What Is Hard Money Lending? Top 10 Hard Money Loan Questions

Hard money lending is an extremely popular form of short term financing for real estate investors looking to fund fix and flip or new construction projects.

Traditional mortgages tend to place the most importance on the borrower’s credit score, but hard money loans place more emphasis on the value of the asset involved in the specific investment. A hard money loan is primarily used as a source of leverage for real estate investors looking to maximize their capital or as a source of financing that can be available quickly in order to capitalize on a time sensitive investment opportunity. Hard money can be a confusing topic for new, and even some experienced real estate investors. To make things easier, we’ve put together a short list of some of the most common questions about hard money loans that we answer on a daily basis.

Does credit matter for hard money lenders?

Your credit score is not factor when underwriting a hard money loan. If your credit is recovering from something like a bankruptcy but your recent credit history has been clean, we frequently move past credit to look at the other factors in the loan file.

Can I get a hard money loan for a property I currently live in?

Due to various laws and regulations, hard money loans are not available for a primary residence. Great Jones Capital only funds real estate investment projects, and will only loan to an entity (LLC or corporation instead of an individual).

What is the difference between a hard money lender and private lender?

There are a lot of differences between a hard money lending company and a private lender, depending on your definition of a private lender. Traditionally, a private lender is a wealthy individual who offers to fund part or all of a project with their own cash. Unlike professional hard money lending companies these private lenders are more likely to run out of money, and have fewer processes in place to assist and protect the borrower. Great Jones Capital is well-capitalized and can fund individual loans up to $10 million. 

What is the typical length of a hard money loan?

Our hard money loans almost always have terms from 3 - 18 months, but can be extended depending on the situation. Since we do not charge pre-payment penalties, many of our borrowers pay off the loan before the maturity date of the loan.

What kind of interest and points are involved?

Typical hard money lending interest rates are 12%-14% annually, and 2 to 4 origination points. The origination points are a fee paid to the lender based on the amount of the loan, usually due at closing. It is also worth noting that your monthly payments are interest only until maturity.

Will the loan cover repairs if I am trying to fix and flip a property?

Yes! In fact, the majority of our borrowers are real estate investors that have purchased a property and are looking to rehab it and then sell it for a profit. For a fix and flip loan, Great Jones Capital will fund up to 80% of the purchase price plus 100% of the rehab costs.

Do I need to bring my own money to the table?

Most hard money lenders require the borrower to have some sort of skin in the game and cash reserves. We typically require borrowers to bring 20% of the deal cost to the table. In addition to funding part of the purchase for a fix a flip loan, it is important to have enough money in the bank to pay interest and deal with unforeseen project expenses.

Do hard money lenders care about the specifics of the project?

Very much! During the underwriting process our loan officers and underwriters will go through all of the deal economics with you to make sure the project is profitable for everyone involved. As a real estate investor you obviously want to make sure you can make a substantial return on your investment, and as a lender it’s in our best interest to only fund projects where everyone can make money.

How much money can I get from a hard money loan?

The answer to this question varies significantly based on the hard money lender that you are speaking with. In terms of dollar amounts, Great Jones Capital's current loan programs start at a minimum of $250,000 and go up to $10 million.

What is the process to apply for a hard money loan?

The first thing you do is speak with a Loan Officer. They’ll discuss the deal economics with you and figure out if the project seems like a profitable project for everyone. If it does, the next thing you’ll do is fill out a loan application and provide some basic documentation like a purchase contract for the property and a scope of work for the anticipated rehab or construction if applicable. During this time, we’ll also order an appraisal for the property. As the application progresses, our underwriters will collect additional documentation related to the borrower such as cash availability, income statements, and tax returns. We’ll also ask for information regarding the project’s contractor, title history, property insurance, as well as formation and EIN documents for the borrowing entity (since we only loan to entities, not individuals). Once all of this is in order, the loan moves to closing.

For a more in depth look at the entire loan process, please check out our how we work page. Have a project in mind that you’d like to speak with a Loan Officer about? Complete our short Pre-Qualification form or give us a call at (202) 810-5273

How Commercial Real Estate Loan Underwriting Works

Understanding the commercial real estate loan underwriting process can give you a big advantage when seeking debt financing for a commercial property. In this post we will discuss how lenders underwrite commercial real estate loans, how they determine the maximum loan amount for a property, and then we’ll tie it all together with a clear example.

