No form of lending is without its risks. But when it comes to hard money, risk tends to be an out-of-sight, out-of-mind kind of thing. We do not think a lot about the risk simply because we don’t hear a lot of stories about hard money lenders crashing and burning. However, coronavirus has changed things. A number of recent developments clearly shows that hard money is not without its risks.
According to The Real Deal real estate news website, a number of hard money lenders active in New York’s commercial real estate scene are suddenly facing a day of reckoning. The local real estate market is suffering from a lack of interest in both commercial and residential space. And with the market suffering, developers and property owners are unable to generate sufficient revenue to pay their loans.
What do you do if you are a hard money lender who has invested significant resources in a project that looks like it will not be completed? How do you make good on your own financial obligations when clients are not repaying their loans?
Billions in Potential Losses
One of the projects highlighted by The Real Deal involves a hard money lender that shelled out more than $1 billion to finance a new high-rise in Manhattan. Everything was going along swimmingly until the pandemic hit. Now the project has ground to a standstill. The lender stands to lose it all if they cannot find a new developer to take over the project. Repossessing and selling the property as-is wouldn’t even come close to paying off the loan.
At the root of the problem was the high acquisition cost paid for the land itself. At approximately $1,100 per square foot, it was one of the costliest real estate deals in New York’s history. It is highly unlikely the lender could sell the property for that much now, especially with the city’s real estate market in decline. The only remaining option is to complete the project and get the space rented.
It’s All About Collateral
Salt Lake City’s Actium Partners, a hard money lender with a penchant for real estate deals, says hard money is all about collateral. Lenders look good and hard at whatever collateral borrowers offer. In the case of land development, the future value of the property being acquired often serves as loan security. Unfortunately, this adds an element of risk to the equation.
As the lender on the New York project found out, future value is never guaranteed. They are married to collateral that now has insufficient value to cover the debt. If they cannot find a new developer to take over, it could be lights out.
On the other hand, what if the original developer had offered other properties as collateral? A few other properties already generating revenue would be more realistic targets for seizure and sale in the event of default. The lender’s risk is substantially mitigated under such a scenario.
Assessing Risk Case-By-Case
If nothing else, the pandemic’s effect on hard money lending reinforces the idea that risk must be evaluated case-by-case. It is clear that the lenders cited by The Real Deal are in trouble. But it’s also clear that not all hard money lenders are having a tough time of it. Some are doing very well even in the midst of the ongoing coronavirus issue.
The truth is that hard money is not without its risks. Lenders and borrowers alike assume a certain amount of risk whenever they agree to do business. Risk is a fundamental principle of both traditional and nontraditional lending.