WEBVTT 00:00:00.000 --> 00:00:02.319 Hard money. It just has a certain ring to it, 00:00:02.339 --> 00:00:05.219 doesn't it? It really does. I have to be honest, 00:00:05.280 --> 00:00:07.240 when I first saw this was our topic for today's 00:00:07.240 --> 00:00:11.320 deep dive, my mind did not go to, you know, legitimate 00:00:11.320 --> 00:00:14.279 finance. Oh, where did it go? Straight to a noir 00:00:14.279 --> 00:00:17.960 film. I'm talking like a rainy Chicago alleyway, 00:00:18.199 --> 00:00:21.660 maybe 1940s. There's a guy in a trench coat, 00:00:21.879 --> 00:00:24.820 fedora pulled down low. That's cigarette, definitely. 00:00:25.140 --> 00:00:27.160 Oh, absolutely. A cigarette dangling from his 00:00:27.160 --> 00:00:30.329 lip. And there's a suitcase full of Cash non 00:00:30.329 --> 00:00:32.649 -sequential bills, of course, being slid across 00:00:32.649 --> 00:00:35.289 a wet table. That is a remarkably vivid picture 00:00:35.289 --> 00:00:39.250 and a very common reaction. It just sounds so 00:00:39.250 --> 00:00:42.590 intense, maybe a little illegal. You know, if 00:00:42.590 --> 00:00:44.270 I'm asking for hard money, it feels like I've 00:00:44.270 --> 00:00:46.049 run out of all other options. Like you've burned 00:00:46.049 --> 00:00:48.490 every other bridge in town. Exactly. It sounds 00:00:48.490 --> 00:00:51.630 like the kind of money that. comes with a very 00:00:51.630 --> 00:00:54.049 specific very physical repayment plan if you 00:00:54.049 --> 00:00:56.070 miss a payment you're talking about broken kneecaps 00:00:56.070 --> 00:00:58.549 i didn't want to say it but yeah my imaginary 00:00:58.549 --> 00:01:00.609 version of this definitely involves kneecaps 00:01:00.609 --> 00:01:03.009 being at risk well i can assure you and everyone 00:01:03.009 --> 00:01:05.170 listening that we are not here to discuss organized 00:01:05.170 --> 00:01:08.329 crime or loan sharking today okay good while 00:01:08.329 --> 00:01:11.250 the name is gritty and frankly the industry knows 00:01:11.250 --> 00:01:13.709 it has a massive branding problem what we're 00:01:13.709 --> 00:01:17.069 actually talking about is a legitimate pretty 00:01:17.069 --> 00:01:20.909 sophisticated and an absolutely critical corner 00:01:20.909 --> 00:01:23.129 of the financial world, especially in North America. 00:01:23.390 --> 00:01:25.489 So it's a real financial instrument. It's a financing 00:01:25.489 --> 00:01:28.549 instrument that keeps a huge, huge portion of 00:01:28.549 --> 00:01:30.329 the real estate market moving. So I should probably 00:01:30.329 --> 00:01:31.950 put the trench coat away. I would put the trench 00:01:31.950 --> 00:01:34.950 coat away. But keep the skepticism because this 00:01:34.950 --> 00:01:37.349 is a world that operates on a completely different 00:01:37.349 --> 00:01:39.870 set of rules than your local neighborhood bank. 00:01:40.170 --> 00:01:42.329 That's what I want to dig into. Because looking 00:01:42.329 --> 00:01:44.510 at our research stack here, and we've got a lot 00:01:44.510 --> 00:01:48.019 from trade group resolution, to, you know, federal 00:01:48.019 --> 00:01:51.340 regulatory history. It feels like a parallel 00:01:51.340 --> 00:01:53.939 universe to traditional banking. That's a perfect 00:01:53.939 --> 00:01:56.079 way to put it. For a long time, it was basically 00:01:56.079 --> 00:01:58.739 a shadow banking system. So what's our mission 00:01:58.739 --> 00:02:01.000 today, then? We've got to decode this whole world. 