Before a new loan goes through the full underwriting and credit approval process, the lender and the borrower will often have a preliminary discussion. The purpose of the discussion is to get a better understanding of current interest rates, the bank’s current internal loan policy on underwriting ratios, including the loan to value ratio and debt service coverage ratio, as well as any possible lender adjustments to Net Operating Income (NOI).

At this stage the borrower might submit a rent roll and a real estate proforma for the lender to evaluate internally. Typically the lender will discuss the deal internally with the senior lender or credit officer, and if the bank is comfortable with the deal then they’ll issue a term sheet and move forward with the full underwriting process.

Net Operating Income (NOI)

The first step in commercial real estate loan underwriting is determining the appropriate net operating income. The borrower will typically submit a rent roll and a proforma, but the lender will almost always construct their own proforma for loan underwriting purposes, which may result in a different NOI calculation. Possible lender adjustments to NOI include increasing the vacancy and credit loss factor to account for market conditions or tenant rollover risk, or deducting reserves for replacement from NOI.

After determining NOI, lenders have internal loan policy guidelines they use as underwriting criteria for different real estate projects. The two most important loan underwriting criteria used are the Loan to Value Ratio (LTV) and the Debt Service Coverage Ratio (DSCR).

Loan to Value Ratio (LTV)

The loan to value ratio is simply the ratio of the total loan amount borrowed in relation to the value of the property.

LTV = Loan Amount / Property Value

For example, suppose the requested loan amount for a commercial real estate property was $1,000,000 and the the appraisal came in with a value of $1,250,000. The LTV ratio would simply be $1,000,000/$1,250,000, or 80%.

Different banks usually have different but similar LTV requirements. This is driven by each bank’s internal strategic growth goals and existing portfolio concentrations. LTV guidelines also vary by property type to reflect variations in risk. For example, land is considered to be much riskier than a fully leased apartment building, and as such the required LTV on land would be lower.

A critical issue with the loan to value ratio is how a lender determines value. Normally a third-party appraisal firm is engaged to provide a full appraisal report on the property. However, it’s worth noting that the lender doesn’t have to fully accept the appraised value and can still make downward adjustments to the appraisal.

Debt Service Coverage (DSCR)

The debt service coverage ratio is the ratio of NOI to annual debt service. The reason why this ratio is important to lenders is because it ensures that the property has the necessary cash flow to cover the loan payments. The DSCR formula can be calculated as follows:

DSCR = Net Operating Income / Annual Debt Service

The DSCR gives the lender a margin of safety. For example, by requiring a 1.20x DSCR the lender is building in a cushion in the property’s cash flow over and above the annual debt service. At a 1.20x DSCR the property’s NOI could decline by 17% and the loan payments would still be fully covered.

Like the LTV ratio, the DSCR is set internally by the bank’s loan policy and can vary by property type. Riskier properties like self-storage will typically have higher DSCR requirements than more stable operating properties like apartments.

Maximum Loan Analysis

The purpose of the maximum loan analysis is to determine the maximum supportable loan amount based on the NOI, the DSCR, and the LTV requirements. Once a lender calculates the correct net operating income they will then calculate the above mentioned loan to value and debt service coverage ratios. Next, the lender will then take the lesser of the two loan amounts calculated based on the LTV approach and the DSCR approach.

The Best Tools for Real Estate Developers

Real estate financial modeling and real estate development must incorporate the best data and information. When you make well-informed decisions you achieve better risk adjusted returns. Whether your goal is to learn a new skill, dive deeper into a particular financial discipline, or to familiarize yourself with a new tool, all the resources below allow you to do so from the convenience of your couch. Finding these resources ensuring their credibility can be daunting, so we’ve put together this convenient guide to point you in the right direction. We highly recommend these useful tools for your team and your next project. 

