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.

No, I’m not writing about NASCAR or the IndyCar Series. And no it is not the video game.

I’m talking about those rare occasions where you need money and you need it fast.

If you are a commercial real estate sales agent or commercial loan broker, what do you do? Do you know who to turn to in a pinch?

In baseball many teams have the left-handed specialist who will come into the game to get one batter out.

Basketball teams have their specialists as well. The Chicago Bulls had Michael Jordan. The Lakers, Kobe Bryant. Who is your “Go-To-Guy” when time is short and you need a “sure thing”?

“Clutch”

Coaches depend on “clutch” players that will perform when the game is on the line.

Do you have a lender you can depend on when there are 10 seconds left and you are down by two? Do you have a “clutch” lender that understands real estate and can salvage a deal when your client’s deposit is on the line and close of escrow is days away?

Built for Speed

Most hard money lenders are built for speed. Some models of business are faster than others, but in general this is one of the advantages of hard money.

Because most private money lenders don’t have FDIC and state banking guidelines to follow they can underwrite and make a decision much faster than a bank. This allows them to fund deals much faster than a bank.

Always Be Prepared

No one plans on a deal going sour at the last minute, but it is good to have a plan for a “what if” scenario.

Like the Boy Scouts’ motto Be Prepared, commercial real estate specialists should have a tool for every situation. Having a relationship with a hard money lender for deals that require them is just another tool in the commercial real estate professional’s belt.

The Essence of a Professional

Which do you think sounds more reassuring to a client and more professional?

“I never have seen this situation happen before. I’m not sure what to tell you Mr. Borrower. I will have to get back to you on our options.”

Or

“Mrs. Borrower this situation rarely happens. However, I have developed a relationship with a lender that specializes in closing loans quickly. They are a more expensive than bank financing, but they will allow us time to find a more permanent solution.”

Quick Close Scenarios

Mr. O’Skool Mr. O'Skool is an experienced real estate investor. He is very "old school" and doesn't like much leverage. He speaks slowly and always has interesting anecdotes about life. He drives a late model station wagon and brags that he has a second matching station wagon at home in the garage. You are not sure you have seen him without a sweater on.

Mr. O'Skool owns a variety of properties He owns two apartment buildings free and clear. Through his network he learns that another apartment house is available for purchase. He knows that he can purchase it from the current owner if he closes in 15 days time at a 15% capitalization rate, otherwise the owner is going to list it on the market.

Can you get Mr. O'Skool the money he needs to purchase the property in 15 days?

Ms. Forshewnat

Ms. Forshewnat is a very successful real estate investor. She began with a few properties her late husband left to her and has parlayed that into a multi-million dollar real estate empire.

Through the grapevine you have heard that she is not extremely pleased with the service she has received from her previous lender. You have been courting her business for a while and she has finally agreed to allow you a chance at winning her business. She tells you that she is has other notes coming due in the coming months.

She has asked you to finance an office building she owns as the note is coming due in 120 days. You take Ms. Forshewnat to one of your lenders that has a great program for office buildings.

Everything is moving along without a hitch until the lender runs a new credit report 20 days before closing. It seems that Ms. Forshewnat co-signed a loan with her 23-year old son who has missed two of his payments. Now her credit score has dropped and the lender is unable to extend financing.

Can you find a lender to close in 20 days in order to keep Ms. Forshewnat from having a default and jeopardizing future loans?

Buying Time

In general, hard money is not a long-term solution. But it can buy you time to find that permanent solution.

Having a reliable, direct hard money lender can be invaluable to commercial real estate professionals.

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.