The Facts About Hard-money Lending

Seller carry, bank debt, conduit financing – those are the typical ways you finance a self-storage facility. But there’s another method that rarely gets discussed: “hard-money” lending. In this Self-Storage University podcast we’re going to explore the concept of hard-money loans and drill down on the risks associated with this alternative funding source. 

What is The Self Storage University Podcast?

Welcome to the Self-Storage University Podcast, where you will learn the correct way to identify, evaluate, negotiate, perform due diligence on, renegotiate, finance, turn-around and operate self-storage facilities. And your host is a partner in one of the largest real estate portfolios in the U.S. with nearly $1 billion of holdings, Frank Rolfe.

We all know about seller financing. We're pretty familiar with traditional bank debt. We know about conduit lending. But what do you know about hard-money lending? This is Frank Rolfe with the Self Storage University podcast.

We're gonna talk about that often-not-talked-too-much-about aspect of financing called hard money. Now, why do they call it hard money? Well, if you look it up on Wikipedia, they think it may be tied to the concept of cold, hard cash, and maybe that is one attribute. But another option may be that that kind of financing is pretty hard on the borrower based on what the outcome may be. Because hard money lending revolves around somebody making loans who's not actually licensed and sanctioned by the world of banking, they don't fall under the FDIC requirements. They don't do any reporting or any of that stuff. They just make loans to people in businesses for set interest rates over set periods of time. And that's the initial first problem with the idea of hard money lending, is that it isn't really controlled.

There really is not a referee. It's not like when you go down to your bank in downtown and you make your deposit, or you make a loan. That's all seen under the oversight of this giant overarching banking regulations committee at the federal government. But the hard-money lender isn't in that loop. They're not in that good old boys club, they're an outsider. And the problem is, since they're an outsider, they don't have a lot of regulations they have to answer to.

Banks are very, very attuned to what happens, but the hard-money lender isn't, because they don't have to answer to anyone. They don't have any bank auditors, they don't have any auditors from the federal government. They're just kind of doing it their own way. So that's the very first problem, is there's no one supervising many of these hard-money lenders, and that's indeed a problem.

Also, typically, hard-money lenders only come on the scene when all other forms of financing fail. If you can't get seller financing, if you can't get bank lending and you can't get conduit lending, then you might draw it back and do a hard-money loan. And as a result, many people have to do hard money, and hard-money lenders know this because regular debt is not attainable. So as a result, they're gonna demand a much, much higher interest rate and typically a much shorter amortization and loan balloon length than the traditional bank would do, because they have you over a barrel. You don't really have any other options, and they know that.

So if a bank is currently charging an interest rate of 8%, well, a hard-money lender might charge you 16. Because, again, they don't answer to anyone, and they're using the premise that you probably really need the money and you can't get it anywhere else, or you wouldn't be calling them. So traditionally, their terms are pretty bad. That's, I think, a universal feature of all the hard-money lending I've ever heard from people, is they did it because they couldn't get a regular loan, not because they wanted a hard-money loan, and as a result, the hard-money lender takes advantage of the situation and charges them an excessive rate for a very short term.

But the big problem you have with hard-money lending, even beyond those basic issues, is a simple fact that they are oriented completely differently than a bank is. Because when a bank makes a loan, the bank's intent is simply to get their interest and the return of their capital. That's all. They don't get any part of the upside. That's just not a way bankers work. But a hard-money lender frequently uses a different axiom, and it's called loan-to-own. And what that means is, they're hoping you default so they can take the property away from you, and now they have a property that they're in a very low basis, so now they can sell it at a large profit. They literally wanna take your down payment away, so to speak, because they like the profitability of controlling and owning the asset. Whereas the bank has no interest in that kind of a plan. And because of that, they frequently don't wanna work with you when you have a problem.

Now, if you have a regular bank loan or seller-financed loan, and something should come up, it could be a weather event, whatever the case may be, they'll typically do what they can do to help make things right. If you say, "I need to have lower payments for a while," they'll say, "Okay, I'll run that by the committee." "Okay, I got that approved." But you're gonna lose that frequently with a hard-money lender, because your hard-money lender will say, "Oh, I'm sorry to hear that. So do you just wanna go ahead and deed the property over to us now, or do you wanna wait and miss a few payments and have us foreclose on you?" They seem to have, among the other reasons for the word of hard-money lending, a fairly hard attitude when it comes to making exceptions and being very pliable. And that's a real problem to you as the borrower, because we all anticipate our lender to be on the same team that we are on, but frequently, the hard-money lender is not on your team. The hard-money lender is on their team.

And that construction, that lack of being a team member can really be startling and alarming to many borrowers. And to me, that's probably the biggest problem with the whole hard-money lending concept.

Now, there may be some great hard-money lenders out there. We've never used hard-money lending, so I'm certainly no expert on it, but I talk to a lot of real estate owners who have used hard money loans in the past, and all I hear over and over are horror stories from them. I've never had anyone say, "Oh, yeah, I borrowed some money once from a hard-money lender, and I had a great outcome." Never heard that. But I have heard, "I borrowed money from a hard-money lender, and it was a real disaster." I've heard that one frequently.

But I can't lump them all together, and maybe it was just the same source, the same lender over and over that got the negative commentary. I don't know. But you also have to remember that when you try and get into real estate, particularly, if you're lacking in capital, often you have to do wild and crazy things to get your foot in the door. My partner, Dave Reynolds, and I both started at our careers doing credit card drawdown. It's a crazy concept at 30% interest. Far higher than any hard-money loan would ever be. But we had to do that to get things going. We couldn't just do conventional stuff 'cause we didn't have the capital early on to do conventional things.

So if the only way you can get in the business is to use hard-money lending because you can't, at this point, get seller financing, bank financing, conduit financing, then it may be worth the risk, and that's what often may push many people to do hard money lending, is it's the only way they can get started. And if that's the case, well, then maybe you should be grateful for the hard-money lender because it makes access to the capital attainable.

This is Frank Rolfe, the Self Storage University podcast. Hope you enjoyed this. Talk to you again soon.