Hard money commercial loans are becoming more prevalent as borrowers feel the pinch of the credit crisis and find that traditional sources, such as their local banks will not approve their loan request. Some borrower are often surprised, maybe shocked to receive the notice that their loan has been “called" due to the banks desire to lighten its exposure. As of April 2008, it's estimated the turn down rate from traditional banks to be as high as 90%. . . The void is being filled, to a degree, by hard money commercial loans.
The positives are that the borrowers enjoys less red tape, closing often take as short as 2 -3 weeks and in general a more “common sense" underwriting mindset prevails. Despite the positives, borrowers still normally rely on this type of financing only as an option when they cannot get conventional financing; and for good reason. The increase in speed and flexibility with underwriting comes at price for the borrower with interest rates in the 12-16% range and front end points from 3-6%. In addition the loan will normally not be extended beyond 24 to 36 months.
Why would anyone agree to such terms?
1. They have no other options or
2. Despite the high rate and points the overall deal makes sense for their situation.
Here are two examples where it made sense for the borrower to go forward with a hard money commercial loan.
Denver, Colorado. Small retail building that had been owned by the same owner for 30 years where he occupied his business. In short, despite the borrower's lack of development and real estate management experience he wanted to move his business out and convert the property into a 4 unit rental property. To accomplish this he needed to completely gut the property, alter the facade and make changes to the parking lot. And of course, he needed a lot of money to accomplish this.
His problems where many: First of all he had no development experience, his credit was in the low 500's, had almost no liquidity AND his business had been losing money for the last 2 years. . . In short he had no chance of getting conventional financing.
What he did have was a solid building right outside of downtown that he owned free and clear. The loan that we put together was at 50% loan to value with an 18 month payment reserve. Meaning the first 18 month “were" prepaid" taken out of the loan proceed and put into a 3rd party escrow account. This was the only way the lender would agree to the deal which made sense because the borrower didn't have any cash to make the monthly payments! It also gave him sufficient time to renovate and lease out the property. The payment reserve was a huge relief to the borrower as well, because he knew all too well his cash flow situation.
Metro Detroit. A local business that owned a large light industrial building with a retail component was shocked by their existing bank. Despite the borrower 15 year loyalty to its banks and never being late on one payment their loan was “called" meaning forced balloon (yes banks can do this; there is a call provision in almost all commercial bank mortgages). The rationale behind this was the bank did not like the industry the business was in (tier 3 automotive supplier) and didn't like the building type. Industrial properties in metro Detroit continue to get hammered as the market slides with the automotive industry.
As the business begun to search for options they discover that
1. no conventional source wanted their loan and
2. that the few that showed some interest had to have a full recourse loan, meaning full personal guarantee.
Though the CEO had a 2% ownership, the rest was controlled through a family trust. The CEO was not willing to sign off and none of the family was willing to either. Many private money lenders want full recourse, but this is a negotiable item. And as long as the loan to values are below 60 - 50% you can often find a source. So the borrower decided to go the hard money route with a 3 year interest only loan. They refinanced the mortgage as well pulled out an additional $700,000 to consolidate date, which greatly improved their cash flow situation.
These are typically scenarios, others include foreclosures, distressed properties, recent bankruptcies, lack of existing cash flow, partnership buy outs, land contract refinances, “need for speed, " etc. Bottom line, hard money commercial loans are expensive but can be a viable option.
248 885-8797 Jeff Rauth is President of Commercial Finance Advisors, Inc out of Birmingham, Michigan. He specializes in Commercial Real Estate Loans between $300,000 - $5,000,000. Offers unique loan programs such as Commercial Second Mortgages, Commercial 30 Year Fixed and 90% non SBA financing, and Commercial Equity Lines. 248 885-8797
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