Hey, welcome to Real Investor Radio. I’m Craig Fuhr here with Jack BeVier and Fred Lewis of the Dominion Group. Guys, welcome.
Jack BeVier (00:22.862)
Thank you. Good to be here.
Fred Lewis (00:23.726)
Good to see you.
Craig Fuhr (00:25.794)
Hey, so we’re just going to do a little bonus content here. If folks want to listen and go deep with us on the content that we provide, you can check us out at realinvestorradio.com or on any podcast server, you’ll find the podcast. So guys cost of capital. It’s been a roller coaster ride. Let’s talk about it. Jump in.
Jack BeVier (00:48.426)
Yes. So was disturbed this week to see the five year treasury rate climb above 4.4 percent, which I think is actually now above the peak even of last year. We’re right there at the same level. Yeah, it’s actually a little bit above the October peak of 2022, which is a brutal stat because the reason the reason that I pay a lot of attention to the five year is that a lot of the
Mortgage products that are lent to investors, particularly the DSCR loans, as well as pricing from a bank that’s based off of the five-year treasury, those five-year loans from a bank are priced off of the five-year. That means that cost of capital to real estate investors who are adding rental properties is at a literal all-time high in the past 15 years. That combined with kind of top line prices.
have not decreased, particularly in the affordable segment, and rent growth has kind of sputtered out. Rent growth has certainly decreased significantly, and in certain sub-markets we’ve seen some decreases in rent. It means that the ability to add a rental property and for that leverage to be accretive, for that leverage to be productive, where you’re actually getting more money from the house than you’re paying to the bank.
is harder now than ever. So it’s a challenging time. Hopefully it changes, but we wanted to do a quick kind of market update here because that’s a depressing but concerning stat, one that all real estate investors who are looking to grow their rental portfolios should be paying attention to.
Craig Fuhr (02:35.47)
Jack, I hear investors talking about the 10 year note all the time and why we should be concerned about that. I love the fact that you’re mentioning the five year here because that is the rate that really investors should be looking at. Fred, you were talking about a meeting that you may have had recently or even this morning about the SOFR Plus. So go ahead there if you would.
Fred Lewis (03:01.142)
Well, I think banks in general are struggling with how to price loans. They’re seeing the repricing of their deposit base repriced rapidly and more. It’s almost like it’s exponential in the last month or so. Banks rely on people who put money into their banks’ savings accounts or deposits at 1% and 2% and it was below that obviously for a long period of time.
And now it’s common knowledge that you can go on and get a money market rate at five and change. So anyone with any kind of, you don’t even have to be that knowledgeable anymore. You can turn your computer on and you’ll see an ad for 5%. And that’s repricing really what the bank’s cost of funds are, which is forcing them to really rethink. Their overhead can’t adjust fast enough.
And the regulatory environment requires a high level of support, whether it’s risk and compliance and people and loan officers and IT and tech to run the shop. So ultimately they have no, they have really no choice, but to consider how to reprice loans and what banks are doing is they look at the SOFR. That’s one of the core indexes that banks use. They use the five year treasury as well. Often.
Jack BeVier (04:27.527)
The SOFR is the Secured Overnight Funding Rate. It’s basically a newer index that pretty much replaced LIBOR, which was the London Interbank offering rate. But that got phased out in favor of SOFR. So you probably see term sheets these days quoted in SOFR instead of LIBOR.
Fred Lewis (04:49.314)
Right. And so for today, it’s 5.3 as we speak. And so what any financial institution does, a bank does is they look at a spread over that index. So if they’re going to use SOFR at 5.3, they’re looking at spreads between now. It was a month ago, 300 over, 325 over was acceptable. Now the arguments are.
Craig Fuhr (04:49.562)
So SOFR is currently at about what, 5.3?
Fred Lewis (05:18.286)
375 may not be enough. We’re starting to see the industry go to 375, 400, four and a quarter. So if you think about just 400 basis points over 5.3, that’s a 9.3% loan. I saw a loan in the market get shopped around a 10% the other day, just yesterday. So you’re starting to see pressure
Jack BeVier (05:36.142)
from a bank.
Fred Lewis (05:48.182)
bank level to be at 9 to 10 percent on new loans and what will be renewals of existing loans.
Craig Fuhr (05:57.166)
What’s that? So on a on a loan like that, Fred, is that a is that a construction loan? Is that like a long? What what is an investor looking at? What type of deal am I doing there? Okay, got it.
