Casting Wider Net in Realty Rehab Market

Baltimore's reemergence as a desirable place to live has spawned a new line of business for the $489 million-asset K Bank of Owings Mills, Md.: purchase-and-rehabilitation lending for individual investors.

Though it has long made purchase/rehab loans to developers with track records in buying, fixing up, and selling homes, K Bank, unlike most banks, now makes such loans to borrowers with little or no real estate development experience.

David H. Wells Jr., its president and chief executive, said lots of the people flocking to the Baltimore City area, where many old houses had been neglected, need a loan that can finance rehabilitation as well as the purchase.

Most of the borrowers fix up the homes and rent them or quickly sell them, he said. "At least half of them are fixing them up for resale."

The bank entered the business in 2001; today such loans make up about 10% of its portfolio. Mr. Wells is so bullish on the business that K Bank, whose holding company is K Capital Corp., recently opened a division focusing on purchase/rehab loans for individual investors.

Historically, banks have been skittish about fronting the cost of fixing up a house unless the borrower intends to live in it. The idea is that such borrowers have more incentive to repay.

Still, with the return to city living in many areas of the country, banks making purchase/rehab loans say the rewards far outweigh the risks. Individuals generally pay higher rates on such loans than on conventional mortgages. If the homes are resold, the loans are repaid fast; if they are rented out, the loans are typically restructured as conventional mortgages.

HomeStreet Bank of Seattle, which has $1.6 billion of assets, got into the business about seven years ago, said Susan Greenwald, its director of single-family lending. It saw a market for the loans in its hometown, she said.

The version for individual home investors was modeled on the Federal Housing Administration's 203K rehabilitation loan program, in which HomeStreet started participating more than a decade ago, Ms. Greenwald said. Under that program, the FHA insures loans that individuals take out to fix up old homes.

But since 1996 the program has required that the borrower live in the home once the repairs are completed. Banks are therefore making fewer 203K loans and more of the less-restrictive purchase/rehab loans; this year only about 5,000 homes - half as many as five years ago - are being renovated under the 203K program, according to the FHA.

Laura Randall, the head of K Bank's renovation lending division, said that though the bank is qualified to offer 203K loans, it has not made one in more than two years. Most purchase/rehab borrowers want to rent out or sell, she said, and some renovations would take longer than six months, the maximum for a 203K loan; K Bank's rehab loans can last up to a year.

Even without the FHA insurance, the number of loans defaulting has been "virtually nonexistent," Ms. Randall said. She credited K Bank's strict requirements. For example, she said, all loans are cross-collateralized - that is, the lien is on the borrower's primary residence, not the half-finished investment property.

"We have spent an awful lot of effort on risk management, so we are probably overcautious about it all," Ms. Randall said.

ShoreBank in Chicago has also managed to mitigate the risk of its loans, according to senior vice president Jack Crane. Fewer than 3% of its single-family rehab loans are past due, he said. That includes one-year loans for investors who plan to resell.

Mr. Crane said the $1.5 billion-asset community development bank, whose holding company is ShoreBank Corp., has managed to keep risk low because it has been in the markets where these homes are located for three decades and its lenders know what appropriate investments and rehab costs are.

And unlike most lenders, ShoreBank makes sure that when the refinished home is sold, the price is within reach to people of low- or middling income, Mr. Crane said. "In this product we are very selective about who we will work with and want to make sure they are buying for the right reasons … and will be selling it at reasonable price," he said.

ShoreBank really started promoting its purchase/rehab and investor loans for single-family homes about two years ago, after watching developers buy rundown properties in the community and then sell them at prices beyond the means of low- to middle-income people. Now these loans make up about $175 million of its loan portfolio, and Mr. Crane said he expects that to increase.

"In Chicago the homes are 40, 50, 60 years old," he said. "And most banks won't fund a home loan if it has rehab, so there is a real market."

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