It is true that hard money is easier to come by when a property investor is looking to finance a new purchase. Traditional lenders are more leery of real estate investments, so their approval and underwriting requirements are more strict and complex. But even hard money lenders have their requirements. A solid exit strategy is one of them.
What is an exit strategy? It is a viable plan for repaying a loan on its maturity date. There are few hard money lenders willing to approve sizable loans without reasonable exit strategies in place. To do otherwise would be to take on too much risk.
Hard money has an advantage in that lenders can be flexible about exit strategies. If a borrower can convince a lender that an exit strategy is both viable and virtually guaranteed, no problem. You do not get that kind of flexibility from a bank.
Arranging Traditional Financing
At Actium Partners in Salt Lake City, UT, the vast majority of their hard-earned loans go to real estate investors. One of the most common exit strategies they work with involves the borrower arranging traditional financing after the fact. This is to say that in the weeks following a deal’s closing, the borrower applies for a traditional loan at a bank. The bank loan repays the hard money loan.
This particular strategy works for real estate investments when acquired properties have significant rental value. Prior to the purchase, the bank was not so sure it wanted to get involved. However, once a property has been acquired and starts generating rental income, things are different.
There are never any guarantees that arranging conventional financing will work. Therefore, hard money lenders need to evaluate the likelihood of a borrower making such arrangements. If conventional financing is not likely, the borrower will need some other type of exit strategy.
Tapping Future Rental Income
Another fairly common exit strategy is tapping future rental income. A borrower believes a property’s rental value will provide more than enough income to meet operating expenses and cover the loan amount. If the lender agrees, tapping into rental income could be a viable exit strategy.
This particular strategy works best when hard money loan terms are closer to twenty-four months. That gives the borrower plenty of time to generate rental revenue and put it away in anticipation of satisfying the loan on its maturity date.
There is a downside to this strategy, though. Hard money loans of this nature are generally structured as interest-only loans. That means the borrower still has monthly payments to make. Should those payments combine with maintenance and repair costs to take a substantial chunk out of monthly rental income, the borrower could come up short when the loan comes due.
Selling the Property
Plenty of real estate developers take a short-term approach to acquisitions. They do not plan to hold properties for very long. Their exit strategy is to hold just long enough to let the property appreciate before turning around and selling. The exit strategy in such a case is selling the property being obtained by the hard money loan.
This is a very risky strategy due to the fact that there are no guarantees that property values will rise sufficiently during the term of the loan. Both lender and borrower need to be cautious about relying on selling as an exit strategy.
One way or another, borrowers have to offer solid exit strategies in order to get hard money loans. Without an exit strategy, there is no convincing a lender that an acquisition is a worthwhile risk.