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Monday, August 3, 2009

Top Tips on Hard Money Lending

Eureka! You've found a golden real estate deal. But what happens if your bank won't finance the amount needed to secure the property, or won't do it in the short time frame needed? Do you cry yourself to sleep or do you seek alternative options?

One such option is a hard money loan. This is an asset-backed loan where the borrower receives funds secured by the value of a parcel of real estate. In situations where money is needed quickly, going down this route can be very successful. However, before you run out the door, blueprints in hand, to your local hard money lender there are a few key factors you need to keep in mind.


The rate charge by hard money lenders is typically far greater than banks, which is understandable given the short turn around time and looser lending criteria -the credit profile of the borrower is not as important as the loan is based on the value of the property that is put up as collateral. The rate is not dependent on the Bank Rate. It is instead more dependent on the real estate market and availability of hard money credit. Figures available for the last year give a range of hard money rates from the mid 12%-21% (points are often charged upfront.) In situations where the borrower is unable to meet payments, they can be charged a higher "Default Rate". While it is to be expected that the rate you will be charged is relatively high, it is also wise to ensure that this rate is somewhere in the normal market standard range.


One needs to be aware that the amount of funds typically lent are, on a loan to value basis, less than bank loan to value ratios. Usual ratios are around 60% LTV. This relatively low ratio provides additional security for the lender so that they can foreclose on the property in the event of non-payment by the borrower.

It's also important to note that this LTV is calculated on the property's current value rather than a future value. This is the amount that a lender could expect to earn from a quick sale of the property in the event of a loan default. Current market values can differ greatly to market value appraisals which assume a sale in which neither the buyer nor seller is in a rush to close.


Hard money lending often receives critical press for its fee structure, which commonly charges up front fees in order to work on the loan proposal. Concerns mainly stem from those lending companies in the industry who take upfront payments to investigate loans and refuse to lend on virtually all properties while keeping this fee. While it is typically a virtue of hard money lending which can't be escaped, borrowers should be mindful of both the amount of fees charged and also the track record of the company to follow through on their initial loan estimates.


These types of loans often can be closed within 30 to 45 business days if the loan is already in process with a bank. This rapid time frame can provide a lot of flexibility for sponsors. Using hard money loans can allow sponsors to tie up and close deals quickly typically providing an opportunity to negotiate favorable "all cash, quick closing" rates with pressured sellers or banks.


For many borrowers the only alternative funding source is bringing in a new equity partner and giving away a percentage ownership in the property or company. As a result, before agreeing to work with a hard-money lender sponsors typically ask themselves:

"Is it worth it for us to rent the capital for one, two or three years in order to achieve our business goals or should we bring in a new equity partner and permanently give away a part of our real estate or company."

The answer is inevitably a very simple ROI analysis that shows that in the long run, if there is a large capital growth component to the project, the cost of the hard money loan is far less expensive than sharing the expected EBITDA growth over the next two to three years with partners. On the other hand, having lived through a downturn in the market over the past few years, sponsors have to be very certain that their business plans will play out as expected so that the sale or refinance events take place to replace the expensive hard money loans. Many developers had to turn over the keys to their hard money lenders because their market expectations did not play out as expected. Caveat emptor - buyer beware.


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