  • CBRE Research Center: CBRE provides an annual report on national market trends. If you want to understand what forces are shaping the U.S. economy and driving business, then the CBRE Research Center is essential.
  • Cushman Wakefield Research: Cushman Wakefield has a long history of providing the best information on real estate markets around the globe. From local to global reports, know what’s going on in real estate industries, broken out by country, city, and neighborhood.
  • JLL Market Research: There’s no substitute for quality real estate market research. If you want to know the latest trends in development, what’s selling the most in the hottest markets, and what buyers are steering clear of, JLL Market Research reports are all you need. From banking to utilities, know what’s going on in every industry affected by real estate.
  • CRE Trends From PwC: PwC offers analysis and reporting on commercial real estate trends. In particular, their annual market study should not be missed.
  • ApartmentUpdate: When you need to research apartments in any market, at any price point, and of any size, ApartmentUpdate will help you stay on top of the latest listings in real time. You even get market reports every quarter of the year.
  • Rent vs. Buy Calculator: For those times when you need to determine if a city’s rental or for sale market is more attractive, this calculator will be an invaluable tool.
  • Commercial Mortgage Rates: RealtyRates gives you up-to-date mortgage rates in a streamlined, actionable format.
  • Loan Pre-Payment: Everything you need to know about defeasance in one place. Defease With Ease allows you to find accurate estimates of pre-payment penalties with their defeasance and yield calculators. Be sure to download the app.
  • ARGUS: ARGUS is a software package that will help you analyze investments from the top down. Customize your reports to track cash flows, keep up with forecasts, and keep your business profitable.
  • Real Estate Financial Modeling: Real Estate Financial Modeling has the best financial analysis tools and data solutions in the real estate market. And they’re all free.

No matter what sector you serve or what market or region you operate in, if your goal is to be first in class, you need the best tools you can find. These tools for real estate developers won’t guarantee your success, but they will equip you with the information and resources you need to be a top performing developer. 

What is a cap rate and how do you use it?

Real estate investors use different criteria to determine whether an investment is right for them. A common valuation method used across is the industry is cap rate, a simple tool to estimate the profit generating power of an investment property.

What is cap rate?

The capitalization rate, more commonly referred to as cap rate, is a simple percentage that expresses the potential return an investor can expect on their real estate investment. This rate of return is based on the income that the property is expected to generate, taking into account operating costs. The cap rate is calculated by taking the investment’s net operating income (NOI) and dividing it by the current market value of the property or purchase price, expressed as a percentage:

Net Operating Income (NOI) / Current Market Value = Capitalization Rate

For example, if you are looking at a property that is priced at $500,000 based off of current market value and after operating expenses you expect the property to generate NOI of $50,000 a year, the capitalization rate would be 10% ($50,000 / $500,000 = 0.10 = 10% ). While expenses such as property taxes and maintenance are included in the NOI, this number does not account for items like depreciation or capital improvements. It is also good to keep in mind that even though a higher cap rate suggests a higher profit annually from the property, like most investments with higher yields, it also implies greater risk.

What are the main components of cap rates?

There are three components to a cap rate: net income, property value and rate of return, which is essentially the cap rate. By using the simple formula, if two of the components are known, just like any mathematical equation, then the third can be determined. For example, if a property is advertised as having a 5% cap rate and the property value is $600,000, the calculated NOI is $30,000. The net operating income (NOI) takes into account all of the revenue of the property minus operating expenses. Operating expenses include any expense needed in order to run and maintain the property such as insurance, property management fees, utilities, property taxes and repairs. But an investor needs to keep in mind that this component does not account for principal and interest payments on the loan, depreciation, amortization or capital expenditures. In addition, investors need to critically examine the financial statements and supporting information to determine whether the NOI provided is actual or projected, and the financial assumptions underpinning it.

Why is the cap rate important?

The cap rate is an important tool that enables an investor to quickly size up an investment, relative to similar investment opportunities, to identify which ones might meet their financial goals. 

Do hard money lenders focus on cap rates?

When we underwrite a transaction we focus on the final value of the property. If a borrower intends to purchase, renovate, and retain a property for the long-term then the cap rate is an important measure of the value of the property when the renovation is complete and the building is fully leased. 

Mezzanine Loans vs. Preferred Equity

Real estate investors often use the term mezzanine loan to mean different things. And the distinction between mezzanine loans and preferred equity isn't always clear. Many times investors use the terms interchangeably. Mezzanine loans and preferred equity interests are both forms of investment in commercial properties; they are favored by investors, particularly institutional investors, that want a fixed, or at least floored, return and priority as to both their return on and return of investment.

