four levels of documentation that we use. We have some one pager material that's informative, but even something that they could use as a marketing document, we allow for it to be white labeled that we've got, obviously there's some credit information that's embedded in our rate sheet. We then go to probably a 12 slide PowerPoint which digs into the guidelines a little bit deeper. We have one of those for our rental product. We have one of those for our fits and flip product that we can. But we issued a third parties and then we have our core gut guidelines, which is 42 pages or so. The product is transitions pretty well from us to a third party. We can get on the same page. We allow a lot of the processing of this loan to be done with that third party. You send it to us we underwrite it, we condition it, you send us the conditions, we clear it to close, we close it, we fund it.

Nema Daghbandan:

Got it. And then kind of dealing with the documentation side, I can briefly speak to this because a lot of this was when we obviously prepare loan documents as a matter of practice. And so when the rental products started really showing up on our doorstep, we were trying to figure out how to create a systematic approach to the documents. And this was conversations with people like Ben and also oftentimes with the capital sources backing up companies like Constructive to understand what are the expectations. Cause you have this weird situation where you've got residential collateral, but oftentimes the companies that are involved on the eventual purchase oftentimes have a commercial lawyer sitting in the background. And so they're really confused on collateral and the conditions they're expecting to see because they're used to these very, generally speaking, these much larger size transactions. And so over time we were able to figure out and get alignment of expectations about what would actually be a realistic set of documents that a rental investor would sign, but also give the capital market side some understanding of their recourse.

So what makes these typically different than I would say is from a fixed and flip product is that they generally going to require impound accounts for taxes and insurance. The consistency, going back to this check the box methodology, there's not a lot of variance in the documents. You're not going to see a lot of trading or back and forth or negotiation consistency in the document stack is going to make these trade much easier. And that's what they're looking for. On the investor side there's definitely a component of can you have a let's say for example, if it's an LLC or corporate borrower, can they pledge the entity itself, particularly in these judicial foreclosure states, particularly for larger loans law times, there's an expectation that they can pledge the company's collateral collateral in addition to the underlying real property. You have to identify whatever the DS c R requirements are.

So you need to very much know what the investor demands from the dscr side to make sure that that's in the underlying loan agreements. And oftentimes there's a little bit of tweaking to the insurance requirements. So for example requiring rent loss is typically required as a required piece of insurance in the documents. And then one thing that was interesting, at least previously, and I'd actually be curious to get your thought, I don't know what the marketplace looks like right now on this one, Ben. It's just oftentimes they had occupancy restrictions which meant that if the property was not actually going to be rented out and they lost the tenant that there was a step up in the interest rate. I don't know whether that's still kind of a thing or the expectation on that side in the world we live in.

Ben Fertig:

Yeah, it is. And we actually work with your doc team on this to get the language that was satisfactory to one of our buyers that requires this. But the way that it works with us is that if the loan is a purchase or it's a refinance that was acquired by the underlying borrower in the last six months, we'll allow for that property to be vacant at the time of origination. And we'll use the market rent from the appraisal as the qualifying rent. So long as and this is a function of the legal document, so long as that property is leased for at least that market rent amount within 60 days of the loan closing. So to the extent that it isn't right, you've, you know, kind of go from dscr risk to vacant property risk, which are two completely different risk profiles. And we've got an interest rate trigger that says it steps up. I should know this, but I think it's 200 basis points.

Nema Daghbandan:

Yeah, it's pretty simple.

Ben Fertig:

Is that what it's in the docs? Yeah, so it's 200 basis points to the extent that that property is not leased and that lease isn't provided to us within 60 days of the note date.

Nema Daghbandan:

Makes

Ben Fertig:

Sense. And that's different than it was before because we did not have the vacancy rider and those provisions before we had the vacancy rider, but it didn't trigger an interest rate step up.

Nema Daghbandan:

Got it. And then we can just talk about the ecosystem. Cause I think that's the other thing that really identifies and makes this a product different than a typical balance sheet product. And so we'll just talk about who are the participants in the transaction and what do they expect from one another. Oftentimes I get for example, lots of questions about capital sourcing and oftentimes there's a, Hey, can I cut out the middle man? Can I cut out the Constructives of the world, right? Because ultimately it's why can't I just go to Blackstone or whatever it is and start negotiating these agreements myself? And so oftentimes I have to explain, here's the ecosystem, here's what every participant in the ecosystem is looking at. And so do you have a giant balance sheet and a very, because if you don't not going to talk to you, there's no interest in the conversation.

