You may or may not have heard of the term ‘private lending.’ It is in fact a necessary player in real estate finance but often it’s misunderstood. It’s also sometimes referred to as ‘hard’ money while both terms are interchangeable. What is private lending and why is it so important?
The term ‘private’ refers to just that. It’s an individual or group of individuals who privately finance real estate transactions outside the realm of traditional lending. While the vast majority of my volume was in conventional and government-backed mortgage loans, I did have the ability to contact and use a private lender.
Private lenders do not sell loans in any secondary market. There really is no secondary market for private, or hard money. A private loan is issued as a short term solution to a financing issue. In most instances, private money is used to address a short term issue and when that issue is resolved, the private lender wants its money back. Once the issue is resolved, the goal is to get the property or the transaction in such a position to be able to qualify for traditional financing.
For instance, say a potential buyer has identified an apartment building that sparks some curiosity. But there are some problems with the building, primarily there are some stages in development that aren’t yet completed. While a bank certainly does finance apartments, the apartments, much like residential property, must meet certain conditions. In the case where an apartment building is left unfinished or perhaps there are too many individual units not occupied by tenants, a bank won’t touch this transaction for these reasons.
However, a private lender can take a peek. A lender in this instance looks at the potential or the ‘exit’ strategy. If the lender does decide to place a note on the property, the lender needs to see a clear cut exit strategy and it’s up to the buyers to provide that strategy. Once the plan is introduced and the private lender understands what’s going to happen once the problems are resolved, the buyers can then refinance the private loan and replace it with a traditional one with more favorable terms.
Private loans carry much higher interest rates and want some initial equity upfront. A private note might ask for a down payment of up to 50% of the ‘as is’ value of the unit. Rates can be in the double digits. That’s why the buyers need to be certain, as well as the lender, that traditional financing is waiting as long as the problem issues are resolved.
Without private lending, that unfinished building would just sit there and ultimately fall into a state of disrepair to the point where a rehab is impossible.