A loan shark used to be the go-to guy when you needed quick, easy money and were willing to pay through the nose in interest. These days “hard money loans” don’t carry such a stigma: The term “private equity consultant” sounds better than “loan shark.” And many high-profile East End builders are taking advantage of these high-interest loans from private investors to finance their projects. It’s an industry that few know exists, and it’s hugely beneficial to lender, investor, and the middlemen who make it happen.
Sure, banks still finance builder projects. As Jim Whitehouse, senior vice president of residential and multifamily lending at Suffolk National Bank, said, “Ben’s [Krupinski] a good customer of the bank. I hope he doesn’t run too fast to private equity.” Of course the banks charge less exorbitant fees. And they employ research and development to introduce new packages that conform to the laws that tie their hands.
But, according to Brendan Byrne, a real estate broker with the Global Group in Southampton, “Since the banking crisis, banks are not aggressively lending — they’re more in the business of charging fees.” Mr. Byrne’s “primary stream of income is hard-money lending,” he said, which he does through his company Hamptons Financial. “I’m not the type of person doing open houses and serving brownies.” Instead, the former stock trader works the deal from beginning to end, helping builders find both lots and financing.
Even Mr. Whitehouse admits “private equity is going to become more popular.” Governed by less stringent rules, private equity lenders “can structure deals more liberally than a bank can.”
Because of the losses banks incurred during the financial crisis, they are risk averse. The irony, Mr. Byrne said, is “banks are willing to lend money to people who don’t need it.”
The way these deals work is this: Private investors — doctors, lawyers, probably even Indian chiefs — looking for a generous return lend typically from $200,000 up. In return, they get 10 or 12-percent interest at the end of the loan term, usually a year, or two at the outside. Upon closing, they also receive two to five points (each point being 1 percent of the loan). Then they pay the private equity broker his commission, about 1 or 2 percent, pocketing up to the high teens. Let’s face it, the opportunities for investors to see returns in the double digits are rare.
Why are borrowers paying such high rates, when banks are charging 4 to 6 percent? Mr. Bryne works with James Hovanec, a private equity consultant who saw the writing on the wall after the banking collapse. In 2008 he was a mortgage broker and former banker who switched from residential lending to commercial lending.
Mr. Hovanec, managing partner in Link Asset Solutions in Lindenhurst, explained that a builder, let’s say Joe Farrell for our purposes, needs loans “for multiple projects at once.” Banks, he said, finance one at a time. According to Mr. Hovanec, getting one bank loan takes “at least 90 to 100 days,” and is often a “five-month cycle.” Not to mention the fact that it can be “stressful, time-consuming, and paper-oriented.” On the other hand, he said, “We can underwrite it in five days,” and “I don’t need your tax returns.”
With conventional long-term mortgages, the borrower pays the interest before the capital, and by the end of the term can pay more than double the capital in interest. With a hard-money loan you are paying less than 20 percent of the capital, with both interest and capital due at end of term.
These bridge loans are in essence construction loans, paid back once the builder finds a buyer, which could be very quickly after starting to build. The sooner a buyer makes the purchase, the better the chances of customizing the property. “We provide capital so they can build till they find the buyer,” said Mr. Hovanec. “Once they start building, they start marketing.”
The good news for the investors is that there’s virtually no risk. “Only limited markets are investment-worthy,” said Mr. Bryne. With Mr. Hovanec, they are working other hot spots including Williamsburg in Brooklyn, Long Island City, and parts of the Bronx. “The market in the city and the Hamptons is hot,” he said. “Just west [of the Hamptons] is not.”
And the investment is secured by real estate; instead of investing in a fund, the investor is putting his money on a particular asset. “We’re lending on as high as 75 percent of the value of the property,” said Mr. Hovanec. Hard-money lending has higher equity requirements than bank lending, where it is theoretically possible to buy a house putting down 5 percent. Even if the loan defaults, the hard-money lender can foreclose on the property. “It’s a highly secured investment . . . the investor is protected by the asset. It puts everyone on an even playing field.”
Link Asset Solutions has about $25 million out in loans in the Hamptons and another $100 million in the city.
Mr. Hovanec and his ilk do not lend to residential buyers. The Real Estate Settlement Procedures Act (RESPA) protects consumers against what the government considers usury. This is not to say that all hard-money lenders are kittens. There are unscrupulous lenders who target residential homebuyers who, through low credit scores or lack of documentation, don’t qualify for bank loans. These are the vultures hoping you’ll default so that your equity reverts to them. “We’re not in the business of evicting people,” said Mr. Byrne.
As for builders, Mr. Byrne said, “anyone building is getting hard-money loans.”