And so we'll talk a little bit about each participant and what makes them unique in this ecosystem. So the first one is just the actual loan originator. And oftentimes what's interesting is you can wear multiple hats. So sometimes Constructive is the loan originator when you're doing direct and origination. And sometimes the participant might be the actual, they want to balance sheet loan. So these rules are fluid and oftentimes participants will wear multiple hats in a transaction. But in this context, really is this the person on the ground getting the initial loan in the person who's actually working directly with the borrower? And it might be a direct origination for someone like a Constructive but let's assume it's a third party origination. So what is the originator expecting from you as the funder? What are their economic expectations?

Ben Fertig:

Yeah, I mean it varies. I think that prior to all of this, I mean there were rich premiums available in the market. We passed those premiums along because these are business purpose loans. Those premiums never really needed to be disclosed to the underlying borrower. So we saw originators being able to participate in the revenue opportunity with origination points and then also get paid from us. But I think that anything else, I mean we, speed was always something that has been important in private lending. I mean, we tried to pass that along so that the ultimate borrower experience could be better but look mean at the end of the day our biggest value add was being able to provide consistent, reliable capital. Because quite honestly, getting to the Blackstone might be the easy part. See, getting to the Blackstone is probably easier than finding how you're going to get to the Blackstone.

Finding a warehouse line to allow you to originate non QM loans is a little bit more difficult. And I think we'll talk about that. Blackstone will buying from you, probably you could do enough from 'em do enough of 'em, and you can figure out how you're going to fund them. But if you're a bridge originator and you know, originate a bridge loan that's got a 12 month maturity and you know, get stuck with that loan, you know, probably got a decent interest rate and you've got something that you know, don't think that the duration's going to be 30 years on. I mean, you get stuck with 30 year paper at 6% and most originators aren't capitalized to be able to deal with that. And then if you hit the black swan that we did we've been talking about since the beginning here you've got to be ready to absorb a loss. And those are the kind of things that we're insulating our third party clients from.

Nema Daghbandan:

And then you've got the funding source here. So why don't you're in this interesting position where you're being pulled in two different ends. You've got an originator who wants their economic expectations and also wants to get the loan funded. And then you've also know that you've got both your line of credit provider as well as, and purchaser who's looking at this thing. And so what is really, what's happening from your perspective and what's the pull in either direction?

Ben Fertig:

So we had three warehouse lines we've got two now. One of them didn't renew because of the market environment but I think what they're asking for is they want you to prove that whatever you're doing has a liquid exit. Typically they're going to ask for at least two buyers of whatever you're originating. And if you can get to that point, then you've got to meet all of the corporate covenants. You're going to have a liquidity covenant, which generally they're going to want you to have a couple million dollars in cash on hand at all time. You're going to have a tangible net worth covenant you're going to have a profitability covenant. And then what gets scary in some of these markets is principal's going to have a personal guarantee on these lines mean just when the funding stopped the funding stopped in mid-March. I mean, we had 40 million worth of exposure that we needed to administer.

So those are some of the things that they're going to look for. And then you've got to again, be able to operationalize it. So I have two accountants who are solely focused on capital management and warehouse tension in those types of things. So I would tell you that being in this business as long as I have finding the Blackstone to sell the loan to is the easy part in a lot of ways. Now there's certain requirements that they're going to expect also, they want to make sure that you can backstop any reps and those types of things. But I think the warehouse lines are more difficult when it comes to 30 year loans. You can't fund that stuff with friends and family money.

