I get this questions a lot, so I figure it’s time to try to answer it. Why it’s called hard money is another story.

Hard money lending is also sometimes called private lending, equity lending, or trust deed investing. (I use these terms interchangeably.) In its simplest form it is generally short-term, low-leverage loans with relatively high interest rates, made by private individuals, groups or institutions, backed by equity in hard assets. The most common asset being real estate, of course.

This is a brief overview but hard money lending is distinguished from conventional lending in the following way:

Conventional (bank) loans are what I call cash flow lending. The primary underwriting factors involve the borrower’s credit worthiness: willingness and ability to pay. The value of the actual property–the collateral–is an important but secondary consideration. For a residential borrower this means your credit history, and income level and stability is all important. In the commercial realm it means the property’s ability to cover the debt, as well as the sponsors financial condition. In short, the primary issue is the ability to make monthly loan payments.

Hard money loans flip this around. The single most important factor is the collateral itself: how much is the property realistically worth and how much equity cushion does it provide to protect the loan. The lender’s primary concern is, if the borrower defaults and he has to foreclose, can he quickly and easily dump the property and recover all of his principal and (hopefully) interest and fees.

The second critical factor in hard money underwriting is exit strategy, or how will the borrower repay the loan at the end of the term. Since most of these loans are short-term–1 to 5 years–there has to be a clear and plausible strategy for repayment.

Below these factors comes the borrower’s credit worthiness: ability and willingness to make monthly loan payments. Before the credit crisis this was barely a consideration at all. Since 2007 even hard money is looking a little more carefully at a borrower’s ability to service the debt.

Hard money lending (as we call it today) has been around for decades and until 20 years ago or so had a pretty seedy reputation as being not much different than loan sharking. While there are still unsavory characters in the lending business, the hard money profession has, overall, become quite professionalized. There are lenders that specialize in all types of assets and transaction types, and that provide outstanding and highly professional customer service. It is also a common misunderstanding that all hard money borrowers are financial hardship cases. This is simply not true. Private money provides a speed and flexibility that conventional, “check the box” lenders simply can not match. Many, if not most, hard money borrowers understand the strategic value that it provides in the appropriate situations.

“CMBS Market Begins to Show Fissures”

The following is an excerpt from the Wall Street Journal – WSJ (11-19-08):

The market for debt used to finance hotels, offices and shopping malls tumbled Tuesday on worries that the long-feared rise in defaults for commercial mortgage-backed securities had begun, possibly ushering in the next phase of the financial crisis.

According to a Citigroup Inc. report, the overall number of commercial mortgages packaged into securities that are 30 days or more past due rose to 0.64% in October from 0.39% at the end of last year, with most of the increase coming in October. The latest figure, though low by historic standards, marked the highest delinquency rate in two years.

The jump in soured commercial loans was mainly due to the financing drought and a lack of buyers. Property owners have been unable to refinance mortgages as they have become due, forcing defaults if existing lenders have been unwilling to extend loans under the same terms.
(You can read the full WSJ article here: CMBS Market Begins to Show Fissures – WSJ.com.)

Despite the dire headlines I can tell you that nobody in the industry is surprised by this.  The commercial mortgage market has lagged the devastation of the residential market but a downturn was inevitable.  Most commercial mortgages come due in 5 to 7 years, so all the commercial mortgages originated during the meteoric rise in real estate prices are starting to come due just as economic pressures come to bear and available financing disappears like the dinosaurs.

What the article just glosses over though is that delinquency rates are still at all time historic lows. Over-leveraged property owners with little equity are more likely to default, but those that have something to lose are not so willing to hand the keys back to the bank.  Solution?

Enter the Commercial Private Mortgage Lender.  Private lenders are not subject to the whims of the public debt markets and do not make their money by selling the paper to someone else. (The key implication of that last point is that we do not make stupid loans on the basis that we can offload the risk onto some other unsuspecting investors.)  A quick assessment of the property’s potential and it’s protective equity can be just the lifeline troubled property owners need.  The money is expensive; much more expensive than a conventional bank loan, but it’s far less than an equity partner. Private money is not the solution for everybody but it can save your property, and your financial life – and fortune. Risk is appropriately accounted for and everybody wins: borrower gets a low friction loan and the trust deed investors get a great return on their money.

