Historically, the business-purpose residential real estate lending industry has operated outside of the traditional financial system. The financial sector commonly known as “hard money” fills a much-needed niche. Many banks won’t lend money on single-family or multifamily homes that have a construction element, due to adverse regulatory treatment.
The government-sponsored enterprises (GSEs) Fannie Mae and Freddie Mac don’t effectively fund this type of asset class either. So, there’s historically been a funding hole that has been filled by local lenders that frequently raise money from friends, family or other noninstitutional sources.
Because there was limited competition from banks or other traditional financing sources, people offering this kind of funding have frequently charged high interest rates with unfavorable loan terms. As a result, these loans are known as hard money loans.
While the exact etymology of hard money is unclear, Investopedia noted that the term may have originated from the use of hard metal coins many centuries ago. It also is believed to be the origin of the colloquial English term “cold, hard cash.” Another notion is that the term may have developed from the fact that the loans are secured by real property. Whatever the origin, these “last resort” or short-term bridge loans are primarily used in real estate transactions, with the lender generally being an individual or a small company rather than a bank.
Over the years, the hard money lending niche has developed something of a bad reputation because it has been associated with unscrupulous lenders that, in many cases, were looking to “loan to own” by taking the opportunity to foreclose on a property at the first opportunity. In the past, many borrowers seeking these loans had poor credit and limited access to competitive financing options.
Those days are behind the industry and the “hard money” phrase is no longer an appropriate description for a market that has been significantly institutionalized. It also is not a phrase that many high-quality creditors in the private lending industry seek to associate themselves with.
The term ‘hard money’ just doesn’t reflect where the bulk of the industry is today.
In the past decade, the private lending industry has started to evolve due to a number of major players that have pushed to increase underwriting standards, provide efficient wholesale funding to lenders and support the institutionalization of the market. Loan coupons have decreased by hundreds of basis points and loan structures have become more borrower friendly. Loan-to-value ratios have increased to market levels and there has been growth in the number of larger lenders.
All of these changes have made the market highly competitive. Borrowers now have many more options to choose from, and private lenders have become increasingly reliant on efficient, institutional capital. The term “hard money” just doesn’t reflect where the bulk of the industry is today.
Look no further than Google to see that things are changing. Google keywords and search traffic are shifting indicators of interest, i.e., how the market thinks of products and services. A snapshot of 1,000 keywords related to “hard money” on Google in March 2022 showed an estimated total monthly search volume of roughly 111,000.
On the other hand, a snapshot of 1,000 keywords related to “private lending” showed an estimated total monthly search volume of roughly 591,000, more than five times as much. Google Trends data also shows a 500% increase in monthly search volume over the past five years for “private lenders near me.”
The private lending industry is currently in discussion about ending the use of the hard money name. In fact, in March 2022, the National Private Lenders Association passed a resolution that urges the industry to move away from the term “hard money.”
The American Association of Private Lenders (AAPL) was called the National Hard Money Association when it was founded in 2009 but changed its name soon after forming. More recently, AAPL has published an article on its website, “The Demise of ‘Hard Money’ in a Private Lending World.” The article states that the AAPL has been trying to minimize the use of the “hard money” term since the group’s formation.
The AAPL notes that it is promoting the use of the term “private lender” as a replacement for hard money. The article does acknowledge, however, that borrowers still tend to search for “hard money” when looking for a private lender. Both the NPLA and the AAPL have published ethics guidelines for members to follow in an effort to support the elevation and institutionalization of the market.
Leading lenders in this sector do not use the term “hard money” to describe themselves to their investors or Wall Street firms. Many major private lenders do not use the term when describing their companies or their products in corporate communications. Similarly, many leading issuers in the securitization market stay well clear of the phrase and instead use the more apt terms of “bridge loans” or “transitional loans.”
The idea of moving away from hard money isn’t without pushback, and there are two major objections. One is a semantic objection while the other has to do with process. Both arguments are unconvincing.
The semantic objection entails that hard money doesn’t really mean hard in the sense of “unfavorable” or “harder to pay back,” but hard because it’s secured by a hard asset. This explanation falls flat when considering that plenty of other lending activities involve hard assets but never with the “hard” moniker attached.
For example, a new house that was financed with a “hard money” construction loan could get a mortgage from one of the GSEs after the work is finished and it would be called a mortgage, not a “hard mortgage.” Loans for aircraft aren’t “hard loans,” and there are many other asset classes secured by physical assets (such as art) that are not referred to as “hard.” It makes no sense that the private real estate lending space is the only one that describes itself with the “hard money” term.
The process objection is more practical: Even if someone fully agrees with everything about the merits of removing the hard money label, they still need to use this terminology when dealing with advertising, especially online, to get business leads. The term also may be part of the company name. There is inertia in the fact that a lot of people search for hard money-related keywords, so businesses selling these products want to buy ads for these keywords to attract clients.
The solution is not to simply stop buying ads overnight but to make sure companies don’t use the term “hard money” on their websites when describing their products, or when proactively reaching out to prospective clients. Over time, search volume for “hard money” keywords has and will continue to decrease, meaning that the need to buy ads based on these keywords will diminish as well.
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Similarly, companies that have “hard money” in their names are understandably trying to capitalize on the existing association with the lending products they’re selling. Companies used to put “AAA” or “A1” in front of their name so they would show up first in the phone book. As listings moved online, however, the need for such tactics changed and names like this have faded. This, too, is likely to organically change over time within the private lending space.
The first step with any major change is to agree on the destination. The private lending industry needs to come together to distance itself from the hard money moniker. This will not be an overnight process, but together the industry can effect change over time. ●
John Beacham is CEO and founder of Toorak Capital Partners, a leading correspondent lender dedicated to purchasing small-balance business-purpose residential, multifamily, mixed-use and residential bridge loans throughout the U.S. and the United Kingdom. Headquartered in Summit, New Jersey, Toorak acquires loans from leading originators and manages all aspects of the investment portfolio, including loan sourcing, pricing, underwriting, acquisition and asset management.
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