Nema Daghbandan:

And then talking about the Blackstone side, so you've got the end purchaser and what they're looking for and their expectation, and you've already kind of touched upon a lot of this, but from our expectation one is they're going to end up more likely than not issuing securities based off of this. So they're thinking about the end in mind as well. They're not the balance sheet holder either. And so they're looking for consistency in operations, consistency in documentation. They want to make sure that you have, you've built a machine in the background that's going to make widgets that look very, very similar that they can understand. And then they push down significant reps and warranties down on the funder level to make sure the M LPAs are pretty scary to look at and fight over. And they hold, even if you negotiate very, very well they're just have a minimum level of expectation on that side of it. And then also to this, there's an extensive due diligence on the funding source. So they want to make sure it's not just a balance sheet, it's operations, it's they're going to want to make sure you actually are capable of running and have a scalable business. So it is a pretty deep exam. And then lastly, it's kind of spot audits all throughout the process as well. I What is the, being on the funding side typically, what's the interaction like with a lot of these investors?

Ben Fertig:

Look, I mean, I think that if you're an operation and if you've got three, four people, I mean, that's typically not what they look for. So they're going to want to see qa, they're going to want to see qc, they're going to want to make sure that you've got a loan origination system and that it's backed up and secured correctly. They want to make sure that you've got an accounting and finance team to your point, you're going to have reps that survive the issuance of the securitization relating the fraud and wrap. I mean, if there's a manufacturing rep that occurred a while back, data integrity E and early payment defaults and things like those. I, I'll give you something that happened with us recently was we talked a little bit about mark to market exposure and one of our aggregators happened to switch their financing structure from Mark to market to a non marginable facility. And so that facility pushed them into, so they've got now a new creditor and it's saying, Hey look, you should have these originators buy back these, I mean, I got three requests that we didn't have to buy any of the loans back, but I mean these were like 2018 originations. So I mean, it kind of goes back that far.

So what we're trying to do in this ecosystem is make it a lot easier. I mean, our agreements are about as easy as it gets. So we are here to absorb this end purchaser risk for our partners. I mean, besides providing the funds, that's our biggest value add.

Nema Daghbandan:

Right. No, that makes sense. And that kind of just leads to the last kind of participant in this, which is, and the reason why that they're as aggressive as they are is they're going to securitize the asset itself as well. And so they've got consistent issue or risk, which is the asset. The loans in the asset pool have to look similar, they've got to have consistent risk allocation in there. The documentation has to be consistent. There can't be a ton of exceptions sitting in the asset poll. And then consistent, you see in the credit profile, the borrower, the borrowing base has to look fairly similar and have minimum standards. And so it's this consistency. We talked earlier about the story of fix and flip. The story doesn't matter here. You can't explain the story in a securitization, no one cares about the story, right? Did you check the boxes?

Can you demonstrate that you have consistency in your practices? And that's probably the biggest philosophical shift that happens here. So that's all we've got for the presentation. We'll open up the floor. We've got a questions already in the pipeline here that happy to answer. Feel free for those that are sitting on here, as well as there's a Q and A box. So if there's any questions you've got by all means, feel free to ask them here and we'll answer any questions you have. So the very first question that I've seen here which is directed to you Ben, is are you writing rental loans on multifamily residential or commercial office retail? What's your focus there at Constructive?

Ben Fertig:

So that's a great question we did prior to this quite frankly, I used to sell those loans to the party that I was just talking about. That issued us the old request. No. So right now we're focused on one to four. We'll go up to 20 units on our fix and flip product. We did have the ability to go up to a hundred units prior to we don't have the ability to fund those assets now.

Nema Daghbandan:

Got it. And then next question here is, what is the actual dscr R requirements that you guys currently have?

Ben Fertig:

1.15.

Nema Daghbandan:

1.15. Got it. Next one here is how have they addressed the risk of eviction moratoriums in their underwriting? So when you guys are dealing with underwriting, I mean are you baking in, and I know we've done a lot of work with you guys in terms of getting matrix after matrix about what's happening in every single jurisdiction and what are the moratoriums and Peoria or whatever. So how are you guys dealing with this rapidly evolving legislative environment and moratoriums and everything?

Ben Fertig:

Yeah, I mean, I think there's a couple of things. First of all, from credit policy, we talked about we're asking for more reserves than we did prior to. I think all of us that are familiar at all with rental properties know that trying to evict somebody in Chicago, for instance, three months of reserves aren't going to do much good. It's going to be a much more elaborate process than that. But I think that it's been addressed where one of our programs is six months versus three, the other's nine months versus three. I think that's a logical way to try to address it. But I think the other is that it's baked into the rates, right? You're seeing these loans trade 125, a hundred. And I think that the fact that there can be some issues with the underlying tendencies is baked in.

