Profiting From the Tight U.S. Housing Market

A financing strategy that makes it possible to upgrade older housing stock also offers  wealthy investors an opportunity to earn income. 

The approach is based on so-called residential transition loans—bridge financing for contractors, flippers, and other small-scale real estate investors. These transition loans are helping to address a nationwide shortage of single-family homes that grew to 6.5 million units in the decade through 2022, data shows. Slower construction after the 2007-10 subprime mortgage crisis caused lending to dry up, and more recently, higher materials costs, land use regulations, and more, contributed to the problem, according to mortgage guarantor Freddie Mac.

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Another issue is the fact that the U.S.’s housing stock is a median 40 years old, and, in such a tight market, few buyers have the means to buy a home and pay for thousands of dollars on upgrades and repairs, says Gregor Watson, co-founder of 1Sharpe Capital in Oakland, Calif. That represents an opportunity for small investors and entrepreneurs around the country who buy older houses, renovate them, and then resell them.

Those flippers pay 1Sharpe a relatively high interest rate of 10% for loans with a duration of about a year, but with an overall maturity between five and six months.  Higher rates in the residential transition loan market reflect “the inherently increased risks and sometimes speculative nature of the underlying property improvement projects,” according to a June article on the sector by the law firm Mayer Brown. The borrowers only pay interest on the loans until they mature and a balloon principal payment is due, usually within three years, the firm said.  

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1Sharpe then packages these short-duration loans made to borrowers in the U.S., U.K., and Ireland into an open-end, private credit fund for qualified investors. Because 5% to 10% of the Income Fund portfolio matures every month, investors can buy or sell their shares in the fund monthly.

With assets of US$1.4 billion, the 1Sharpe Income Fund fund aims to provide returns of 4% to 5% above Treasury bills. The fund returned 7.65% over the past year through November—compared with 4.67% for the Barclays three-month Treasury Bellwether Index—and is currently yielding around 9%, according to the firm. 1Sharpe has invested US$10 billion in this strategy since its inception in 2016.

What distinguishes the attractive yields in the fund is the safety of the assets behind them, Watson says. 

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“There are a lot of credit funds out there that are really stretching to get (sizable returns) while taking material credit risk,” he says. In contrast, 1Sharpe’s loans are short duration, use little to no leverage, and are backed by a first lien on the underlying property. The loans also go through “labor intensive” underwriting standards, Watson says.

The rising interest-rate environment has been a bonus for the strategy, as the loans generate hefty cash returns that the fund simply redeploys, he says. Though Watson describes the housing market as “fragmented,” he believes there’s still no end in sight for the deep supply-demand imbalance. 

1Sharpe’s strategy isn’t as vulnerable to economic downturns as others may be, because lower home prices are a boon to flippers who need the firm’s loans. (Home prices have risen at a compound annual growth rate of 7.5% since 2012, according to the Federal Housing Finance Agency.)

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Watson and co-founder Rob Bloemker bring years of experience in the U.S. housing market to 1Sharpe. Both are serial entrepreneurs who’ve founded a long list of housing companies, including Dwell Finance—a lender to investors of single-family homes. The firm was sold to a unit of the private-equity firm Blackstone in 2015.

Most investors in 1Sharpe’s income fund are institutions and family offices, but it’s open to individuals and other qualified investors with the ability to invest the US$1 million minimum. Investors pay an annual management fee of 0.5% and a performance fee of 20% if the fund returns at least 1.30% over the three-month Treasury index. 

This story originally appeared on Penta.

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