Competitors don’t exactly envy the multi-housing investor who turns to a funding source of last resort. That would be those “hard-money lenders” known for quick closes of loans against issue-laden properties—but also for high rates, huge fees, and tough terms. Nevertheless, developers tapping these lenders today are seeing some benefits of heavier competition in the hard-money sector, primarily in somewhat lower interest rates that make these financings a bit less painful than they would have been just a couple years back.
The additional capital targeting hard-money lending, including hedge funds, has put downward pressure on rates, which in some cases might be near the 10 percent mark these days, said veteran hard-money mortgage broker Les Smith, principal of Evergreen Asset Group in Marietta, Ga. But these lenders are generally endeavoring to offset the yield erosion by standing firm on their notoriously high fees, Smith cautioned.
A case in point is veteran Atlanta-area developer and architect Chuck Schmandt, who needed bridge financing in a hurry to complete the parcel assemblage for his promising $55 million Lofts On Antique Row development in suburban Chamblee.
When a last-minute delay in closing a construction financing package nearly triggered a default on a short-term loan secured by a key parcel, Schmandt and a partner were in danger of losing the $2 million in capital (not to mention much of three years) they’d already invested in the venture. Schmandt was wary of going to a hard-money lender, having heard horror stories about the huge fees and inflexible terms they’d insist on.
Nevertheless, Meridian Capital, the group’s mortgage banker, called on one of the larger hard-money lenders, Kennedy Funding, which is known for closing quickly when necessary. Schmandt and partners spent a weekend signing loan documents and executing personal guarantees, anticipating a needed close of the $3.7 million bridge loan the following Monday.
But then one of the partners controlling the key parcel pulled out and wanted his capital back, requiring Schmandt and the remaining partner to revise the deal with Hackensack, N.J.-based Kennedy (including additional fees).
When all was said and done, Kennedy’s commitment and other fees added up to 6 percent of the principal amount. But Schmandt doesn’t feel too bad about the 11 percent interest rate—which is certainly on the low end of the hard-money spectrum these days (rates can run well into the high teens).
What made it worthwhile
Other hard-money sources quoted loans at 12 percent to 15 percent, all with equally stiff points and fees. So Schmandt is actually quite comfortable with the Kennedy loan, which is secured by the assembled five-acre site valued in the $6.5 million vicinity.
Yes, the terms aren’t exactly borrower-friendly—the rate immediately rises to 13 percent if the partners don’t pay off the loan when it matures after one year. But Schmandt feels he now has plenty of time to secure an attractive construction financing package, and is once again busy working with the original lead bank.
“Under the circumstances we feel the expenses are reasonable—considering the alternative,” Schmandt said.
As Schmandt’s situation illustrates, investors and developers frequently tap the hard-money sector when time is of the utmost essence. “In many cases our borrower clients need loans to close quickly, so they’re willing to pay the price” of a hard-money deal, said Steve Sullivan, chief operating officer at Direct Lending Group in Seattle.
Smith of Evergreen Asset Group pointed to a recent situation in which a client and his partner had negotiated a “below-market” price for a New York mixed-use property, but the 50-50 equity partner suddenly backed out a week before the scheduled closing.
“I was able to find a hard-money lender that moved fast, and we closed the deal seven days later,” Smith recalled, though he declined to provide further details, citing the client’s request for confidentiality.
Just as often, real estate entrepreneurs seek construction or bridge-type financing from hard-money lenders to improve properties that just don’t qualify under traditional lenders’ guidelines. “We bridge the gap and get them to where they can qualify” for more conventional financing, said Sullivan.
The hard-money poster child
Perhaps an apropos poster child for such predicaments is downtown Los Angeles’ 1917-vintage Frontier Hotel, whose longtime owners have been converting the property from single-room-occupancy (SRO) operations to luxury lofts a floor at a time.
The local banks and other traditional lenders that typically finance downtown loft projects weren’t interested in financing the conversion venture dubbed Rosslyn Lofts, said David Young, principal at interim-financing specialty mortgage broker Partners Realty Capital (PRC) in Newport Beach, Calif. Property owners Joseph and Robert Frontiera had been trying to resolve various issues with city officials pertaining to operating the SRO hotel and policing its grounds in a neighborhood transitioning from Skid Row to a viable loft district. And the disputes certainly hadn’t escaped the attention of the local media.
Meanwhile, the Frontiera brothers were seeking funds to continue combining clusters of three hotel rooms each into spacious loft units, starting with the top (12th) floor and working down—while still operating the SRO on lower floors.
“Most of the traditional regulated or local lenders wouldn’t touch it,” Young said. “We talked with lenders active downtown, and they politely ended the conversation” when the property’s notoriety came to light, he recalled.
Young and his clients ultimately closed a $5 million facility with hard-money specialist Avatar Financial, which offers longer-term commercial mortgages on a quick-close basis as well.
The funds from Seattle-based Avatar allowed the Frontieras to pay off a small existing loan against the property and continue the conversion activity. The structure includes draws as needed for construction, along with an interest reserve. Young declined to provide pricing specifics, other than to note that the interest rate is fixed and the bulk of the fees were paid at closing rather than out of pocket.
It wasn’t difficult for the Frontieras and their mortgage bankers to demonstrate to alternative financiers that they were working hard to eliminate every issue that would concern a traditional lender. Perhaps most fundamentally, SRO tenants were gradually moving out as the renovations were proceeding, Young said.
“The Avatar people have plenty of experience that lets [them] get through all that,” he continued, adding that PRC expects to help the developers secure financing from a more traditional source as the project further progresses and units lease up.
The lender calculated the loan-to-value (LTV) at less than 60 percent and was hence comfortable making the commitment, Young said. “That’s one attractive thing about a hard-money loan: If the real estate has clear value, the lenders aren’t so concerned with personal credit.”
A considerable chunk of the hard-money deals Smith has seen of late are bridge-type loans allowing developers to refinance slow-to-lease development projects on a short-term basis as construction facilities come due. It’s not cheap debt, but it typically allows for a more attractive permanent loan once the project is filled, Smith added.
Along with the hard collateral value, a borrower’s credit remains a key consideration in rates and terms of hard-money loans, Smith and others noted. “We’ve seen some (credit) tightening,” he continued. “If the deal’s good but the credit’s not, we’ll see that reflected in the rates and LTV.” Personal recourse appears to have become even more prevalent of late, Smith added, but it rarely becomes an issue as LTVs tend to be so conservative (rarely above 65 percent).
Meanwhile, Schmandt was satisfied enough with the Lofts On Antique Row financing that he closed another $15.5 million short-term loan from Kennedy, allowing him to start development of his nearby mixed-use International Village and complete a buy-out of his partners.