Nema Daghbandan:

And then next question here is <laugh>. I don't know if this is how to answer this one, but I'll say the question and I'll see. I don't know if that's a great answer. You and I will have this question, which is if there's a conspiracy of loan fraud by the loan broker, the borrower, can we ask the loan broker to buy back the loan? I mean, I'll put from a purely legal perspective is there's going to be agreements. We talked about the ecosystem a second earlier. So the ecosystem has agreements, the originator has agreements with the funding source. The funding source has agreements with the repo line, has agreements with the and purchaser. So there are underlying agreements to your point, one of the nice things about being an originator is that they have the thinnest agreement. And so yeah, there's going to be some reps and warranties fraud, assuredly will be one of them.

But so I guess in theory you could have a daisy chain of risk liability because assuredly it's going to be in every agreement that you cannot commit fraud in the origination process. But I would say ultimately it's going to depend on what the underlying agreements are between the parties and what rep and warranty risk they took in the origination. It tends to be, fraud is one of the easier ones. It gets a little trickier when you read the reps and warranty sections of the loan purchase and sale agreements and the M LPAs to see what is really, oftentimes it's if you have these catchalls that you will originate with prudent practices and these sorts of things, which can be a little trickier to get caught on down the road, but if there's actual fraud occurring or an allegation of fraud occurring, you know, can presume that there's going to be some risk out there. So the next question here is what is the range for the economics for third party origination? So typically, what is the spreads right now and where, I don't know if you can give me historical and where they're at now. What can an originator typically expect from a spread perspective?

Ben Fertig:

Yeah, so we generally had what we call the yield spread program where we paid up to 200 basis points depending on what the terms ended up to be. But we gave our third party partners the chance to earn 200. Now we give them the chance to earn a hundred and look, that's only because our maximum premium on the loans is less, less than it was. But they can still combine that with front end points to the extent that they're making three or four gross points. I mean, that's fine with us.

Nema Daghbandan:

Got it. And then the last question I see in the hopper here, is there an appetite among institutional buyers for refinancings into a 30 year rental loan?

Ben Fertig:

Absolutely. I mean, I think that if you can create that conveyor belt with, I mean that's what we consider the home run. I mean, it's like if you can provide somebody a fix and flip or a bridge loan to acquire, renovate, stabilize the property, take it out into a rental loan and keep doing that I mean, I think that's the best origination process that you can have.

Nema Daghbandan:

Next question I've got here is, what's the process like for a broker sending you a loan? So if you can just walk the story of someone wants to originate, they don't do 30 year rental loans. Walk us through the process with Constructive.

Ben Fertig:

Yeah, so first thing is we would approve you as a broker. That's an easy process. Effectively it's assign signing the agreement. There's a little more to it, but not much at that point. We've got a portal set up where the broker goes in enters the loan, application orders, title orders, appraisal. You can either submit us a loan that's got after you have the appraisal back, or we will allow you to submit the loan with the appraisal invoice. So as long as we know that it's ordered and the borrower's paid for it, we'll start working on it. And effectively what happens is we take that from the portal and go straight to underwriting With that what'll happen is a conditional approval will be issued. The conditional approval usually almost always has conditions at that point. We engage our processor, our processor works with the third party to clear the conditions. Once those conditions are cleared, we clear the loan to close and then we close it. So it's submitting the loan through our portal with either a completed appraisal or the invoice and appraisal. And we've got approved valuation vendors where we set the third party up with 'em and it's, they generally send a link directly to the borrower. So nobody's got to handle funds, collect funds take credit card numbers or anything along those lines.

Nema Daghbandan:

And how can you break down that cycle in terms of kind of what's the typical timing expectation of each portion of that cycle?

Ben Fertig:

So if we get the loan with an appraisal and it's not a file that needs to be heavily conditioned, I mean we can move it in 10 days to two weeks. On the flip side, if we get a file that's just got the minimum submission requirements, we get the appraisal invoice. The appraisal invoice is in a market where appraisals take a long time. I mean that obviously will be integrated into your but a lot of it is dependent on what we get and when we can move as fast as 10 to 14 days. I mean if a file comes in with an invoice and we don't have title and there's 22 conditions on the file, it could be a 30 day process.

