Peter Pays Paul

Most of the time serious real estate investors do not want to think of calling a hard money lender. The interest rate and fees are likely to give many an investor a heart attack or at least cause them to faint.

However, there are times when a hard money loan makes sense, a lot of sense.

“We’re Out of Time”

Hard money loans are the most effective when time is short. Borrowers or real estate investors that don’t have time to wait for the conventional loan approval should consider a hard money lender.

This situation most often arises when another lender is unable to come through on their promise and a transaction is in danger of falling out of contract. Sometimes this can arise when an opportunity to purchase arises and a discount is offered if the property is closed on by a certain date. This can also arise in the situation of a 1031 exchange, where the purchaser needs to close prior to a looming deadline.

Because hard money lenders use private capital to fund their loans, their organizations are usually much flatter. This means that loans get approved much quicker. So a deal that might take weeks to get approved at a bank, can be closed in a matter of days for a direct private lender.

A Diamond in the Rough

Many real estate investors look for properties that are in need of a little TLC (tender loving care). They need work. Maybe the building is in need of repair or it needs to be reconfigured to maximize the value of the property.

However, with a little bit of vision and a lot of elbow grease this property will be worth significantly more than what the investor paid for it. These are value add deals. The investor adds value to the property and is able to realize the gain through either higher rents or a greater sales price after repairs or upgrades are performed.

These deals too are a good fit for hard money lenders.

Most hard moey lenders are “real estate guys”. They understand real estate and have a good handle on it’s value.

If a deal makes sense and the lender can see the properties future value, then the deal is likely to be approved. However, don’t expect to do many 100% financing deals with hard money lenders.

Cross-Collateralized Properties

Sometimes a borrower does not have enough equity in a single property to get the financing necessary for his needs. Many real estate investors own multiple properties and some of those properties may have a significant amount of equity.

A hard money lender can use one property as the primary collateral and a second property as additional collateral to secure the loan. The properties are said to be “cross-collateralized”.

Because most private money lenders understand commercial real estate value, they are able to be creative and provide these types of solutions.

Getting Deals Done

Hard money lenders are not a good fit for every deal. But in some cases they can provide the best solution to get a difficult deal financed. Borrowers that are facing a huge tax liability for a 1031 exchange gone sour may think a hard money loan fee a small price to pay  in comparison to Uncle Sam’s bill.

The trial of the owners of Estate Financial, a now shuttered San Louis Obispo based hard money lender, has been postponed.

Trial for Paso lender Estate Financial pair delayed, co-owners remain in jail – Breaking News – San Luis Obispo.

Jack M. Guttentag, “The Mortgage Professor” on Yahoo! Finance has written an article proclaiming the advent of good times for hard money lenders.

Like all disasters, the financial crisis has its share of beneficiaries who profit from it. The hard-money lenders, who lend strictly on the basis of collateral, have profited from the financial meltdown. These non-institutional lenders require a lot less paperwork than institutions because they don’t worry about whether or not borrowers can afford the payments, or whether or not they are creditworthy.

Read the rest of the article..

I would mostly agree with Mr. Guttentag. However, with the value of real estate hard to determine in a falling market it is also a potentially treacherous time for lenders as well. Making a loan at a high LTV on a property that is decreasing in value can be risky, because equity can be eroded quickly.

I can attest that we have seen an increase in the quality of deals that we are reviewing. However, many of the existing financing was underwritten at lower cap rates and higher values. (Remember that cap rates and values have an inverse correlation of each other. As cap rates rise value falls.)

Now with higher cap rates and lower values these properties are worth less than when the original mortgage was put in place. Without an injection of equity from the borrower many of these loans are unable to be refinanced.

A Vortex for Trouble:How the Central Coast became the center of a specialized type of lender fraud.

Michael Stoler of the New York Sun has written an article about our industry. (HT: The Dirt Lawyer)

Mr. Stoler accurately states that for new or inexperienced developers the sources of capital are few and far between. He writes:

“The answer for a growing number of these borrowers is alternative, or specialty, lenders that provide financing at higher rates and with stricter conditions.”

Still Lending

While the credit crunch has decreased the supply of funds, specialty lenders are still willing to lend on the right deal. Specialty lenders can be hard money lenders or hedge funds.

In order to obtain a loan from these specialty lenders, borrowers should have lots of cash and a solid project grounded in reality, not the past boom market. Mezzanine lenders and joint venture funds help borrowers with limited cash acquire the necessary equity to gain financing.

