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5 min read

The Different Types of Hard Money Lenders

Many people, including real estate agents, conventional mortgage brokers, and escrow and title officers think of a hard money lender as someone who funds a few local loans per year, or a local lending company that funds fix and flip transactions. The reality is, the industry has expanded significantly beyond these local lenders. Nationwide, hard money lenders originate loans and sell to pension funds and Wall Street investors, leading to greater product offerings for the end user, the real estate investor.

This blog post will discuss the five different types of hard money lenders and why they're important to real estate investors and real estate industry professionals. 

Five Different Types of Hard Money Lenders:

  1. Individual Trust Deed Investors
  2. Real Estate Investors Lending Money
  3. Family Offices
  4. Conduit Lenders
  5. Mortgage Funds

Individual Trust Deed Investors

As I mentioned at the start, most people think of individual trust deed investors when they think "hard money lender." Before I started in hard money lending 10 years ago, I only knew of a few local investors who had loaned a friend in Portland money for about 40 fix-and-flip projects.

The reality is there are many high-net-worth individual trust deed investors that loan to real estate investors. Some lenders directly lend to local real estate investors a few times a year to fund their projects. Others use one or more mortgage brokers to fund dozens of loans annually in many different states.

Most of the individual trust deed investors we work with at FCTD have a background in real estate, finance, law — or a combination of the three. They know real estate well and are pretty sophisticated about 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 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 a license as long as the loan is for business purposes.

The benefit of borrowing from an individual trust deed investor is that the process can move quickly, with less due diligence like credit, rental income and background checks. 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 is the pricing may be higher and the Loan-To-Value (LTV) may be lower than the other types of lenders we’ll discuss below.

Real Estate Investors Lending Money

Some real estate investment firms with large property holdings also lend money 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 hands-on knowledge, they’re able to fund loans that other hard money lenders will not. Conversely, their expertise can help pinpoint problems or red flags on a specific property or area — which can be invaluable.

In the past, FCTD has placed second mortgages for apartment buildings with a real estate office that has significant apartment holdings. One second mortgage went up to 73% Combined Loan-To-Value (CLTV), 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 was that the borrower refinanced the building seven months later into a Fannie Mae loan just under 3% (this was 2021).

Family Offices

Family offices are a family version of real estate investors who lend money. They often have significant multi-generational real estate holdings, and have lent money to other real estate investors for the last 15-20 years.

FCTD works with a few family offices that specialize in 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 had in the second half of 2022. They can structure the loan creatively using multiple properties, and close within a few days by foregoing a commercial appraisal for their own property and market analysis, and walkthrough with the borrower.

The drawback, at least with the family offices we regularly work with, is the leverage can be lower than what other lenders would offer.

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, we’ll often combine a family office on the first mortgage at 55% LTV with a 65% or 75% CLTV second trust deed, either from an individual trust deed investor or a real estate office.

Conduit Lenders

Conduit lenders originate loans off a bank credit line and sell them to a secondary market investor to hold until maturity. In the hard money lending world, the majority of fix and flip lenders are structured this way, as they make 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 seven to eight years. This financing structure and market competition created downward pressure on pricing and increased pressure on leverage — up to 90% leverage on the purchase with 100% leverage on the project renovation. Investors are then better resourced to take on more projects at the same time.

To obtain this kind of 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 and after repair value
  • Renovation budget
  • General contractor review
  • Credit and background check
  • Two years of tax returns — business and personal
  • Two months bank statements — business and personal
  • Track Record

The borrowers benefit from lower costs and higher leverage while times are good.

But the drawback, as we saw starting in April 2022, is that with rising interest rates and falling real estate values, 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 couldn't be sold to secondary market investors.

Mortgage Funds

With the turbulence of 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 composed of several investors pooling their money into an entity overseen by a fund manager and their staff. These lenders can have portfolios of $10 million, or 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 fund manager makes the decision. Unlike conduit lenders, they don’t need confirmation from a secondary market investor that the loan can be sold. All decision-making is made internally and finalized 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 drawback to mortgage funds is that they often have limited product offerings. Most will only provide first mortgages and only up to 60% or 65% LTV. Pricing is hit or miss. Funds can offer low-price, low-leverage models, high-price, higher leverage models, and everything in between.

Conclusion

Hard money lending has evolved beyond the local investor financing a few loans each year for the same real estate investors. The industry now consists of several types of funding sources for real estate investors, with the right capital needed for their projects. Some lenders, like real estate offices, focus on a specific niche like second mortgages on apartments, while others, like mortgage funds, originate loans on both commercial and residential properties.

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