In the dynamic world of residential real estate investing, debt funds have emerged as a popular avenue for investors seeking a balance of risk and reward. Our debt fund platform, including the borrower side of the fund called Rehab Wallet, is a notable player in this sector, offering a unique perspective on real estate lending, particularly in the domain of residential fix and flipping with hard money loans. This article delves into the intricate details of Rehab Wallet’s loan structures, risk mitigation strategies, borrower profiles, and the impacts of market fluctuations on their operations.

Loan Terms and Interest Rates

Rehab Wallet’s offerings include 6- and 9-month loan terms as most fix and flips are completed within a 4-6 month timeframe. We offer the 9-month to those with a more extensive rehab budget but also charge a premium for the extra duration. We are also attracting borrowers with competitive interest rates of 13.75% and 14.25%, respectively. This structure caters to the fast-paced nature of property flipping, ensuring a quick turnaround and appealing returns for borrowers.

The borrowers are fine with the higher interest rates since they typically cannot get a traditional loan from a bank since most lending institutions lend on the borrower’s merits primarily and not the underlying asset. We are doing asset lending so that is more important to us even though we still look at the borrower’s track record. Our lending platform is also able to close loans much faster at around 7-10 days whereas a traditional bank takes up to 60 days to close.

Borrower Profile and Property Characteristics

The typical borrower at Rehab Wallet is a full-time entrepreneur engaged in fix and flipping multiple single-family homes simultaneously. The typical borrower is paying off 2-3 loans a year with Rehab Wallet and 85% of the time they are only doing cosmetic improvements throughout the entire home and rarely adds a bath, bed, or additional square footage. With an average loan amount of around $226,000, these properties are usually modest in size – about 1,500 square feet with three bedrooms and two baths. Rehab Wallet’s primary focus on single-family homes reflects a strategic choice, given their widespread appeal and market stability.

Loan-to-Value Ratios

A critical aspect of Rehab Wallet’s risk management is its conservative approach to Loan-to-Value (LTV) ratios. Capping the LTV at 70% with a portfolio average of 66% indicates a cautious lending strategy, providing a buffer against market fluctuations.

If a borrower defaults, this lower LTV criteria allows us to have confidence that we could foreclose on the asset if needed and be able to recoup the funds. 

The Foreclosure Process

Understanding the nuances of the foreclosure process is crucial in real estate lending. In South Carolina, where Rehab Wallet predominantly operates, they use a judicial process for foreclosures and the average foreclosure timeline is around 2 months. This expedited process minimizes the duration for which capital is tied up in non-performing assets.

Policy on Owner-Occupied Properties

Rehab Wallet does not extend loans to owner-occupied properties. This policy aligns with the company’s focus on professional flippers who are rehabilitating properties for resale, rather than personal use. 

Also, when you start lending to owner-occupied homes, there is a whole separate set of regulations and licensing that accompanies. We also know that most consumers are not looking for a higher interest rate mortgage for only 6-9 month duration. Your residential mortgage customers will go with a local bank to obtain the longer term and better interest rate. 

Foreclosure Policy and Borrower Support

Rehab Wallet adopts a supportive approach towards borrowers facing financial difficulties. The company’s policy includes offering loan extensions and a 60-day grace period before initiating foreclosure. This strategy underscores Rehab Wallet’s commitment to building long-term relationships with its borrowers, rather than aggressively pursuing foreclosures.

If a borrower is making their monthly interest payments and making active progress to exit the loan, then we don’t mind offering the loan extensions with a 1% loan extension fee. Rest assured that our in-house compliance team does issue default letters and if no payment is received within 60 days of non-payment, we start the foreclosure process to not cause any delays in our capital being tied up without payment.

Draw Process for Borrowers

The draw process at Rehab Wallet is managed through a proprietary draw tracker tool, emphasizing transparency and accountability. Borrowers are required to provide visual evidence of progress with time-stamped pictures and videos, ensuring that funds are utilized appropriately.

Financial Auditing and Compliance

PIC Fund I and Rehab Wallet’s financials are reviewed by the Otemanu Group, LLC, aligning with end-of-year tax preparations. This review process enhances investor confidence in the accuracy and reliability of financial reporting.

