Have you heard of private lending? Not so much as an owner-financed home but loans made by a certain type of lender using its own internal guidelines without having to follow third party regulations? Private money, or so-called “hard money,” is a valuable asset in the world of real estate and without it many existing properties could ultimately fall into a state of disrepair such to the point where it detracts value from surrounding real estate. In the residential world, private loans are used to buy and rehabilitate investment properties.

Most residential loans today are issued following guidelines set forth by Fannie Mae or Freddie Mac. When a lender approves a loan using these standards the loan is then eligible for sale in the secondary market. Selling a loan means freeing up more capital for the lender in order to make more loans. With a private loan, the goal isn’t selling the loan, it’s getting the loan paid back. Private loans will carry higher interest rates and are only available for a short period of time, time enough to buy and rehab a property. Once the property is rehabilitated it can then be in a condition where traditional financing can be used.

For example, consider a fourplex unit that is vacant and needs more than a little TLC. The property is in such a condition that a traditional loan can’t be placed. An investor sees the potential in the property and with a little due diligence comes to the conclusion the property would show some serious cash flow once stabilized and sell for a tidy profit once the repairs have been made. The investor then contacts a private lender and makes the proposal for a private loan.

Private lenders look primarily at the “exit strategy” which means telling the story how the private loan would be paid off. Typically, the exit means the property will be sold once repaired. The private lender agrees and issues the needed funds to buy and rehab the property. After a few months, the property is completely rehabilitated and ready for conventional financing.

If private lending didn’t exist, this same fourplex could fall into such a state of disrepair the only option is a complete demolition and building brand new from the ground up, a costly proposition compared to a private loan. When you hear the term “hard money” it’s far from a bad thing. For many projects, it’s the initial seed capital needed to turn a dilapidated property into a money maker.

Written by David Reed