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   ARTICLE   |   From Scotsman Guide Commercial Edition   |   October 2013

Hard-Money Evolution

Look into this viable, well-established lending model

Over the past few decades, hard-money lending has evolved from a shady practice to an essential, well-established financial tool. A plethora of large, fund-based and professional private-money operations have emerged and provided commercial mortgage brokers with a reliable funding channel for their deals. 

In the late 1970s, a $35,000 second-trust deed on an owner-occupied property was a typical hard-money transaction. Drive down the street, find the worst house on the block and that was likely the address of the subject property. As the U.S. headed into an extraordinary period of inflation, hard-money lending decisions were strictly asset-based and self-serving with little regard for borrowers’ needs or best interests. 

By the beginning of the 1980s, interest rates and points were in double digits. Countless hard-money lenders failed, thereby incurring huge losses for their investors, spawning the enactment of knee-jerk legislation to protect consumers and investors. This cleared the landscape for new hard-money operations — the green shoots of the next boom-and-bust cycle. The hard-money stigma then was earned.

Overreaching legislation and business restarts are nothing new to hard money. This well-established pattern preceded the recession of the early 1980s, and the process has continued unabated in every subsequent down cycle. Wall Street, the securities industry and large money managers, however, slowly began to look at trust deeds as a solid, sensible, alternative income investment, an unthinkable catalyst for change in the ’70s and early ’80s. Armed with those dollars, a new breed took the leadership role in this highly cyclical, often-dubious industry, and the evolution toward fund-based, private-money lenders took hold.

The new breed of hard-money lenders focused on a higher caliber of borrowers. Better designed and adapted for the highly cyclical nature of the commercial property lending environment, many of these new lenders developed and adhered to more disciplined lending models, moving away from purely asset-based lending.

The cost of money began to decline materially as the ground shifted to provide a balance of benefit and value to all parties. Lower borrowing costs attracted bankable borrowers looking for responsive transitional financing on high-quality, well-located properties. Together with disciplined underwriting, these adaptations helped create sustainable operations that survived and spanned recessionary cycles, allowed the funds to continue to grow and adapt, and permitted operations to change not just themselves but the entire face and direction of the private-money industry. The larger private money funds have come to dominate market share, adding legitimacy and longevity, qualities that were rarely in evidence before.

As the capital under management and the capability to fund larger commercial transactions have grown and evolved, fund-based lenders have expanded operations significantly and reduced the cost of money within the industry as a whole. Today’s high-quality borrowers look to private-money funds for a host of lending programs that may not be available from conventional banks.

Gone is the stigma, and what remains are many of the core strengths of the old hard-money industry, such as the responsiveness and flexibility to design a lending structure that makes good business sense. Coupled with that are far greater capacity, deeper pockets and lending professionals with sophistication at a different, higher level.

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