Borrowers should expect a rate in the double digits and higher fees to pay for the speed that specialty lenders provide.

If you need specialty financing, please feel free to call me at (925) 280-5388.

Not many mortgage brokers live consistently in the world of hard money. It is a subject despised by some and feared by others. When I call on brokers for the first time, many of them report, “We don’t do that here.”

I believe commercial mortgage brokers, often times, don’t understand the role hard money lenders can play in serving their clients. Anything new can be intimidating. Especially, something that if not handled carefully can injure your business. Hard money is like a sword: wielded by an experienced broker it is a valuable tool. Wielded recklessly by an amateur, the user is likely to lose a limb or a valuable client.

Below are some hard money hints to help you avoid cutting off a limb.

1. Beware of application fees. Most hard money lenders will require a good faith deposit or an application fee. This when used properly protects you the broker and the lender from a “window shopping” borrower. A good lender will refund this deposit if the loan is not funded, less any expenses incurred by the lender for legal fees, travel, appraisal, etc. However, there are some unscrupulous lenders that collect application fees as a source of revenue with no intention of refunding the fee. Others charge a due diligence fee to even review the loan scenario and underwrite the loan.
2. Beware of hard money brokers. Some hard money “lenders” are really hard money brokers. By this I mean that they do not personally or corporately directly lend the money. They have a list of investors that they broker deals for. These investors may have anywhere from $25,000 to millions to invest in trust deeds or mortgages secured by real estate. Each of the investors has a different appetite for property types and individual lending ability. The “lender” matches the loan request with the proper investor or investors. Sometimes a loan is too big for one of the investor and multiple investors must be sought.
   This may cause problems on larger deals or when time is of the essence. It takes time to match borrowers to investors. Investors may want to review the underwriting themselves. This can delay the loan process until the contract has expired and your client has lost their deal. You may have lost the client.
3. Beware of staged construction funding. “Staged” funding occurs when the “lender” cannot raise enough capital initially to fund the entire cost of the construction loan. The lender is betting that as construction is completed they can raise the additional capital to fund the balance of the construction loan. This tends to happen more frequently with hard money brokers described above. The danger arises when a “lender” cannot raise the additional capital required to complete construction. Your borrower is left with a half-finished project and no money to pay for the remaining construction.
   Often whatever the total amount of funds initially obtained by the “lender” is deposited into an account accruing interest at the borrower’s expense. The borrower has not used the funds, but the borrower is already paying interest on those funds. This is because the “lender” has promised a return to the investor and must start charging interest to maintain that return. Most banks and some hard money lenders only charge interest on the amount of funds used, not on the total loan amount.
4. Cheaper is not always better. I had a boss that consistently told me “Peter, you get what you pay for. You pay for quality, you get quality. You pay less, you get less quality.” This axiom, though not always true, is often true. Though, you may get the loan for a lower price or lower rate, what is being sacrificed to achieve a lower rate? Can the lender perform on time? What is the hard money lender’s reputation? Can they guarantee the funds will be there? Will they be true to their word when it comes to the closing table?
5. Make friends with a hard money lender. You never know when one of your clients is going to need money in a hurry or have a problem with their credit. If you can’t get the deal done for them, your client will look for someone that can. You may not need a hard money lender more than once a year, but it will be nice to know who to call. It never hurts to close one more deal a year.
6. Don’t charge an exorbitant fee, because it is “hard money”. Lenders have underwriting criteria and a risk tolerance level. If a client is willing to pay a broker 10 points to place a hard money deal, something might be wrong with the deal. We tend to raise our eyebrows a little. Please understand that in know way do lenders begrudge you making a commission. Understand that from the lender’s perspective you are not undertaking risk warranting 10 percent of the loan amount. You provide a valuable service and should get paid, just don’t be miffed if lender’s are turned off by a large broker fee.
7. Avoid daisy chain loans. A deal comes across your desk from another broker, who got it from another broker, who got it from another broker, so on and so forth. Usually, every commercial broker in the chain wants a fee and the borrower or lender gets cold feet. These deals can be extremely frustrating because there is a lack of control. If you are the last broker on the chain, you get whipped back and forth by the other end. It will save you a lot of stress and time to avoid the majority of these deals.

This list is by no means exhaustive. It is meant to be a useful tool to get you on the right track to using hard money wisely. I hope that it does.