Nema Daghbandan:

Got it. The next question here is, what is the rate range for this type of financing?

Ben Fertig:

So most of what we're doing right now is trading at about six and a half to six and three quarters.

Nema Daghbandan:

What's the max loan to value currently available?

Ben Fertig:

75 for rate term and 70 for cash out. S 75 for purchase and rate term and 70 for cash out.

Nema Daghbandan:

Do you currently require tax returns and are they used for stability and trending?

Ben Fertig:

No, we do require 'em on our fixed and flip product. We don't require 'em on a Dscr R rental product.

Nema Daghbandan:

Yeah. So yeah, I mean, what is the documentation need then on a Dscr rental product?

Ben Fertig:

Yeah, I mean effectively it's the application, the lease, the reserves the entity documents. I mean title appraisal, homeowner's insurance, close the loan.

Nema Daghbandan:

Got it.

Ben Fertig:

It's pretty sim. It's pretty simple. I, in a lot of cases pre covid, a lot of what we did was cash out refis where the reserve requirement of itself was getting covered with the cash out. I mean, they were pretty relaxed. Documentation loans, and this is no different than anybody who's familiar with fixing flip. I mean, a lot of it sometimes is if you're underwriting a complex entity or something along those lines. A lot of times the most difficult part, I mean the lease versus the rent on the appraisal versus the reserves is not egregiously difficult.

Nema Daghbandan:

What's the fee range charge to the borrower? And do you participate in that or does it go to the correspondent?

Ben Fertig:

So it depends. We have two pricing structures. One of them we actually have to charge some points on and then the correspondent charges on top of that. The other one we're just making all of our money on the back end, so we just have our processing fee. It's 1495. Again, full disclosure, before covid it was 9 95. But I mean, it's just quite honestly, it's just a function of the premiums that we can make when we sell the loan. Right. I mean the loan level economics are different. Since we rolled out early May, we've seen those go in the right direction. My opinion for what it's worth is it'll continue to go in that direction and we'll adjust our low level economics according accordingly. But it's 1495.

Nema Daghbandan:

Next question here is I'm not sure if those can answer. Are there any national banks doing a homestead 30 year mortgage warehousing

Ben Fertig:

A what?

Nema Daghbandan:

You and I both <laugh> 30 year

Ben Fertig:

Mortgage? Say that again.

Nema Daghbandan:

So are there any national banks doing a homestead 30 year mortgage warehousing?

Ben Fertig:

Yeah, I mean, I think if Homestead means just owner occupied agency and FHA loans I mean there's tons just about every bank's got a more warehouse lending program. Whether or not that warehouse program's going to allow non QM assets in this market environment is a thousand question. I mean, but yeah, no, I mean there's plenty of 'em that do.

Nema Daghbandan:

Got it. And then related question

Ben Fertig:

Correctly.

Nema Daghbandan:

Yeah, we'll see. And a related question to the previous one we asked or that was asked was, so in addition to let's say processing fee, what about the actual points or whatever? So here the question specifically is what about the actual loan fee charged to the borrower, not just the processing fee. So effectively is, I'm assuming the point of this question is in addition to whatever Constructive minimum requirements are that you're going to retain can a third party originator tack on their fee, assuming the bar is willing to pay it from a origination fee perspective, and can they retain that?

Ben Fertig:

Yes. Yes, yes.

Nema Daghbandan:

Easy enough. That is the last question I have in the hopper here. Thank you very much, Ben. Obviously our emails are at the bottom of the screen here. So for any of those, any of you that are listening that, that want to learn more about working with Constructive, reach out to Ben feel free to reach out to me and I can get you guys connected as well. Ben, thank you so much. Hopefully this has been a good experience to understand what the heck's happening in the market and expectations. I think right now we're really trying to get people information more than anything, and I learned a lot during this process. So thank you. And it's always great to be able to work with you and speak with you here, Ben.

Ben Fertig:

Yeah, likewise. Thanks for having me. I enjoyed it a lot.

Nema Daghbandan:

Yep. All right, everyone, take care. Hope you have a great rest of the afternoon.

Ben Fertig:

Thanks.