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The Different Types of Hard Money Lenders
When most people think of hard money lenders, including real estate agents, conventional mortgage brokers, escrow and title officers, they mostly think of an individual investor who funds a few loans per year or a local hard money lending company that funds fix and flip transactions. The reality is that the industry has expanded significantly beyond local lenders to nationwide hard money lenders originating loans and selling to pension funds and Wall Street investors, which has led to greater loan product offerings for the end user, the real estate investor.
This blog post will go discuss the five different types of hard money lenders and why, as a real estate investor or real estate industry professional, it’s important to know.
Five Different Types of Hard Money Lenders:
- Individual Trust Deed Investors
- Real Estate Investors Lending Money
- Family Offices
- Conduit Lenders
- Mortgage Funds
Individual Trust Deed Investors
As I mentioned at the start, most people think of individual trust deed investors when they think of a hard money lender. Before I started doing hard money lending ten years ago, I only knew of a few local investors who had loaned a friend of mine in Portland money on his 40+ fix and flip projects.
The reality is that there are many individual trust deed investors who would be considered high net-worth individuals making loans to real estate investors. Some lenders make a few loans each year, working directly with local real estate investors to fund their projects. There are others who work through a mortgage broker, or with several mortgage brokers, funding dozens of loans annually in many different states.
Most of the individual trust deed investors we work with at FCTD have a background real estate, finance, law, or a combination of the three. They know real estate very well and are pretty sophisticated when it comes to investment properties, as most have residential and commercial investment properties, in addition to funding loans.
Trust deed investors are not usually licensed. In some states, like California, Oregon, Idaho, Montana, Arizona, and Nevada, they will fund loans through a licensed mortgage broker or mortgage loan originator. Other states like Washington, Hawaii, and Colorado allow lenders to fund loans directly without any licensing regulation as long as the loan is for business purposes.
The benefit of having a loan funded by an individual trust deed investor is that the process can go quickly with less due diligence like credit, rental income, background checks, etc. Individual lenders will often do their own property due diligence, meet the borrower at the property for a walkthrough, and fund the loan. The drawback to this is that the pricing may be higher and the Loan-To-Value (LTV) may be lower than a borrower could obtain through one of the other types of lenders we’ll discuss below.
Real Estate Investors Lending Money
There is another category of real estate investment firms with large property holdings that also lend money out to other real estate investors. Over the years, FCTD has developed relationships with some of these firms, which have become instrumental in helping our borrower clients acquire and renovate numerous projects.
Real estate offices often specialize in a specific segment of the market like apartments, hotels, or industrial buildings. With their hands on knowledge, they’re able to fund loans that other hard money lenders will not take on. To the contrary, they may know something about a specific property or an area that is a definite red flag and their input is invaluable.
In the past, FCTD has placed second mortgages on apartment buildings with a real estate office with significant apartment holdings. One second mortgage went up to 73% Combined Loan-To-Value (CLTV), which was higher than other trust deed investors were willing to go. The real estate office liked the property, cash flow, borrower strength, and exit strategy (refinance into a new Fannie Mae loan when the yield maintenance period ended). However, if the borrower defaulted, they felt that 73% of their internal value was a good price for the building.
The end result of the loan is the borrower refinanced the building seven months later into a Fannie Mae loan just under 3.00% (this was 2021).
Family offices are a family version of real estate investors lending money. They often have significant real estate holdings that have been in the family business for a few generations, lending money to other real estate investors for the last 15-20 years.
FCTD works with a few family offices that special commercial real estate loans. They evaluate properties quickly and rely on FCTD as the mortgage broker to provide the background details on the borrower (credit, capacity, and capital), or sponsor, as we say in commercial lending parlance.
The benefit of funding through the family offices is pricing, creative structure, and speed of closing. Depending on the scenario, the pricing can be very competitive in a rising rate market like we have in the second half of 2022. They can structure the loan creatively using multiple properties, and can close within a few days by foregoing a commercial appraisal by doing their own property and market with analysis and walkthrough with the borrower.
The drawback is, at least with the family offices we regularly work with, the leverage can be lower than what other lenders would do.
If a borrower needs higher leverage from 65% to 75% LTV, we could place the loan with a different lender on a first trust deed. However, it’s common that we’ll combine a family office on the first mortgage at 55% LTV with a second trust deed, either from an individual trust deed investor or a real estate office up to 65 or 75% CLTV.
A conduit lender is a lender who originates loans off a bank credit line and sells the loans to a secondary market investor who will hold the loans until maturity. In the hard money lending world, you’ll find the majority of fix and flip lenders are structured this way, as they make loans and immediately sell the loans to a pension fund manager or Wall Street investment firm.
Conduit lenders and their secondary market loan buyers have played an integral role in helping professional house flippers grow and expand over the past 7-8 years. This financing structure and market competition created downward pressure on pricing and increased pressure on leverage, going up to 90% leverage on the purchase with 100% leverage on the project renovation, making it easier for investors to take on more projects at the same time.
To obtain this kind of loan leverage, conduit lenders underwrite loans more strenuously than individual trust deed investors, real estate offices, and family offices. It’s common to see conduit lenders requiring the following underwriting criteria:
- Appraisal: As-Is Value & After Repair Value
- Renovation Budget
- General Contractor Review
- Credit & Background Check
- Two Years Tax Returns – Business & Personal
- Two Months Bank Statements – Business & Personal
- Track Record
The benefit to borrowers is lower costs and higher leverage while times are good.
The drawback, as we’ve seen play out starting in April 2022 when interest rates started to rise and real estate values looked to be unsustainable, is the secondary market refused to buy loans at previous prices from conduit lenders. Loans that would have funded one month earlier didn’t close because they could not be sold to secondary market investors.
With the turbulence conduit lenders have experienced in 2022, mortgage funds stepped in and funded many of the loans that in years past would have been funded by conduit lenders.
Mortgage funds are hard money lenders comprised of several investors pooling their money into entity being managed by a fund manager and their staff. These lenders can be as small as $10 million and exceed $2 billion. They originate short-term hard money loans on both residential and commercial investment properties, hold the loans in their portfolio, and provide a yield to the fund investors.
The benefit of a mortgage fund is that the decision making is done by the fund manager. Unlike conduit lenders, they don’t need to get confirmation from a secondary market investor that the loan can be sold. All decision making is made internally and is final with the fund manager. If they have the money and they like the loan, they’ll fund it.
As 2022 progressed, FCTD had to switch several loans from conduit lenders to mortgage funds. These transactions ranged from fix and flip projects, bridge-to-sale loans on completed spec homes, and 85-lot subdivisions.
The drawbacks to mortgage funds are that their product offerings can be limited. Most mortgage funds will only provide first mortgages and only up to 60% or 65% LTV. Pricing is hit and miss. Some funds offer a low-price, low-leverage model, while others offer a high-price, higher leverage, and everything in between.
Hard money lending has evolved way beyond the local investor doing a few loans each year for the same real estate investors. The industry is comprised of several types of funding sources providing real estate investors with the capital needed for their projects. As you can see, there are different types of hard money lenders providing financing. Some lenders, like real estate offices, focus on a specific niche like second mortgages on apartments while others like mortgage funds will originate loans on both commercial and residential properties.