Are cockroaches lurking in real estate direct lending?
Originally published on LinkedIn in Jan Brzeski’s Observations newsletter. Republished here with permission.
Commenting on several high-profile bad loans in private corporate credit, JPMorganChase CEO and Chairman Jamie Dimon recently warned that “when you see one cockroach, there are probably more.” Although real estate direct lending has gotten less attention than corporate private credit in the current cycle, it is worthwhile to consider some leading indicators for trouble.
When borrowers and lenders wink at each other, watch out
A recent trip to North Carolina gave me pause. I met a homebuilder selling 7–8 entry-level homes a month under $300,000 across central NC. Strong demand, sound model.
The problem isn't him — it's his lenders. Some are offering 90% financing, with a few loans approaching 100% of project cost. Borrowers are quietly coached that they can get even more leverage if they pad their construction budgets, and originators sell this as a feature. It rhymes with the pre-2008 game of musical chairs: everyone knew it would end, nobody wanted to stop the music. This niche is too small to threaten the broader economy, but when borrowers are being guided to mislead their lenders, something is off.
A 95% loan-to-cost loan has no margin of safety
Lenders defend these loans by pointing to experienced borrowers whose finished projects pencil out to a 70% loan-to-value. Fine in theory. But if the borrower stops executing — say, a health issue — the lender can't realistically take over dozens of half-built homes and recover the full loan.
So why does this niche get leverage that apartment buyers and shopping center developers (typically capped around 75%) never see? A few reasons:
Low historical losses. True, but home values haven't meaningfully dropped since this niche emerged post-2008, outside a few Texas and Florida cities.
Houses are liquid. Plenty of buyers, both investors and owner-occupants.
Wall Street loves RTLs. Residential transitional loans have become bond fodder. Once the securitization machine starts humming, standards drop to keep it fed — and bankers paid.
High-leverage fix-and-flip loans: what comes next
The credit cycle is predictable in shape and unpredictable in timing. Standards loosen, then tighten. The question is always when.
Securitization is where the swings show up first. Think of it as cartilage between slow-moving private markets and the instantly emotional public ones. The window stays open for months or years, then slams shut in days. We saw this in 2008 and again after Covid.
When it slams, the most aggressive lenders — the ones living off cheap Wall Street financing rather than their own balance sheets — stop originating overnight. The disciplined players left standing get to reset terms. We don't know what triggers the next reset. We only know there will be one.
What rational investors can do now
Keep a margin of safety. Require real borrower cash. Not every developer wants 100% financing — some have learned that all-leverage careers come with brutal highs and lows. Lending to the slow-and-steady ones often beats chasing the cowboys.
Be willing to grow slowly, or not at all. Capital is plentiful and the temptation to deploy it on whatever terms are available is real. But the same logic that rewards patient developers rewards patient lenders.
Hunt for overlooked niches. Howard Marks calls it second-level thinking — looking past what everyone already sees. North Carolina is growing fast and a great place to live; but with some homebuilder borrowers being handed near-100% financing, there is real risk for whoever ends up holding these loans. The market is wide. There's almost always a “best available strategy”, a corner where you're paid for the risk you're taking, even when the rest of it is frothy.
What's the overlooked niche you'd point to right now?