As Wall Street Titans Fall, Hard Money Lenders Step Up To Fill The Void

Wow! I’ve been saying for a long time that this current financial crisis is worse, and will last longer, than most of the public pundits or government officials will ever admit. (Especially in an election year.) But even I’m a little in shock at just how brutal the carnage has been. First Bear, then Fannie and Freddie, now Merrill Lynch is auctioned off, AIG is holding a sign saying “will work for food,” and Lehman Brothers is in bankruptcy! Wow! Even the largess of the US government (thanks to you and I the taxpayers) has hit its limits with this one. Whatever we may think of the Wall Street culture, it is a bit sobering to see so many financial titans go down so hard and so fast! They really screwed the pooch on this one. (The pooch, by the way, is likely to be us taxpayers again.)

The press will beat this to death so I won’t ramble on about how we got here, but if you thought credit has been tight lately for any sort of residential or commercial real estate deals, watch how fast the remaining commercial banks pull their limbs into their shells. Private money lenders are nearly the last bastion of real estate credit out there. Even some of the big hard money lenders are finding themselves capital constrained as the volume of high quality deals is skyrocketing.

Now there has truly never been a better time for hard money mortgage pool investors!

The Real Estate Mortgage Crisis is the Perfect Investment Opportunity.

New Years is coming, and on January 1st there will be a lot of bleary-eyed people downing Alka-Seltzer, holding their head in their hands and swearing they’ll never drink again. (Right!) But for those that kept their wits about them this is the perfect opportunity to get a jump on the New Year while the rest of the world is too hung over to pay attention.

The same is true in real estate. For the past five years or so real estate markets have been binge drinking on free flowing credit. But the party has ended, the tap shut off, and the financial hang over is a doozey! Should we swear off real estate forever? Absolutely not! In fact, now is the perfect time to get a jump on good real estate investments while the rest of the world is nursing that hangover. Here are four key reasons why.

A basic principle in the real estate profession is that you make your money on the buy. What this means is that if you pay too much for a property it’s unlikely the market will make it up to the point that you achieve a reasonable return on your investment. Property prices across the country have been dropping steadily for the past year, and this trend is likely to continue for at least another one to two years. With property prices down and investors nervous about real estate we’re entering a buyer’s market that makes it much easier to find a strong value investment.

You’re probably wondering: “why should I invest now if you’re telling me prices might continue dropping for another year or two?” Simple: because precise market timing never works. If we knew exactly when the bubble was peaking millions of people wouldn’t be in such dire straights now. (And if New Years partiers knew exactly when to stop drinking they wouldn’t have such a hangover.) When the absolute bottom becomes clear to the market as a whole, it will turn into a feeding frenzy and the odds of overbidding for low quality assets increases. Besides, real estate is a long-term asset. You should have at least a five year time horizon – which brings me to point number three.

Over the past few years the cheap debt available for real estate made a lot of lower quality properties seem like they were performing well. It didn’t matter as much if rents were not keeping up with the market or if operating costs were running a little high. Today real estate valuations have shifted back to the fundamentals: can the property attract and keep good tenants who’ll pay good rents, and still keep operating expenses low? The property needs to stand on its own, without excessive debt. So now you can look for fundamentally good real estate to hold for the long-term without the irrational bidding wars of recent years.

Finally, what’s often lost among all the headlines lately is that the basic character of real estate hasn’t changed. People still need a place to live, and a place to work; businesses need to manufacture and store their products, and retailers need a place to sell them. Most importantly, this country continues to grow. The U.S. population grows by about 1% every year, or over 3 million people. That’s like a new city the size of Chicago popping up out of nowhere every single year, with all the corresponding roads, houses, jobs, schools, factories, and commerce. Wouldn’t you like to get in on the ground floor of that growth? And that’s before any productivity growth which only increases your opportunity for building wealth. Of course this growth is spread across our vast nation but with the right knowledge and a little work you can find the properties that will bring you great financial rewards in the coming years.

The opportunity to invest in real estate has never been better, but with such a wide variety of investment options, how do you choose? What’s the best way to evaluate a real estate investment? Evaluating a real estate investment starts with evaluating yourself. So this New Year make your resolution to truly evaluate your investment objectives and see how real estate can benefit you – and of course to come back and read my discussions about how to perform these assessments and what types of real estate you should consider.

HAVE A VERY HAPPY NEW YEAR