Last month I introduced a group of our readers to an investment opportunity, and immediately, the hate emails started to roll in. Folks were implying that it was a scam…
The opportunity was a deal to finance a condo project in Mexico, Vista Encantada. The developer was offering a return of 45% on a US$50,000 investment over a maximum period of four years. The returns were being paid by condo sales, and the developer also offered a condo unit as collateral.
This investment offer is what we call a hard money loan. It’s an alternative financing option often used by real estate developers to raise capital for commercial real estate projects.
Here’s Why Real Estate Developers Use Hard Money Loans
One reader asked, “Why doesn’t the developer just get the loan from a traditional bank?”
It boils down to two factors: speed and simplicity. When a real estate developer or investor has a deal on the table that they need to close on quickly, they may not have the time to go through all the red tape associated with securing a conventional bank loan.
The loan process can take several months with a traditional bank, while a hard money loan can fund a deal in as little as seven days. In fact, the Vista Encantada offer is already closed. The project has been funded and construction is finishing up.
In addition to speed, hard money lenders do not require as much documentation as a bank.
While a bank tends to focus more on the personal credit history and assets of the individual principals behind a real estate project, a hard money lender is more concerned with the underlying asset that will be used as collateral against the loan.
Ultimately, the repayment of the hard money loan will come from the income and value generated by the real estate, not from the individuals behind the project. In other words, a hard money loan is an asset-based loan through which the borrower receives funds secured by real estate property (the underlying asset).
Typically, hard money lenders are interested in commercial property such as multi-family apartment buildings, office buildings, industrial parks, warehouses, and mixed-used properties. They also provide loans for the construction of commercial buildings and the development of raw land into a master-planned community or a shopping center, for instance.
Another key point regarding hard money loans is that they have higher interest rates, usually between 10% and 20%, and the financing terms are much shorter than a conventional bank loan, between one and five years.
Why would a developer accept a loan at a high interest rate that needs to be paid back in just a few years?
Again, speed and simplicity. Plus, the developers recognize that they can generate huge profits from their project that will offset the higher interest rates associated with the loan.
People assume that hard money loans are for developers with poor credit or under financial stress… But hard money loans are simply another financing option for developers and investors to raise capital. Many real estate developers and investors with excellent credit, strong financials, and access to bank financing will utilize hard money loans.
Who The Hard Money Lenders Are, And Why You Should Consider Becoming One
Typically, hard money loans are funded by small private investment groups, hedge funds, and venture capital firms. Hard money lending opportunities are out there for private individual investors (like us), but you have to actively seek them out.
From time to time, over the years, we at Live and Invest Overseas have offered these opportunities in cases where we like the fundamentals. The buy-in amount is usually at least US$50,000, and you’ll probably need to meet the criteria of an accredited investor.
Why should you consider hard money lending as a real estate investment alternative?
For one, you can generate above average returns (between 10% and 20% or even higher for international projects) essentially hands free. You invest your funds and the developer takes care of the rest. On top of that, your cash isn’t tied up for a long period of time; the typical term for these types of loans is less than three years.
And while hard money loans are higher-risk investments, they are usually secured by a hard asset: real estate. So if the developer defaults on the loan, you can take possession of the property. Make sure the asset offered as collateral is something you want or something you can use. Land will always have value… but not a condo in a tower that was never built.
Hard money investing also gives you an opportunity to earn yields from real estate without a huge capital outlay, additional expenses, and the administrative hassle of a rental property.
Lastly, should you want to exit your investment, you’ve got plenty of investors out there that would be willing to take over your position—especially for notes that are secured by real estate.
Things To Consider When Investing In A Hard Money Loan
With hard money loans, just like any other real estate investment, there are a couple of things that you should pay attention to in the due diligence stages of the investment.
You need to know if the developer has control and ownership of the real estate asset they are using as collateral. For example, you should confirm that the developer is the title holder for the land rather than just having secured an option to buy the land.
Verify that the developer has all the necessary permits, zoning, and licenses in place in order to proceed with the project. This information may be in the developer’s materials, or your in-country attorney can get it for you.
Gauge the actual viability of the project.
- What market (retirees, tourists, young professionals, corporations, big-box retailers, etc…) is the developer targeting with this project?
- Is the location ideal for their target market?
- What will the average price point or rental rate be?
- Are those price points or rates competitive in the region?
- How will they market the project?
Know the exit strategy. Know how you’ll exit the investment, both at its conclusion and in the interim (if possible).
Be clear on how and when you’ll be paid back.
All of the points mentioned above will be addressed in an executive summary, business plan, or investor prospectus which the developer should present to you.
Get an idea of the developer’s track record.
- How many projects have they completed?
- If they’ve done a residential condo project, have they been able to sell the units?
- If they’ve got a portfolio of multi-family apartment buildings, what are their average occupancy levels?
- If it is a commercial center, have they been able to secure corporate tenants?
Of course not every project will meet every one of the above criteria. Your job as the investor is to make sure that overall, the project falls within your acceptable risk tolerance.
Find out their track record with previous investors if the developer has done previous hard money loan deals. For example, with the Vista Encantada project I mentioned at the beginning, one of our readers invested US$1.3 million in the condo tower project. To date they’ve been paid back US$1.73 million—that’s a 33% ROI.
It boils down to this: You need to know if the developer will succeed in executing the development portion of the project (construction or renovation) and, equally as important, if they’ll be able to make the sales. Knowing this gives you a good gauge of the value of the asset that’s being used for collateral.
Once you’ve done your due diligence (with the help of an attorney as required), you should be able to determine whether the rate of returns on the offer (the potential reward) is worth the risk. (For more information on assessing your risks, see my previous article on risk assessment here).
Is A Hard Money Loan Right For You?
While hard money loans are higher risk, they are an investment that you should consider adding to your real estate portfolio—so long as the entry point is low enough and the potential reward outweighs the level of risk associated with the investment.
The Vista Encantada hard money offer that I introduced a few weeks ago is now fully-funded, and the developer is in the final stages of construction on the first tower.
I do, however, have a similar offer in Cartagena, Colombia. You can read about that loan offer here.
For Overseas Property Alert
Lee,I know you did a lot of travel and research in Mexico last year and settled on purchasing in Mazatlán.
By chance did you go to Rosarito Beach? The ocean view condos seem on par with those in Mazatlán but have the advantage of a shorter drive back to the U.S. (for Medicare benefits, etc.).
Do you feel Rosarito is still too dangerous? Not enough Mexican culture like Mazatlán has?
Any opinion on which area for an ocean view condo you feel might have more upside for future appreciation? This would be both a rental investment and our retirement home.
We’re torn between the two cities. Any feedback would be appreciated.
I’ll start by saying that I’ve never been to Rosarito (in Baja California)… so I can’t comment first-hand on the property market, value, or crime stats.
But among the people who live there, some of the big draws are the proximity to San Diego’s medical care, travel from San Diego’s airport, and an easy return to the U.S. for Medicare. Rosarito lies less than 40 minutes from the U.S. border, about 30 miles south of San Diego.
Mazatlán—while perhaps more Mexican—offers none of those “drive to” conveniences, as the drive to the Mexico-Arizona border is almost 14 hours.
If anyone lives in Rosarito and would like to contribute, I’d be glad to hear your comments on it.
Have a question? You can write to Lee (or Omar) here.