Fred Lewis (06:06.541)
It’s a construction loan. It’s an acquisition construction loan. It’s short-term in nature.
Craig Fuhr (06:12.902)
probably a six month to a year.
Fred Lewis (06:15.838)
six months to 18 months is a typical bank term. Now I would say a construction loan at the bank is gonna be 12 to 18 months.
Craig Fuhr (06:17.663)
Craig Fuhr (06:24.39)
Can private money beat that check?
Jack BeVier (06:28.666)
No. I mean, it tries, right? We’re not too far outside of it. But the main way that private lenders are funded are banks. So when banks cost of capital goes up, that tends to flow through the private lending industry. The other way that private lenders are funded is if they’re a larger lender, they’ve done a securitization.
Jack BeVier (06:56.526)
They priced a securitization about a month ago and their weighted average cost of capital was around 9%. So if they do, for example, so if they did a loan at 9% to a borrower and they charged a borrower 9% interest in one point, generally speaking, it costs around 200 basis points to run the shop.
paying the loan officer, paying processors, rent, etc. That’s before the equity makes any money, right? So if a private lender did a loan today at an 11% APR, that would be break even, right? That would be them not making any money. Now, certain private lenders have some money that they raised in the past that’s cheaper. So you may still see a term sheet that’s below an 11% APR, but that’s just because you’re…
accruing the benefit of money that was raised a year ago, two years ago. It’s not going to stay. What’s that?
Craig Fuhr (07:58.382)
still money left in that bucket. There’s still money left in that bucket.
Jack BeVier (08:03.254)
Yeah, but it’s in it, but it yes, but it’s dwindling fast, right? Uh, and, and as time progresses forward, it rolls, it rolls off, right? It expires and the folks that lent them that money aren’t going to do it again. Not at today’s rates. So, uh, if you, if you see less than 11% APR, they’re literally losing money or they should be losing money based off of today’s rates, um,
So that’s kind of serving as the new benchmark floor rate in the private lending space based off of that securitization pricing. And the factors that Fred’s talking about make that, frankly, even worse for those who don’t have access to the securitization market.
Fred Lewis (08:46.418)
So Craig, we often talk about the rate of a loan, but banks, financial institutions also look at credit. They look at deposit requirement. They look at leverage, the risk that they wanna take. And what we’re seeing is that regulated institutions are lowering their leverage ratios. To the extent they’re a bank, they’re requiring 10%, if not more, deposit requirements. If you’re a new customer, it may be higher.
there are banks that may require 15 or 20%. And whether it’s 10 or whether it’s 15 or 20, that factors into the cost of those funds because it’s like borrowing 100 grand but giving them back 10. And you know, so that’s part of the equation. So when you’re dealing with a private lender versus a bank, those are all, there’s a real kind of separation now. Rate aside.
Craig Fuhr (09:31.691)
Craig Fuhr (09:36.759)
You know, you guys had a.
Fred Lewis (09:45.238)
between risk, leverage, and some of those factors. Take an account.
Craig Fuhr (09:52.122)
Fred, you guys had your mastermind, the real investor roundtable mastermind a couple of months ago. I was shocked to hear the number of guys in the room that were talking about hearing from their banks on, hey, now we have a deposit requirement on the loans that we’re extending to you. It felt to me like the overwhelming majority of the room was talking about this. And it felt again to me like a 2008, 2009 time period when we were sort of seeing that scenario play out.
Any comment there?
Fred Lewis (10:26.014)
Well, you know, what’s a shame is that banks, most banks had a deposit requirement of 5% written in their covenants period for years. They just didn’t enforce it because cost of funds were so cheap and there was a gold rush mentality that they wanted to load up on real estate loans. They wanted, they, it was, it was just a gold rush mentality. So they look the other way. Didn’t have to put deposits necessarily.
Craig Fuhr (10:40.23)
Fred Lewis (10:55.362)
You just had a bar of money. And now what they’re doing is the chief credit officers are coming in and saying, well, we have a covenant that’s a deposit requirement. I want it all enforced. And the chief lenders are saying they’re kind of caught because they didn’t enforce it. So that’s becoming a thing. At the same time,
that the leaders of the bank are saying, the chief financial officer is saying, hey, I need that deposit requirement to be 10% or 15 because we need, if we don’t, we don’t really want to make the loan. And so it’s not just the rate and it’s not just the leverage and the deposit, it’s also the access to capital to boot because banks are looking at their book and saying
I think we need to diversify out of real estate lending and a little bit more into maybe consumer lending or inventory lending so that we can rebalance because the gold rush is over. So what does that do to the other factors? It makes it harder. And that’s what we’re seeing hitting the bank sector right as we speak. Right now we’re seeing pressure on rate, pressure on lower leverage.
pressure on better financials, pressure on the fact that you can show that you’re not losing money. All those pressures, it’s not like some of them didn’t exist before. They just were not, they just were not, you know, pushed.
