House flipping, which declined after the financial crisis in 2008, is on the rise again, thanks to low interest rates and rising home prices. And with the renewed interest comes investors looking for a high return.
But the real estate strategy — in which a home is bought, renovated and resold quickly — requires fast access to money, and developers are willing to pay higher interest rates for it. The loans are backed by the property and are short, typically running for a year or less. And the funds that finance them offer reliable returns of about 8 percent, for those who can meet minimum investments, generally $100,000.
The finance industry around house flipping has been active for decades, and it has been ticking up lately. Last year, 5.7 percent of all home sales were flips, the highest level since 2006, according to Attom Data Solutions, a national property database. The trend, popularized on TV series like HGTV's "Flip or Flop" and "Flipping Out" on Bravo, is attracting the interest of Wall Street: Last week, Goldman Sachs bought Genesis Capital, a leading lender to house flippers.
But the loans — sometimes referred to as fix-and-flip or hard-money loans — come with risks, including developers unable to pay them back and a drop in real estate prices that could make properties hard to sell or even rent.
Chris Gutek, a former equity analyst at Morgan Stanley who has been an independent investor in Grand Rapids, Mich., for the last decade, said he lost money on loan funds in 2008 but remained bullish on the sector.
"I was getting nice 12 to 13 percent interest for a few years, but I had one very bad experience in 2008," Mr. Gutek said. "I lost a bunch of money. It was not good underwriting."
Funds set up these days by lenders like Genesis Capital in Los Angeles and Anchor Loans in Calabasas, Calif., say they are more transparent and conservative in their underwriting. He has put about 20 percent of his liquid assets in a fund managed by Broadmark Capital, an investment bank in Seattle that has $350 million in 200 short-term loans.
"Since 2009, the fund hasn't been tested, and I'm very, very aware of that," Mr. Gutek said. "There is some risk that real estate values will reset, but I feel good about the meaningful investment process."
For skeptics, the quick turnaround on real estate speculation might evoke the go-go thinking that led to the mortgage crisis just a decade ago. But investors say hard-money loans are more stable than a bank mortgage because they are secured by properties at a lower loan-to-value ratio, a risk assessment used by lenders.
The average loan-to-value ratio in the industry is about 55 percent, compared with 75 percent to 80 percent for a typical mortgage. This provides a substantial cushion to protect against a property falling in value. It also ensures that developers do not walk away from the properties because they have put a substantial amount of their own money into a project.
"When the loan matures, let's say it's 11 months, we want our borrower to be successful," said Stephen Pollack, the chief executive and president of Anchor Loans.
If the developer runs into a problem, "we'll try to help them come up with a solution," he said. "Maybe we'll ask them to put a tenant in there and take out a rental loan. But if the risk of the loan has changed and it's at a higher leverage amount, we want to do something to get us in a safer position."
In other words, the developer needs to put more money in, which Mr. Pollack said most of them agree to because they want to continue their relationship with Anchor.
And because the length of the loan is shorter than a mortgage, the risk is smaller.
"There's an asset bubble in stocks and a bond rally," said Shannon L. Saccocia, managing director of Boston Private Wealth. "Is this creating the opportunity for another bubble in real estate? The reality is for us, given the short duration of the loans, they're easy for us to monitor. They're very different from securitization."
To make their portfolios more stable, some lenders diversify across several states so they are not stuck in one market or move into different types of real estate, like retail and land.
"The benefit for a high-net-worth investor coming in is, they're instantly diversified," said Joseph L. Schocken, president of Broadmark Capital. "And to have that kind of diversified portfolio producing the yield we've produced — roughly 11 percent — is very unusual. What will get your attention is the stability."
His firm runs two funds and is about to start a third. All three focus on booming cities like Atlanta, Denver and Seattle. He said his goal was to make the book of loans as transparent as possible.
The average loan varies in size depending on the lender, ranging from several hundred thousand to $15 million. At Rubicon Mortgage Lending, loans range from $800,000 to $1 million. Douglas C. Watson, a principal at the firm, said that although Rubicon was focused on the San Francisco Bay Area, it had diversified into retail, storage and land.
Hard-money lenders boast of the speed in which they finance loans, typically in less than a week, compared to several months for a traditional bank. For the smaller builders and house flippers who rely on these loans to do business, the speed with which these lenders can have the money ready trumps the high interest rates they charge.
Jeff Walker, a principal at Square One Homes in Renton, Wa., which builds multifamily homes in Seattle, said he had been using hard-money lenders for more than a decade. He has borrowed often from Broadmark and tries to laugh off the rates he gets — usually around 12 percent interest with 4 percentage points of fees for a one-year loan: "That's outrageous, but what are you going to do?"
It's the company's timeliness that matters to him when he needs to move quickly in the hot Seattle real estate market.
"I can say, I'll close on it within 48 hours, and I can get them to help me do it," he said. "I can compete against a cash buyer, even though I'm not a cash buyer."
But even Mr. Walker, who said he typically made 35 to 40 percent return on his projects, is cautious that too much of a good thing can be, well, too much.
"Seattle is a booming market," he said. "It's going to come to an end at some point, but why not make it while you can?"
Investors seem undaunted by the risk of a collapse.
Richard Mulcahy, president of the Washington division of Northwest Bank, said he started investing his personal money in hard-money loans after seeing how well the builders did with the loans.
"The vast majority of builders could graduate to the national bank stage, but many are willing to pay that cost of credit because they know they can get a loan," he said.
Mr. Mulcahy said he had invested about 50 percent of his wealth in one of the Broadmark funds. "Various people who are professionals in the industry, including one of my sons, says it's too high," he said. "It speaks to my absolute feeling of security and the way they've set up the fund," which has no debt and invests only in first mortgages.
Goldman Sachs's acquisition of Genesis Capital might demonstrate the evolution of the industry.
The firm had expanded rapidly after a 2014 investment of at least $250 million from Oaktree Capital Management that Genesis used to buy out its early, individual investors and grow nationally, said Rayman Mathoda, co-chief executive of Genesis.
Ms. Mathoda said the company focused now on small to midsize real estate businesses, not individual borrowers.
"A lot of folks make the mistake of thinking of this as a 'once in a cycle' opportunity when real estate is booming," she said. "It's driven by the metropolitan areas. We're improving the super-aged housing stock in America."
But the business is still driven by wealthy investors able to meet minimum investments of $100,000 or more.
"In these markets, the risks feel reasonable," Mr. Gutek said. "If Seattle's real estate is cratering, the stock market has already cratered."