Capital Structure of Private/Hard Money Lender

[Yan P.]

I know we have some experienced lenders on BP as well as experienced investors who would know how larger Private/Hard Money Lenders (PHML) are capitalized. Is it always all equity or do the PHMLs ever have a mix of equity/debt in the form of credit lines from commercial banks collateralized by the first lien loans they make? Or maybe something else...

Thank you

[Bill Worsley]

Yan - every lender is different.

Many lenders are brokers who have a group of investors who invest in the note. This is the simplest investment structure. One investor per note, and typically the hard money lender/broker will service the note for the private investor.

Next you will find lenders who do fractionalized note investments, ie multiple investors on one note. This is a new level of complexity, as once you have more than one investor on a note, you officially have a security, and fall under scrutiny of securities law. In my experience you will find these types of structures in markets where loans are on average larger than a typical market. For example, in California, fractionalized notes are more common than in my state, North Carolina, because your average deal size is larger and thus requires larger amounts of capital.

Typically, the next steps for a hard money lender will be to form a mortgage fund through a private placement, and that fund will raise capital through either an equity or a debt structure (there are many ways you can set up a fund). The advantage of a mortgage fund is the hard money lender has more authority in regards to decisions on the placement of funds in loans. With a whole note or fractionalized note platform, you are in effect having to raise capital for each individual deal. The fund allows the hard money lender to be in effect a direct lender.

The fund offer investors diversification - funds are invested in multiple loans collateralized by multiple properties. Fund investors will be paid a yield based on the overall return on the notes held by the fund, with the hard money lender acting as fund manager, being paid a fund management fee and by points and fees charges on loans originated to the fund.

Often, these funds will secure debt financing through a bank, private equity firm, etc. There are several lenders who offer these types of facilities, and typically they will advance a percentage of the note amount (50-80%), and their collateral will be a pledge of the note receivable, along with guarantees of the principals of the fund (not the passive fund investors).

Beware - leverage in a mortgage fund is great when the market is going up... and stinks when the market is going down. Non performing notes combined with declining collateral values is a recipe for a challenge, so any fund should be cautious with the degree of leverage utilized in the mortgage fund. Not saying leverage is a no no, just saying be careful.

Hope this is helpful.