Payouts to Investors

Investors in our debt fund can expect payouts around the 20th of the month following the end of the investment term, whether it be at the 6% or 8% return rate. This predictable payout structure is crucial for investors planning their cash flows.

Most of the investors in our debt fund opt for the monthly compounding option instead of receiving a monthly payout. This allows for a higher rate of return since you are now earning interest on the interest you have already earned. This is a very smart strategy to building wealth for the long-term. 

Tax Implications for Investors

As a passive investor in our debt fund, you should note that returns qualify as interest income, subject to ordinary income tax. This clarity in tax treatment simplifies the process for investors, allowing them to plan their finances effectively.

There is no depreciation benefit with a debt fund as it does not own any of the underlying real estate since it is only lending to borrowers.

Loan Performance and Investor Returns

We often get asked how many loans would need to perform in order for us to continue distributions. In order to maintain investor distributions at the 6% and 8% levels, Rehab Wallet would need 50-60% of loans to perform effectively. The combination of high-interest rates and additional fees provides a cushion, allowing the fund to deliver consistent returns even in less-than-ideal scenarios. Our current default rate is 0% in the debt fund and since inception we have a 0.005% default rate. These low default rates are a sign that our Rehab Wallet team is vetting the assets and borrowers effectively. 

Default Risk and Mitigation

Despite a robust portfolio, the risk of loan defaults remains. Rehab Wallet spreads this risk across its entire portfolio, ensuring that investors receive their projected returns irrespective of individual loan performance. In the rare event of a large number of defaults, Rehab Wallet is prepared to launch a Real Estate Owned (REO) Division, led by experienced professionals, to manage and mitigate losses. One of our founding managing partners with the debt fund, Kelli Garret, has flipped homes for over 18 years and is more than capable of heading up the initiative to flip or rent these assets until the market improves. 

Back in May 2022 we strategically hired an experienced Compliance Director with two decades of expense management and loss mitigation experience. Our compliance team is solely dedicated to leading the initiative that mitigates risk and the potential impact on the performance of the overall fund. 

Impact of Market Dynamics

Rehab Wallet’s business model has proven resilient in the face of regional banking issues and credit crunches. The recent tightening of credit conditions has, in fact, increased the demand for alternative funding sources like Rehab Wallet. This adaptability is a testament to the company’s robust underwriting standards and deep understanding of market dynamics.

The “credit crunch” that has impacted commercial lending has not had that much of an impact on residential lending in the hard money space. Less than 1% of our loans are collateralized by commercial property. In fact, credit has not become harder to obtain but it has become more expensive. We continue to underwrite our loans conservatively to experienced borrowers that primarily flip single family homes valued under $300,000. The current demand for this category of asset is still far exceeding the supply.

Mitigating Risks in a Fluctuating Market

Rehab Wallet employs several strategies to mitigate risks associated with high LTVs, inappropriate fund usage, neighborhood unfamiliarity, and simultaneous foreclosures. These include stringent underwriting practices, comprehensive monitoring of fund usage, and a deep understanding of the primary markets of operation. The company’s emphasis on Southeastern states like South Carolina, North Carolina, and Georgia is a strategic decision, capitalizing on the stable real estate markets in these regions.

Regulatory Compliance

Adhering to relevant regulations is a cornerstone of Rehab Wallet’s operation. As the company lends primarily to business entities, it falls outside the purview of certain residential lending regulations like the Dodd-Frank Act. However, the firm maintains strict compliance with applicable laws, ensuring the legality and enforceability of its loan agreements.

Future Prospects and Market Adaptation

In conclusion, Rehab Wallet’s strategies reflect a well-rounded approach to real estate lending. By balancing strategic growth with risk management, and adapting swiftly to market changes, Rehab Wallet demonstrates a sustainable model for real estate investment. As the market evolves, the company’s focus on compliance, borrower support, and strategic market selection will continue to underpin its success. 

Ready to Invest?

For passive investors seeking exposure to real estate with a conservative risk profile, our debt fund offers a compelling option, blending robust returns with prudent management.