Typical Loan Scenarios

by : jeff rauth

Commercial real estate, private money loans also know as hard money and or bridge loans are becoming more prevalent as borrowers enjoy less red tape, quicker closings and more "common sense" underwriting than conventional financing provides. Typically though, borrowers still relay on this type of financing as an option when conventional sources are not available.

The increased speed and flexible underwriting comes at a steep price with interest only rates often in the teens, 3- 6 points being the norm and loan terms being relatively short at 12 - 36 months.

Why would owners pay such high fees/rates? In short, because it makes sense for them based on their current situation. Below are examples of transactions where it made sense for our borrowers or go the hard money route.

Grand Rapids. Small office building that was previously used as the owners business headquarters. The owner wanted to move his business out and convert the property into a multi-tenant building (investment property). To accomplish this he needed to create common areas, alter the entrance and add an elevator to the property. He needed a substantial amount of cash to make these improvements happen.

The problem was four fold: Personal credit was in the 400's, the owner had virtually no liquidity, the owner had no development experience and the year to date, profit & loss and balance sheet showed that his business was losing money. These issues eliminated any type of conventional financing.

The owner knew that the property would be a cash cow, and drastically improve his overall financial position, if he could get the money needed to complete the project. For the lender the deal made sense as well, due primarily to the low loan to value (High equity). In addition, the exit strategy was simple, after the building was renovated and leased out, the property would stand on its own and qualify for conventional finance base off the new cash flow.

Metro Detroit. Local business that owned six retail buildings and had its loan "called" (forced balloon) prematurely by its bank. The loan was called primarily because the business had lost money for three years in a row. The bank was nervous the borrower would go out of business. The business was forced to seek alternative financing.

Besides the above, multiple conflicting partners further complicated the matter and made conventional financing that much more difficult to obtain.

However, the properties where in solid condition and had much equity. The borrowers where able to leverage the equity and refinance their existing mortgage and roll in other business debt into the private money loan. The result was increased cash flow enabling the business to regain profitability - even though their rate was much higher than the previous mortgage.

Cleveland. A real estate investor was in the process of purchasing a 40,000 square foot mixed use building. The seller became frustrated and began to doubt the buyer's ability to purchase the building as the conventional lender became cautious and dragged the process out. To the buyers shock, the lender pulled out, two weeks before the scheduled close.

The primary issue for the conventional lender was that although the current net operating income could support the proposed loan, the historical (average of the last 3 years) net operating income could not meet the traditional banks Debt Coverage Ratio's.

The buyer, fearing that he would lose the property and money he had already put into the deal, used private money to meet the closing schedule. The exit strategy to pay off the private money loan was to simply continue to document the current net operating income and refinance the debt into a conventional loan one year out.

These are typically private money scenarios, others include foreclosures, distressed properties, recent bankruptcies, lack of existing cash flow, partnership buy outs, land contract refinances, "need for speed," etc.

Common positive traits that make the loans financeable include loan to values less than 60% and clear "exit strategies" on how the borrower is going to pay back the private money lender.

Yes, hard money is expensive, but can be a viable option given the right (Or wrong) set of circumstances.