Owners of commercial properties have capital needs for varied purposes such as purchase and renovations. In a perfect world the owners of the property would seek out conventional lenders such as banks and credit unions since they would most likely offer the lowest cost of money. Sometimes traditional financing is not available to the borrower or perhaps the borrower does not want to tie up personal funds to finance the project at hand.
In today’s more complex borrowing world traditional lenders cannot fulfill all of the needs of commercial borrowers. Often these borrowers look to Private Lenders to move their projects along. On the surface one may question why a borrower would be willing to pay much higher interest rates to Private Lenders (Hard Money Lenders) and may instead elect not to pursue their project until traditional financing could be found.
Hard Money Loans are typically short in duration and come with higher interest rates and fees when compared to traditional financing. For borrowers the analysis is about their end goal and the planned realization of profit from the completion of the project. Hard Money Loans play an increasingly important part in the commercial real estate world. Here are some instances where Hard Money Loans may make sense for borrowers.
If a capital improvement, repairs, or renovations are needed to the property which if completed would enhance the value of the property from both a valuation and/or rental income standpoint – a borrower may look to the shorter duration – higher interest loans as a wise move to achieve the enhancements to their properties. Often in these situation once the work is complete and the increased value and/or rental income is realized the borrowers can look for more traditional financing and pay off the Hard Money Lender and replace the loan with lower cost financing. Or they may look to sell the property and take the profit and move onto their next project.
If a borrower is the owner of a piece of raw land and wishes to proceed with a “ground-up” development – Hard Money Loans may be a source of financing that they cannot find in the traditional marketplace. Lenders will look at a host of variables when assessing the credit worthiness of the project including the borrower’s development experience, collateral, timeline, borrower’s equity in the project, project presentation, and the financial reserves of the borrower. Weakness in one or a combination of these factors may cause a traditional lender to decline the project financing.
Hard Money Lenders will consider the same factors but often weigh them different in making their final determination. Conventional lenders will often put caps on the construction loans that they make as a percentage of the total development costs. In contrast, Hard Money Lenders may lend up to 100% (or more) of the construction costs if the analysis of the project warrants such. In other words – where conventional lenders are limited in the scope of the loans they are willing to make – Hard Money Lenders with experience in development may weigh the attractiveness of the overall project in their determination and ultimate decision.
Purchase of a Property
When borrowers are interested in purchasing a property often the timing of the purchase is critical. Hard Money Lenders service this market and provide an effective tool in the purchase process. Attractive real estate opportunities and strategic property purchases are often time sensitive. Traditional lenders are typically not able to provide financing quickly and thereby are often not a good alternative in these types of real estate deals. Hard Money Lenders are nimbler and able to evaluate, approve, and close loans quicker than traditional lenders.
Undervalued properties or properties that are performing below market efficiency are good candidates for Hard Money Lenders. Traditional Lenders shy away from these loans due to the underwriting guidelines related to income statements and current expenses. In contrast Hard Money Lenders focus primarily on the value of the underlying property. With a properly constructed loan a real estate investor can obtain the required financing to provide time to improve the property, fill vacancies, increase rental income, and get expenses in line. Once the property is stabilized the investor can seek traditional financing to lower interest costs going forward.
It is understood the credit worthiness of the borrower is a primary focus in the underwriting of a traditional real estate loan. Conventional lenders are also restricted by regulatory guidelines which limit how creative they can be in the loan approval process. Factors such as late payments, tax liens, mechanic liens, bankruptcies, foreclosures, and high debt levels all play a part in the underwriting of a loan.
Hard Money Lenders set their own standards concerning the level of risk they are willing to accept. These lenders can establish asset based loans whereby the cornerstone of the loan is the property itself.
Current restrictions in the traditional financing marketplace for those real estate investors that own more than 10 single family rental residences make it difficult to borrower additional funds. Hard Money Lenders are not as concerned about the number of properties that an investor owns rather they analyze the property itself and its attractiveness as an investment.
In closing, Hard Money Lenders can be looked at negatively because they charge higher interest rates to their borrowers. However, Hard Money plays a necessary role in the real estate investment marketplace as they fill a need that is created by the lack of traditional financing sources. Often the higher costs of the loan is well worth the purpose it serves. This provides investors the opportunity to participate in these loans and earn attractive yields with the security of a first position lien status.