Short-term property loans, which had long been considered a last resort option in real estate, have become a hot commodity over the course of the pandemic. Headlines that popped up over the last two years seemed to have a “when pigs fly” connotation, as if there was really anything surprising about what was happening. But short-term property lending has always thrived during economic downturns.
The shutdowns of COVID-19 prompted a mass exodus out of major cities which drove demand for housing. The economic shock of those shutdowns, much like the shock of the stock market crash in 1929, caused banks to become more conservative with their lending. Then the Fed rushed to scale down interest rates in order to mitigate the panic. All of these factors led to inertia within the commercial real estate market. Considering that the word “unprecedented” was thrown around so much in the echo chamber, there was this implication that these kinds of loans were a tailor-made product in response to the COVID-19 crisis. But no, these loans have been around for decades, we just called them by a different name: “hard money” loans.
While the phrase is still in the zeitgeist, many private lenders have been gently stepping away from the term “hard money” for years, even though real estate is a “hard” asset. “Many of these lenders prefer to go by a more friendly-sounding moniker, like a private lender,” says Barrett Financial Group. “Most likely because when people hear the phrase ‘hard money lender,’ they automatically assume a person is talking about a loan shark.” Considering that Google spits out a picture of Jabba the Hutt when you type “loan shark” into the search bar, the rebranding is completely understandable.
“Hard money” was coined after the stock market collapse in 1929 completely shattered the banking system. People panicked and yanked as much of their money as they could from their banks, which drastically limited the number of bills in circulation, which then forced many banks to liquidate their loans, and hundreds of banks had to shut down. The world was short on cash, so people often had a hard time coming up with collateral funding when they needed it. So, many lenders opted to hand out loans that were backed by “hard” real estate assets. Hence the name.
At the time, hard loans were risky. Property owners in severe need of funds couldn’t turn the banks, so hard money lenders were able to charge substantially higher interest rates than a traditional bank loan. Hence the bad rap.
Commercial real estate hard money lending didn’t begin until the late 1950s when banks began implementing quantitative credit scoring. Once again, it became extremely difficult to receive a bank loan, but unlike during the Great Depression, it wasn’t impossible. Commercial borrowers who were denied a bank loan because of the new credit stipulations turned to hard money lending as a last resort option.
Hard money lending has had its ups and downs since then, from the real estate crashes of the late 1980s and early 1990s to the collapse of the housing market in 2008. Even with the stigma attached, hard money lending proves its worth with each economic slump, especially within the real estate sector.
Private short-term lenders enjoyed a surge of demand after then-President Obama signed the Dodd-Frank Act into law. As much as consumer advocates loved the protections and improved transparency of the legislation, financial institutions were not pleased over the more stringent regulations and the tidal wave of paperwork that they required. Not only were bank loans (yet again) more difficult to receive, they took longer to process.
But that surge wasn’t a one-off. Even after the banks adjusted to the law, private short-term lending continues to show its viability during economic stumbles. Consumer lending in the early pandemic days dropped below their year-ago levels in May of 2020, the first time in almost a decade. “This 1 percent fall in consumer loans, and a year-over-year decline of 6 percent in credit card lending, signified changes in consumer spending behavior induced by the pandemic,” said a report by the Federal Reserve Bank of St. Louis. Just like before, households that were uneasy about the state of the world stopped borrowing and stuffed their money away. The banks followed suit by getting more conservative with their lending. Meanwhile, the demand for housing rose in the background, prompting many property owners to renovate their listings to make a profit. Again, getting a property loan from a bank wasn’t an option, so property owners needed cash from somewhere, even if it came with heftier fees attached.
Hard money loans had a long history of being far more expensive than a traditional bank loan, but when the Federal Reserve slashed interest rates in the 2010s so private lenders could acquire cheaper capital, a hard money loan from a private lender became an attractive and reputable product for real estate investors. “From 2009 to 2012, when the real estate market was at its lowest and little capital was available for private lending, hard money interest rates averaged 18 percent,” writes Nathan Trunfino, Senior Director of Sales and Marketing at Lima One Capital LLC. Trunfino penned his article on March 1, 2020, right before the pandemic struck. At the time of his reporting, interest rates were sitting at around 7 percent. Fifteen days later, the Federal Reserve dropped the interest rates to zero in order to protect the economy from the shutdowns. Soon after, demand for private short-term property loans spiked. Now, loan interest rates for short-term private loans sit at 4 percent.
Just like every other market cycle we have witnessed in the past, hard money lending consolidates its position, becoming increasingly irreplaceable with each financial crisis. With the overwhelming popularity it received during this most recent event, it’s clear that hard money lending, or private money lending as it is often referred to now, is no longer a last resort alternative, it has effectively cemented itself into the mainstream.