Hard [hahrd] Mon-ey [muhn-ee], The term commonly used to describe non-bank / non-conventional financing. “Hard Money” is traditionally used for troubled or opportunistic commercial real estate and businesses who do not qualify for conventional (Bank) financing.
Financing for commercial real estate is a completely different game when compared to residential mortgage loans. It moves much faster and is much more flexible.
Commercial Real Estate – Hard, Hard, Hard Money Loans
When purchasing commercial real estate, financing is the most significant factor in determining whether the project is worth pursuing. Although there are a variety of commercial real estate loans on the market, we are going to look at hard money loans in this article.
Hard money loans for commercial real estate are often a matter of last resort. They aren’t good deals, but they can save a financing situation that has gone critical. Most hard money loans come with significant upfront costs and astronomical interest rates. When you are facing the prospect of losing a commercial property, however, they can be a godsend because they also are granted very quickly.
Hard money loans are considered very risky and are issued by private financing groups, not banks or lenders. The loans tend to be only available as the primary loan on the property, which isn’t that rare a situation in commercial property.
Unlike home loans, hard money loans are all about the potential sales price of a piece of commercial real estate. The party considering lending you money is not going to look at the appraised value of the property. They are going to look at the probably sales price if the commercial real estate has to be sold a few months after making the loan. Depending on the condition of the property, this figure will typically be between 50 and 75 percent of the appraised valued of the commercial property.
Put another way, a hard money loan is a short-term loan designed to get you past an immediate problem. It is undeniably a loan of last resort and is not an ultimate solution to a financing problem with a commercial property. It does nothing other than buy you time, and at a fairly hefty cost. If you are in a tight spot and can resolve the problem with a few extra months time, a hard money loan may be the answer.
Before we go any further, let’s make sure we’re working from the same definition of hard money business loans.
For the purposes of this discussion, hard money business loans and hard money loans in general, are typically secured by real estate.
Because the lender is not usually concerned with the application of the funds acquired, I’m further defining a hard money business loan as a source of funds invested into a business operation.
The lending criteria for issuing a hard money loan is primarily focused on the equity held in real estate.
Typical characteristics: 1) private lending sources, 2) short interest terms from one to three years, 3) up front fees on closing, 4) short in duration, 5) use of funds not a focus, 6) limited number of debt covenants if any, 7) interest only payments is quite common, 8) failure to pay results in sale assets to retire the debt.
While hard money lenders have their detractors, they serve a very real and valuable purpose in the commercial financing market place.
Pros and Cons
Pro – The application process for a hard money loan tends to be considerably faster than a comparably sized conventional loan application.
Con – Compared to conventional real estate financing through institutional lenders, the cost of hard money loans is almost always higher.
Pro – In many cases hard money can be lower cost than cash flow financing facilities like subordinate debt and factoring.
Con – Up front fees also add to the cost of hard money business loans which can significantly increase the effective interest rate you’re actually paying over a period of time.
Pro – As a bridge loan, these funds are normally outstanding for a short period of time so the shorter the use, the lower the potential cost.
Con – At the end of the interest term, if an extension is required, but not granted, the loan needs to be paid out in full.
Pro – From a cash flow point of view, an interest only payment, even at a high rate, can still be less strain on the cash flow.
Con – Once you sign up for an interest term, its the same as most fixed interest rate terms whereby there is usually a 3 month penalty for early payout.
Pro – Hard money can also be extended against non real estate assets where real estate is still the primary security in the overall security package for the loan.
Con – If you fall behind with your payments, the foreclosure process can be swift and will typically be as fast as the local jurisdiction will allow.
The basic scenario for considering a hard money business loan is when a business has exhausted its conventional financing sources and is still short money to operate, expand, or just take advantage of short term opportunities.
Because repayment is usually required within a one to three year period, hard money business loans can also be categorized as bridge loans.
If you’re thinking about whether or not to secure a hard money business loan, consider the following points:
>>> Can you generate an ROI? If you have good, profitable business in front of you that you can’t bank because a lack of short term capital, then a hard money business loan may be a solid option.
>>> Do you have an exit strategy? Remember that a hard money business loan is effectively a bridge loan that you’re going to have to pay back in the near future.
If you can’t create a cash flow scenario where full repayment is possible at the end of the loan term, then a hard money business loan may not be a viable option.
>>> What are your alternatives? If your alternative financing options are equity based where you are giving up a portion of the future profits of the business, a hard money business loan can allow you to retain control of the business and keep the related profits.
>>> What’s the impact on personal liability? If your alternative business financing options are high cost and still require a personal guarantee, then a hard money business loan may actually be a better option.
>>> Can you generate enough capital? If a hard money business loan cannot completely address your financing need, then it may not be a good fit.
Sometimes business owners will use hard money to buy time until they can acquire additional capital to meet their entire financing need.
The problem with this strategy is that hard money is not very patient, and if it takes longer to acquire the additional funds than your cash flow allows, the hard money lender will not likely postpone or restructure your debt serving costs.
Instead, if you fall behind in your payments, they will likely realize on their security, which may put you out of business.