By Rob Jafek, Principal | Boomerang Capital
HML. ABL. CBL. BPL. RTL. Maybe you’ve heard of them, maybe not. They’re all part of the alphabet soup that makes up the financing behind real estate investing. So, what do you know about the history of real estate investing?
The oldest label and possibly the most familiar to many of us is probably HML, which stands for Hard Money Loans. And it has a long and fascinating history. We would recognize many of the elements used today in The Code of Hammurabi from around 2000 BC, which discusses title disputes, settlements and defaults. For example, a title dispute resolution:
“If any one buys the field, garden, and house of a chieftain, man, or one subject to quit-rent, his contract tablet of sale shall be broken (declared invalid) and he loses his money. The field, garden, and house return to their owners.”[1]
The Ancient Greeks and Romans for 1000 years (circa 5th century BCE to 5th century CE) also engaged in lending practices that involved the use of collateral. In Rome, for instance, the concept of “pignus” allowed a borrower to pledge property as security for a loan. If the borrower defaulted, the lender could seize the pledged property. And in the Middle Ages (5th to 15th centuries), feudal societies often relied on land as a form of collateral with landowners using their land to secure loans with a failure to repay potentially resulting in the loss of the pledged land.
Islamic finance (7th century onwards) has a long history of asset-backed financing using concepts such as “mudarabah” which involves a partnership where one party provides the capital, and the other party provides labor and expertise. Profits are shared, and losses are borne by the capital provider. This system inherently involves the use of assets to generate profits and further codifies what we would recognize as a settlement statement, allocating the profits to the owners of the asset and the workers . In medieval Europe (11th to 15th centuries), the practice expanded to individual articles and became known as pawnbroking where a ‘pawnbroker’ lent money against the pledge collateral and would keep the pledged item in the event of default.
ABL (Asset Based Loans) and CBL (Collateral Based Loans) are slightly updated terms to refer to the same thing. BPL stands for Business Purpose Loans and has become more common over the past half-dozen years in our industry, but it’s not very specific and is widely used by many other types of lending but in some parts of the country it’s the most commonly used term.
RTL is kind-of the new kid on the block meaning Residential Transition Loans and is more commonly used when referring to loans that are packaged and traded (think Wall Street and large, international bond buyers). Regardless of the string of letters, in our industry all these 3 letter acronyms refer to the same thing: a loan secured by real property.
The interesting thing is the evolution over the last few decades. Last century (damn I sound old), we had a few real estate booms – the 80s and 90s saw real estate prices rapidly rising. There was some value being added from time to time (intro song to “This Old House’) but it also became commonplace to buy a property with no intention of doing anything other than sitting on it for 6 or so months and then reselling it for a profit. All of this became known as ‘flipping’.
“Flipping” came to an abrupt halt with national real estate prices falling 27% over about 5 years, in the period between July of 2006 and January of 2009 and during the worst 6 months investors saw a loss of 9%. Phoenix fared even worse, falling 56% over that same time and suffering at worst a 21% loss over six months. However, unfortunately, it should be noted that there was a six-month period during the years of decline that saw a greater than 10% loss. That was obviously brutal for anyone holding a property intending to do nothing to a property other than to sell it six months later. And that’s a large part of the reason national investors shy away from Phoenix.
Interestingly, we were lending during that time and people adding value to a property still did fine – they may not have made as much money, but they were still profitable, and things weren’t so bad that they decided to leave the industry. And, as a matter of interest, we still have real estate investors that have been with us since 2008.
After the crash, homes were left in various states of disrepair. Some were never completed, like Antelope Valley in California, others sat vacant, or worse with prior tenants stealing appliances on the way out. These properties were not ‘move-in ready’, needing minor repairs or refreshes to get that way. During those days it was tough to find neutral paints like ‘Navajo White’ and ‘Desert Sand’, stainless steel dishwashers and white toilets, such was the demand.
Fortunately, we’ve weathered that storm and come out wiser for it. For some time now, investors have been purchasing properties and making remarkable improvements to the properties and the communities where they work. We have been arguing that this is the same as what happens in the commercial market, where it is referred to as ‘value ad’. The lending market is now recognizing the change as well and has evolved to try to more accurately identify the financing that goes with what the investors are doing.
What are current real estate investors doing that take their projects beyond the “flipping” of decades ago? The broader lending market figures homes are being “transitioned”. Much of that is indeed aesthetics, with gray wood (or engineered wood) floors and white accessories common and on trend, but it goes well beyond that. With the average home in the US more than 40 years old, major systems such as HVAC, plumbing and roofs also need addressing. The new build market has also been helpful in pushing investors to really create a quality finished product, but these are not new builds. The lending market knew these weren’t just ‘collateral’ or ‘asset based’ loans, they had become something else. It wasn’t just some generic ‘business’ thing, it was loans on residential properties that were in transition. Put that all together and you get RTL (Residential Transition Loan) becoming more commonly used, but is the kissing-cousin to ABL, CBL, BPL, and good old-fashioned HML. For the record, I still prefer ‘value-add’, but the addition of ‘residential’ is a good start. No matter what you call it, we’re really not that different from our earliest forefathers with their “pignus” and “mudarabah”. We’re still trying to make some coins, improving a piece of property. We just have better plumbing now.
[1] https://avalon.law.yale.edu/ancient/hamframe.asp Line 37. Lines 49-51 also address similar concepts.