00:02:01.060 --> 00:02:04.060 If it's not illegal, why the scary name? And 00:02:04.060 --> 00:02:05.700 the big one for me, the thing that just jumped 00:02:05.700 --> 00:02:08.879 off the page. Let me guess. The interest rates. 00:02:09.099 --> 00:02:13.360 The interest rates. Why are smart, rational... 00:02:13.560 --> 00:02:16.599 business people willing to pay double digit interest 00:02:16.599 --> 00:02:19.740 rates for this money. That's the central mystery, 00:02:19.879 --> 00:02:22.979 isn't it? Why pay 12, 13, 14 percent interest 00:02:22.979 --> 00:02:25.879 when a bank is charging, what, 7 percent right 00:02:25.879 --> 00:02:27.780 now? Right. We're going to unravel that. We're 00:02:27.780 --> 00:02:29.919 going to get into the mechanics of risk and collateral. 00:02:30.319 --> 00:02:33.060 But I think the most fascinating piece of this 00:02:33.060 --> 00:02:35.680 puzzle is how the global financial crisis of 00:02:35.680 --> 00:02:39.319 2009. The big one. The big crash inadvertently 00:02:39.319 --> 00:02:42.060 poured gasoline on this entire industry. I love 00:02:42.060 --> 00:02:44.240 when we can trace things back to 08 or 09. It 00:02:44.240 --> 00:02:46.419 really does feel like the big bang of modern 00:02:46.419 --> 00:02:49.039 finance. Every time we peel back a layer on the 00:02:49.039 --> 00:02:51.039 economy, there's a route that goes right back 00:02:51.039 --> 00:02:53.620 to the housing bubble or Dodd -Frank. It completely 00:02:53.620 --> 00:02:55.599 reshaped the plumbing of the global financial 00:02:55.599 --> 00:02:58.039 system. And hard money is one of the things that 00:02:58.039 --> 00:03:02.039 grew very quickly out of the rubble. OK, so let's 00:03:02.039 --> 00:03:03.960 set the vibe for everyone listening. If we're 00:03:03.960 --> 00:03:06.340 not in that rainy back alley, where are we? What's 00:03:06.340 --> 00:03:09.199 the scene? OK. I want you to imagine you're a 00:03:09.199 --> 00:03:12.500 real estate investor, not a homeowner looking 00:03:12.500 --> 00:03:15.520 for a place to raise a family. You're a business 00:03:15.520 --> 00:03:17.599 person. You're driving down a street in your 00:03:17.599 --> 00:03:20.580 city and you see that house. Oh, we all know 00:03:20.580 --> 00:03:23.860 that house. You know the one. The grass is three 00:03:23.860 --> 00:03:26.819 feet tall. There's plywood over a couple of windows. 00:03:27.500 --> 00:03:30.340 Maybe a big tree limb has crashed through the 00:03:30.340 --> 00:03:32.639 porch roof and nobody's moved it for six months. 00:03:32.699 --> 00:03:35.520 It's an eyesore. The neighbors hate it. The city 00:03:35.520 --> 00:03:38.039 has probably slapped a condemnation notice on 00:03:38.039 --> 00:03:40.300 the front door. It's the zombie house. The zombie 00:03:40.300 --> 00:03:42.460 house, exactly. Now most people... They just 00:03:42.460 --> 00:03:44.840 drive past that and they see a disaster, a problem. 00:03:45.379 --> 00:03:48.439 But you, the investor, you stop. You look at 00:03:48.439 --> 00:03:50.400 the bones of the house, the structure. You know 00:03:50.400 --> 00:03:52.259 the neighborhood's getting better. Prices are 00:03:52.259 --> 00:03:54.479 going up. You see potential. You see potential. 