Private / hard money not crazy money

Maybe this is cyclical but every three to six months, since the downturn of the real estate market started, I have been receiving calls either from borrowers or real estate professionals who are looking for hard money for 100% of purchase price. The argument is that they are buying properties at such a discount price and that the “real value” is higher than the purchase price, thus there is no risk in financing 100% of the purchase price from the bank. In those cases buyer are acquiring REO properties either residential or commercial ones.

Let’s look first at what is a property’s value. In general we should consider the property’s value the value at what it transacts for, with couple of nuances. For example in today’s market you need to be able to anticipate if the area you are in is at its bottom or not. If when you buy you are not at the bottom you property could lose an additional 10% to 15% in value. More importantly if you buy properties in bulk from banks the price has to be right. Here is a way a lender would look at it, if an individual can buy a REOs at $0.30 per $1.00 of previous value from a bank, this set a precedent for other properties in the immediate area. Also, this means that a bulk buyer needs to buy at a higher discount something like $0.20 and $0.25 per $1.00.

The role of private lenders is to provide loans secured by real estate, whatever type of real estate they deem will work. Until the early 1990’s most real estate financing was underwritten full doc by banks and they were requiring 20% down payment. When I first looked for a loan that was the standard. With new financial markets developed and until late 2007 you could get 100% financing for the real estate you were buying. This was limited to residential real estate financing. You were never able to get 100% financing on commercial the maximum you can get is 90%. Private money lenders are in the business to make loans to project and borrowers that most likely were turn down by banks, meaning that the risks of theses financing are higher than what the banks are comfortable with. To mitigate these higher risks levels private lenders will structure loan differently. One of the ways to structure these loans is by reducing the amount of the loan in relation to the property value. This is why most private lenders will not make loan higher that 65% and in some case 70% of the property value.

Getting back to property values across the nation residential real estate has lost value. In places where there are numerous foreclosures the exchange value of the property is going determine by the exchange price of foreclosures. In places where less foreclosure are taking place then the value will be established by the price at which a property is going to be sold within 90days of being on the market. Any other values are speculative as they don’t represent the market. Asking a private lender financing above 70% of a property value will most likely be turn down. Anything above this LTV should be considered more like joint venture financing, which is not what most private investors would consider.

Last factor to consider in today’s posting is buyer's exposure. Another reason why private investors will not provide higher level of financing is because they want buyers or owners to have some skin in the game. Put another way they want buyers to have some financial or cash exposure into the project. If there is 90% to 100% financing then the exposure is for the private lender. If there is a problem with the project then the private lender will have to deal with it rather than the buyer of the property.