Ins and Outs of Hard Money Lending
Finally! The perfect real estate opportunity has come your way. However, what do you do if your bank refuse to provide the finance needed to secure the deal? You can either mourn your hard luck, or you can explore other alternatives. An option that should be considered is a hard money loan. This is a loan that is secured against the property. When money is needed hastily, this can prove to be a very suitable short term remedy. But before you pick up the phone and call your local hard money lender, there are a few important elements to this approach of which you should be mindful.
Cost
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.) When a borrower is not able to meet payments, a higher "default charge" usually comes into effect. In summary, while one should expect a marketedly higher rate, it is important to ensure that this rate comes within hard money market norms.
Amount
It is important to know that hard money lenders are likely to offer less funds on a loan to value ratio than banks. While banks of late are decreasing their lending amounts also, hard money lenders would rarely lend more than 60% LTV. This lower loan to value amount provides more security for the hard money lender as they can foreclose on the property in case of default. One should also note that this LTV is based on the property's current value, and not 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.
Fees
In the past, hard money lending as been the focus of some strong criticisms regarding its fee structure and practices. Often, an upfront fee will be charged in order to carry out an investigation of the loan request. This is not wholly unreasonable however there have been instances where firms will refuse to lend on virtually all transactions while keeping this fee. With this in mind, borrowers need to be careful and ensure that the fees charged are within market averages and also that the firm they are dealing with have a good reputation in the marketplace.
Timing
Hard money 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.
Conclusion
In many cases, the only viable alternative to using a hard money lender is to bring in an equity partner and give away a percentage of the deal. One needs to ask the question however; "Is the expensive funding worth it in order to save giving away a piece 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.
Cost
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.) When a borrower is not able to meet payments, a higher "default charge" usually comes into effect. In summary, while one should expect a marketedly higher rate, it is important to ensure that this rate comes within hard money market norms.
Amount
It is important to know that hard money lenders are likely to offer less funds on a loan to value ratio than banks. While banks of late are decreasing their lending amounts also, hard money lenders would rarely lend more than 60% LTV. This lower loan to value amount provides more security for the hard money lender as they can foreclose on the property in case of default. One should also note that this LTV is based on the property's current value, and not 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.
Fees
In the past, hard money lending as been the focus of some strong criticisms regarding its fee structure and practices. Often, an upfront fee will be charged in order to carry out an investigation of the loan request. This is not wholly unreasonable however there have been instances where firms will refuse to lend on virtually all transactions while keeping this fee. With this in mind, borrowers need to be careful and ensure that the fees charged are within market averages and also that the firm they are dealing with have a good reputation in the marketplace.
Timing
Hard money 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.
Conclusion
In many cases, the only viable alternative to using a hard money lender is to bring in an equity partner and give away a percentage of the deal. One needs to ask the question however; "Is the expensive funding worth it in order to save giving away a piece 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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