Banker’s Hours: Hard lenders are hurting, but does any one care?
There’s one segment of the financial industry hurting big-time, and nobody really seems to care. That’s the one composed of hard-money lenders. Well, actually, some people do care, such as offspring of the practitioners, who’ve had to take out student loans to stay in college, spouses who’ve had to deal with a radically diminished lifestyle. But nobody else; in fact, a lot of folks kind of think they deserve it.
The picture of the knee-cappers (only a euphemism, class) that most have is the moustache twirling bad guy throwing widows and orphans out of their homes. The truth is far different.
The H.M. guys lent to builders, developers, entrepreneurs and real estate flipping operators. Essentially, it was two tough people going mano a mano. The borrowers couldn’t service the debt they were taking on. Rather, they planned to repay it by making a big score down the line: i.e. developing raw land and selling lots, flipping the property for a big multiple of the sales price., or selling a spec home or building for a high price in a hot market. The borrowers generally had little or no liquidity, and certainly not the income to to pay a 15 to 18 percent interest rate.
The lenders knew this, and bet that the low loan to then current value ratios were more than adequate protection. Generally, the loans were at around 50 percent of appraisal, seldom more than 60 percent.
But the collateral was the most volatile speculative type of real estate: commercial buildings, subdivisions in development, raw land or spec construction loans. If the value of single family residences dropped by 20 or 30 percent in the meltdown, you can bet that the properties backing the hard money deals went down by 40 to 60 percent or more.
Most hard money lenders put just a fraction of their own money in the deal, some none at all. Rather, they attracted individual investors with the high returns, or borrowed low from banks and lent very high to borrowers. Just think about the potential return on a 13 percent spread if you borrow at 5 and lend at 18.
I heard of one practitioner that thought he had a fool proof business model, and it certainly sounded good. He’d borrow from small banks at prime, and lend to developers at 16 to 20 percent. At that high level of return, he figured that 60 percent of his portfolio could go bad, and he’d still be OK. Problem was, 90 percent of it went tapioca.
And now, the H.M. people are experiencing the dark side of lending: a ton of problem loans and foreclosed properties that take an enormous amount of work and expense to manage, without a dime of income coming in the front door.
Once investment capital perceives that the bottom of a market has been reached, money will start to trickle into the hard money market. A 70 percent loan in a down market is clearly better than 40 in a booming one. But, until memories fade in ten to twenty years, we’ll not see the hard money frenzy of the first ten years of this millennium.
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