Craig Fuhr (12:20.59)
Pressure on regulatory.
Jack BeVier (12:30.326)
You were number 11 on the to-do list. You know, it just wasn’t what was prioritized. Hey, Craig, I wanted to mention something. You had mentioned the 10 year rate and yeah, there’s a, there’s a significant, uh, emphasis on the 10 year rate. The reason for that is that the 10 year rate and the consumer residential mortgage rates tend to track very closely together. Uh, and the reason for that is that in general, uh, the, uh, people who
Craig Fuhr (12:35.575)
Jack BeVier (13:00.302)
borrow a mortgage tend to stay for about 10 years. It used to be shorter, but it’s elongated. And so that’s the index that most closely reflects the actual duration of a mortgage that somebody takes. And so mortgages are generally priced off of the 10 year, the 10 year is unfortunately, similarly, above the all time high above the October 2020 not all time, but you know, within recent memory, above the October 2022 level.
Which means that consumer residential mortgage rates are very high right now, right? They’re higher than we’ve seen in the past, you know, 10 years. And so it’ll be concerning, you know, we probably have listeners who are flippers right now who are under contract with a borrower that did a rate lock 30 days ago, 45 days ago. That it’s an interesting dynamic, right? In a rising interest rate environment, if that contract falls out, that borrower
is going to go get a new rate lock at a quarter point higher, 35 basis points higher. That’s how much the 10 years moved in the past 30 days. And so that buyer can actually buy less of a house or is not going to get as good of a deal on their mortgage as they’ve got right now with that existing rate lock. My wife’s a realtor and she had this dynamic play out recently where there’s a borrower who there was pressure for the deal to fall apart, but the buyer really was trying to keep it together.
because they realized that they were going to go get 35 basis points higher on their rate if this rate lock fell out. And so that’s something that we may see like tactically right now that may be a dynamic that’s happening right in this moment when people are listening to this. But generally speaking, it means that for putting new properties under contract right now,
the affordability of the house that you’re listing today is worse today, even than it was in the third quarter of last year, fourth quarter of last year. And so, you know, hopefully this is a, you know, the mortgage traders in New York are all in on the Hamptons right now and no one’s doing deals. And as soon as they come back for Labor Day and throw the kids in school, they’re going to start deploying capital and buying bonds again. And we’re going to see a downtick after Labor Day, but it’s a scary moment in time.
Jack BeVier (15:20.13)
to see rates as high as last October when people were talking about the sky falling. It affects Main Street real estate investors multiple ways through their own borrowing, through the borrowing of the folks they’re trying to sell houses to, and not only borrowing on DSCR loans, but their lines of credit and their longer term borrowing at the bank level as well.
Pressure is still on. We’re still certainly not on the other side of this yet.
Craig Fuhr (15:46.986)
And let’s not forget sellers. I mean, if I.
Craig Fuhr (15:52.198)
I’m in no hurry to sell my house when I know I’ve got a 3.5% mortgage and the mortgage rate’s now 7.2%. I think I’m staying put for a while. Yeah, exactly.
Jack BeVier (15:59.39)
Yeah, also bad for inventory. Yeah, yeah, just from all sides, this is not great for operating in a real estate investment business.
Craig Fuhr (16:09.082)
Jack, you know I usually like to put the happy face on with the news as well, but it’s really hard to find the good news in any of this. I’m struggling to find it. Maybe you guys know something that I don’t. But I think on the last episode, if folks want to tune into episode 11 of the podcast, we talked a lot about patience. It’s a time for especially investors to be very patient in this market.
and make sure that your operationally sound more than anything. So maybe that’s the opportunity here Jack.
Jack BeVier (16:45.398)
Absolutely. That sounds like a good one.
Craig Fuhr (17:13.482)
So thanks for tuning in to Real Investor Radio for this bonus content. We’ll see you on the podcast.