Mezzanine Debt is generally a loan that is secured by a property and senior to any equity, but junior to the senior loan on the property.

Preferred Equity, on the other hand, is an equity investment in the property-owning entity. It is not secured by the property but rather by an interest in the entity investing in (or owning) the property.

Mezzanine Debt is an effective tool to provide sponsors higher levels of leverage at less cost than pure equity. In return, investors get a higher yield for their additional risk in a subordinated position.

Preferred Equity provides a coupon return, similar to debt, and in some cases may provide the investor with upside potential, in the form of a kicker, of remaining equity.

Mezzanine debt and preferred equity can -- and often do -- have similar terms and conditions; nonetheless, institutional and other real estate investors appear generally to regard mezzanine debt as an intrinsically better form of investment than preferred equity.

Advantages of Hard Money Loans

Many savvy investors often ask how hard money loans are used most effectively. In other words, what makes a hard money loan the best option vs. traditional bank financing?

What is the difference between a traditional bank loan and a hard money loan?

Commercial banks focus on two main things: your credit and your ability to make monthly payments based on income. They will scrutinize every point on your credit report, and a history with bankruptcy can undermine your chances of receiving financing. Our team can underwrite a transaction while incorporating your full financial picture. We offer more flexible and creative solutions than a bank can. 

How fast can you fund a hard money loans vs. a bank?

Hard money lending allows the borrower to close quickly. With a traditional bank loan, you are required to jump through several hoops, which means your project then depends on the bank's lengthy time frame – not yours. This process can take anywhere from one to several months. We know you may not have that amount of time – you found a property and you want to close on the loan as soon as possible. We can underwrite a transaction in hours, send you a term sheet the same day, and fund a transaction in 5 business days. We take great pride in our speed and efficiency.

What matters the most from the lender's perspective?

The borrower's credit isn’t as important as the quality of the deal. Numbers matter but not your FICO score.

  1. We require a first position mortgage or deed of trust.
  2. Loan to value ratios are usually 65% of appraised after-repair value.
  3. Loans cover the cost of acquisition and repairs.
  4. Renovation funds are not usually distributed at closing. Draws are made upon completion of work.
  5. The investor will need “Skin in the game” – meaning the investor is required to bring a minimum percentage or dollar amount to the closing table, typically 20%.
  6. Loans are typically short-term which is a good thing because interest rates are higher than rates for owner occupant, traditional loans. Loan terms can have maturities from 3 to 24 months.
  7. Some asset-based lenders offer longer-term loans for landlords with rates more favorable for buy and hold income properties.
  8. Loan proceeds can be used for a variety of real estate related activities. Potentials uses of funds include acquisition and improvements, pre-construction; some also offer refinances (rate/term & cash-out), recapitalizations, consolidations, repositions, partner buyouts and other opportunistic situations.

Great Jones Capital funds non-owner occupied residential, industrial, multi-family, mixed-use, warehouse, office, retail, hotel and industrial. Do your homework and make sure our funding model meets your needs.

What is a bridge loan?

Bridge loans are often used for commercial real estate purchases to quickly close on a property, retrieve real estate from foreclosure, or take advantage of a short-term opportunity in order to secure long-term financing.

Bridge loans on a property are typically paid back when the property is sold, refinanced with a traditional lender (such as a bank), the property is improved or completed, or there is a specific improvement or change that allows a permanent or subsequent round of mortgage financing to occur.

Bridge loans are critical when a developer is facing a time crunch. The timing issue may arise from project phases with different cash needs and risk profiles as much as ability to secure funding. In short, a bridge loan "bridges the gap" between longer term loans.

Exciting News!

Susan B. Hepner and Jordan Hepner are pleased to announce the formation of their new company Great Jones Capital.

Our firm will continue to provide financing for value-add and opportunistic acquisitions, recapitalizations, and distressed debt secured by properties in Washington D.C., Maryland, and Virginia.

We provide bridge loans for commercial real estate borrowers whose projects do not meet traditional lenders’ standards. We offer custom financing for borrowers interested in acquiring and renovating investment properties. Our flexible funding will reduce the overall amount of equity required while lowering a project’s average cost of capital.

Get in touch with our team to explore how we can work together. We look forward to working with you.