Private capital lenders (also sometimes called “hard money lenders”) are increasingly in demand to provide loans for most types of commercial real estate transactions—everything from simple investment-purpose residential properties to large-scale mixed use construction projects, from undeveloped land purchases to cash-out loans on retail properties. Why are they keeping so busy? It’s the approach that they take to financing loan requests. Unlike banks, which prefer to fund low-risk projects by well-known borrowers with high credit scores, high debt-service coverage and long track records, private capital lenders base their underwriting decisions on the value of the property and its potential profitability. This different approach has attracted out-of-the-box borrowers with profitable projects in need of funding that nonbank lenders are willing to provide. These private lenders are not the questionable hard money lenders of decades past who were viewed in a negative light, but reputable small businesses or groups of investors who have the ability to fund large-scale, multi-million-dollar projects.

There are two main ways in which reputable private capital lenders distinguish themselves from bank lenders: willingness to take on risk and asset-based underwriting guidelines.

Acceptable Risk

Private lenders have increased their ability to finance more and larger projects by attracting diverse types of investors (e.g., pension funds, investment banks, endowments, and insurance companies), so that they are no longer individual investors with limited capital to invest in borrowers, but large capital funds which pool together money from multiple investors. In this way, they can lower the risks of individual loans by investing in multiple projects simultaneously (in much the same way that investing in mutual funds works). This also means that these lenders are now focused on earning a satisfactory return on their investment for their investors, so they don’t want to end up owning properties whose borrowers have defaulted on their loans.

The other advantage of having more capital to lend is that these nonbank lenders are able to loan at lower interest rates than previous hard money lenders; today private capital lenders typically offer rates around 10% rather than the older rates of 15% or higher. Although some have concern that private capital loans are more expensive than bank loans, it’s important for borrowers to recognize that these higher interest rates are a trade-off for these lenders to offer quick and convenient financing when banks are not willing to fund the loans.

While private capital lenders will lend on projects that banks won’t, this doesn’t mean that they’ll lend on just any project, or that they are looking for “desperate” borrowers. Instead, they are a useful tool for savvy borrowers who are looking for short-term loans that can be closed in a tight timeframe so that they can profit from quick turnarounds and take advantage of opportunities that might be lost waiting months for financing to come through. They’re also useful for borrowers who have a project that doesn’t fit the post-recession stringent guidelines that restrict commercial lending from banks.

Asset-Based Underwriting 

Although private capital lenders don’t have the same guidelines that banks do, they still conduct due diligence and require much of the same financial information from their borrowers. It’s important for borrowers to remember that even though they’re not dealing with a conventional bank lender, the burden of proof for why their project is a good investment is still on them. Borrowers should expect to provide a fully developed plan for the property they want to purchase, detailed cost lists for any improvements they plan to make to it, financial information (e.g., rent rolls and leases) for any current tenants, photos of the property and any major buildings on it, and the borrower’s credit history. Even though they require much the same due diligence as banks, private lenders maintain speedy approval processes because they don’t have to wait for loan committees to grant approval. Instead, they are empowered to decide for themselves which loans they want to fund.

The other key piece of information that private capital lenders will require is an appraisal of the property’s value. The appraised value determination is another area in which private lenders differ from bank lenders because they have the freedom to use a property’s post-improvement value in the case of a distressed property. Why does this matter? Because private lenders can choose to use this value in their loan-to-value (LTV) ratio that determines the amount of money the borrower can receive. This can be extremely beneficial (offsetting costs such as higher interest rates or lower LTVs) to borrowers who want to purchase distressed or undervalued properties at prices that are less than their current or potential value because bank lenders have to use the lesser of the two values to determine the loan amount. This why, in certain situations, private capital lenders are able to offer borrowers more money even though their LTV rates are typically lower than those offered by bank lenders.

In this way, increased capability and credibility have allowed private capital lenders to grow in popularity in the post-recession commercial lending market. These nonbank lenders now operate in much the same way as bank lenders, yet they retain an edge on these bank lenders by closing loans in shorter timeframes and being more willing to consider loan requests for projects that require creative or flexible financing.