00:03:54.819 --> 00:03:56.879 And you do some quick math in your head. You 00:03:56.879 --> 00:03:59.060 think, OK, if I could buy this wreck for, say, 00:03:59.240 --> 00:04:02.900 $100 ,000 and I put $50 ,000 of work into it, 00:04:02.979 --> 00:04:05.680 I bet I could sell it for $250 ,000. OK, I'm 00:04:05.680 --> 00:04:09.050 with you. That's $100 ,000. profit margin just 00:04:09.050 --> 00:04:12.210 sitting there rotting away it's a gold mine disguised 00:04:12.210 --> 00:04:14.930 as a total dump but here's your problem you need 00:04:14.930 --> 00:04:18.110 the cash now why now maybe it's a foreclosure 00:04:18.110 --> 00:04:20.790 auction that's happening on friday or maybe the 00:04:20.790 --> 00:04:22.810 owner is just desperate and they say look the 00:04:22.810 --> 00:04:25.129 first person who shows up with a certified check 00:04:25.129 --> 00:04:29.009 gets the keys so okay simple i go to my bank 00:04:29.009 --> 00:04:32.269 right i walk into the branch with the free lollipops 00:04:32.269 --> 00:04:34.449 and the pens chained to the counter. I sit down 00:04:34.449 --> 00:04:37.350 with the loan officer and I say, Hi, I found 00:04:37.350 --> 00:04:40.670 a fantastic deal. I need $100 ,000 by Friday 00:04:40.670 --> 00:04:43.230 to buy a house with a giant hole in the roof. 00:04:43.410 --> 00:04:45.449 And what do you think that loan officer does? 00:04:45.910 --> 00:04:48.350 They laugh at me. They look at you, they look 00:04:48.350 --> 00:04:49.930 at the picture of the house with the hole in 00:04:49.930 --> 00:04:52.529 the roof, and they very politely ask security 00:04:52.529 --> 00:04:54.649 to show you the door. They won't touch it. No 00:04:54.649 --> 00:04:57.149 way. Yeah. Traditional banks, they generally 00:04:57.149 --> 00:04:59.389 cannot lend on properties that are considered 00:04:59.389 --> 00:05:01.910 uninhabitable. They have these strict checklists. 00:05:01.930 --> 00:05:04.370 The roof has to work. The plumbing has to be 00:05:04.370 --> 00:05:06.670 functional. And even if the house was in perfect 00:05:06.670 --> 00:05:08.970 condition. They're slow. They move at the speed 00:05:08.970 --> 00:05:11.750 of a glacier. You're looking at 45, maybe 60 00:05:11.750 --> 00:05:14.250 days to get a loan approved. And by that time. 00:05:14.600 --> 00:05:16.699 The deal is long gone. Someone else bought it 00:05:16.699 --> 00:05:18.759 for cash a month and a half ago. So you're stuck. 00:05:18.839 --> 00:05:21.000 You found this guaranteed profit, but you can't 00:05:21.000 --> 00:05:23.759 access the capital to actually unlock it. And 00:05:23.759 --> 00:05:26.740 that is the moment hard money walks in the door. 00:05:26.879 --> 00:05:29.519 That is exactly where our story begins. All right, 00:05:29.540 --> 00:05:31.639 let's unpack this. We have to start with the 00:05:31.639 --> 00:05:33.759 definition because I think hard money is one 00:05:33.759 --> 00:05:35.779 of those terms people just throw around. What 00:05:35.779 --> 00:05:39.410 makes the money hard? Is it hard to get? hard 00:05:39.410 --> 00:05:41.269 to pay back. That's a really common misconception. 00:05:41.709 --> 00:05:44.709 People hear hard and they immediately think difficult. 00:05:44.930 --> 00:05:47.930 But in this context, hard actually refers to 00:05:47.930 --> 00:05:51.709 the hard asset. OK, the physical thing, the property. 00:05:51.889 --> 00:05:54.709 Exactly. It is a very specific type of asset 00:05:54.709 --> 00:05:57.350 based lending. And to really get it, you have 00:05:57.350 --> 00:06:00.389 to compare it to how a normal loan works. Think 00:06:00.389 --> 00:06:02.110 about when you got a mortgage for your house 00:06:02.110 --> 00:06:05.009 or even just a credit card. What did the bank 00:06:05.009 --> 00:06:07.290 want from you? Oh, everything. They wanted my 00:06:07.290 --> 00:06:10.269 pay stubs, my W -2s, my tax returns for the last 00:06:10.269 --> 00:06:12.230 two years. They ran my credit score. They probably 00:06:12.230 --> 00:06:14.870 called my boss to make sure I still had a job. 00:06:15.009 --> 00:06:16.750 Right. They were underwriting you. They were 00:06:16.750 --> 00:06:19.569 looking at your soft data, your character, your 00:06:19.569 --> 00:06:21.889 reliability, your income stream. The bank is 00:06:21.889 --> 00:06:24.490 betting on the person. They want to be sure that 00:06:24.490 --> 00:06:27.209 you personally are good for the money. Which 00:06:27.209 --> 00:06:29.029 makes sense. They want to get paid back. Of course. 