When Diego F. Burneo started buying and renovating homes in 2011, he had to rely on cash to cover expenses, a restriction that slowed his pace and forced him to split profits with a family member.
But in November, the Anne Arundel County real estate investor secured about $840,000 in loans.
Burneo said he expects the financing to boost profits, allowing him to increase his operations from two homes at a time to seven, and to work independently.
"I'm in business by myself — no partner needed," said Burneo, 35. "The returns are going to increase significantly."
Outside financing remains far from the norm in the investor market, where banks pulled back from lending after the housing crash and recession. In October, nearly three-quarters of investor purchases — 72 percent — were paid in cash, according to Inside Mortgage Finance's monthly housing pulse survey.
But that's fallen 2 percentage points since the start of 2011.
Industry members said a new crop of private lenders is moving to fill the gap left by banks. That includes "hard-money" lenders, which accept property as collateral in exchange for short-term loans with high interest rates.
"There's more and more people doing loans in our market," said Beth Marsie-Hazen, a lender and a leader of the Mid-Atlantic Real Estate Investors Association.
In recent years, units of private equity firms Blackstone and Cerberus Capital Management launched lending programs that target mom-and-pop investors.
Other firms are growing. Baltimore-based Dominion Financial Services, founded in 2002, started lending regionally this year, closing on about $20 million in loans. Columbia-based Hard Money Bankers, which dates to 2007 and made about $30 million in loans this year, expanded to Pennsylvania in December.
South Carolina-based Lima One Capital, the hard-money lender that worked with Burneo, started in Greenville, S.C., in 2011 and has since launched operations in nine states, including Maryland in August, with plans for more. It closed on $50 million in loans last year, said CEO John Warren.
The firm's expansion has been fueled by access to some $2 billion in commitments from institutional investors such as hedge funds, Warren said. Still-elevated levels of distressed properties mean demand from rehabbers is also strong.
"Everyone's looking for yield," he said.
Hard-money lenders typically charge interest rates of 12 percent or more while working with borrowers who wouldn't qualify for loans from a traditional bank. Private lenders may offer slightly lower rates, but can be choosier about the deals. If borrowers fail to repay, lenders may seize the property used as collateral.
Roger Staiger, managing director of Stage Capital Group, said private lending is important to the financial system, but borrowers need to understand they're dealing with tougher players.
"I'm not sure it's bad that we have a shadow banking industry, provided there's no implicit [government] guarantee," Staiger said. "My concern is that people using hard-money borrowing still to this day don't understand what it means to borrow from a hard-money lender."
Matt Benson is executive director of the American Association of Private Lenders, an industry group that has grown from 10 members in 2009 to about 275 today. With industry growth, he said, private lending is starting to become more professional.
Benson's Missouri-based organization, for example, is starting to collect data on the sector and has created standards of conduct for the industry in an effort to limit fraud and forestall potential regulation.
"We want to provide the borrowers out there, the real estate investors, a good-quality, ethical lender as an option and keep the private lending industry where it has some credibility," Benson said.
The loans can be very risky. It's easy for rehabbers to pay too much for a property, underestimate how much work it needs and overestimate the resale market. The small Baltimore-based Slavie Federal Savings Bank, which was closed by federal regulators last year, failed in part because of loans made to rehabbers in the city.
Many hard-money lenders said the lessons from the housing crash — as well as foreclosure laws that make seizing property a lengthier and more expensive process for the lender — have led to tighter requirements for borrowers.
Lima One, for example, requires borrowers to pay at least 20 percent of the total project costs in cash. Warren said his firm has a foreclosure rate of less than 1 percent. Loans average about $180,000 and typically are repaid within nine months.
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"We want a creditworthy borrower who's going to complete the project and pay us our interest," he said. "We don't want someone totally over-leveraged where something happens in their life and they have to decide is it going to be a foreclosure or people feeding their families."
Still, as firms attract institutional capital and seek to grow, some longtime lenders said they face increased pressure to make loans. That's already started to result in lower interest rates and looser standards, some said.
"Lenders are becoming a little more aggressive, so underwriting standards are becoming a little bit more lax than they have in the past, as if we've forgotten eight years ago," said Jack BeVier, a partner with Dominion Financial Services.
So far, many lenders have been unwilling to provide longer-term financing, an important tool for investors looking to refinance homes they've purchased and rehabbed with the goal of renting. Michael Braverman, Baltimore's deputy housing commissioner, said that financing is critical to real estate activities in the city.
But that could be changing. New lending products from the units of Blackstone and Cerberus Capital Management — B2R Finance and FirstKey Holdings — offer longer financing timelines.
"For guys who want to flip houses, the market has largely mobilized. The refinancing capital for rental properties is still very hard to come by," BeVier said. "I'm sure money is going to keep coming into that market. … It's starting to shake loose, but it's still taking time."