00:06:29.490 --> 00:06:33.639 But in a hard money loan, the lender is... I 00:06:33.639 --> 00:06:36.160 mean, sometimes almost exclusively looking at 00:06:36.160 --> 00:06:38.319 the thing. The house. The hard asset, the real 00:06:38.319 --> 00:06:41.040 property. So the borrower gets funds that are 00:06:41.040 --> 00:06:43.980 secured by that property. The hard asset is the 00:06:43.980 --> 00:06:46.980 ultimate backstop for the whole deal. So they 00:06:46.980 --> 00:06:48.939 don't really care about me, my credit score and 00:06:48.939 --> 00:06:51.079 all that. They care a little bit. You know, they 00:06:51.079 --> 00:06:52.980 want to know you're not a known fraudster or 00:06:52.980 --> 00:06:55.339 something. But they care mostly about the building. 00:06:55.959 --> 00:06:59.540 Their internal logic is basically this. I don't 00:06:59.540 --> 00:07:01.740 really care if this borrower lost their job last 00:07:01.740 --> 00:07:03.600 month. I don't really care if their credit score 00:07:03.600 --> 00:07:06.579 is a 600. What I care about is if they stop paying 00:07:06.579 --> 00:07:10.139 me, can I take this house, sell it, and get all 00:07:10.139 --> 00:07:12.720 my money back plus profit? So the building itself 00:07:12.720 --> 00:07:16.199 is the cosigner on the loan. The bricks and mortar 00:07:16.199 --> 00:07:18.579 are doing all the heavy lifting in the approval 00:07:18.579 --> 00:07:20.579 process. That is a perfect way to put it. It 00:07:20.579 --> 00:07:24.160 is collateral -centric lending. But, and this 00:07:24.160 --> 00:07:26.610 is the key. Because the lender is relying so 00:07:26.610 --> 00:07:29.870 heavily on the asset and often ignoring those 00:07:29.870 --> 00:07:32.490 soft metrics like a perfect credit score, the 00:07:32.490 --> 00:07:34.649 whole risk profile changes. And because the risk 00:07:34.649 --> 00:07:36.769 is higher. The terms have to look very, very 00:07:36.769 --> 00:07:38.569 different. And this is where we get to the numbers 00:07:38.569 --> 00:07:41.290 that make people's eyes pop. I really want to 00:07:41.290 --> 00:07:43.410 talk about the cost of this money. It is not 00:07:43.410 --> 00:07:46.230 cheap. That's for sure. The sources we have mention 00:07:46.230 --> 00:07:48.089 interest rates starting around, what, 8 % or 00:07:48.089 --> 00:07:50.949 9 % on the absolute low end. Much more commonly 00:07:50.949 --> 00:07:54.029 sitting at 12%, 13%, even 14 % or higher. Yes. 00:07:54.560 --> 00:07:57.199 Double -digit interest is the norm in this industry. 00:07:57.540 --> 00:08:00.079 And then there are points on top of that. Yes, 00:08:00.120 --> 00:08:02.620 points, which are basically origination fees. 00:08:03.139 --> 00:08:05.379 Usually a hard money lender will charge anywhere 00:08:05.379 --> 00:08:08.259 from two to four points right up front, and one 00:08:08.259 --> 00:08:10.920 point is just 1 % of the loan amount. Okay, so 00:08:10.920 --> 00:08:13.319 if I'm borrowing $100 ,000, I might have to pay 00:08:13.319 --> 00:08:16.060 $3 ,000 or $4 ,000 right out of the gate just 00:08:16.060 --> 00:08:18.279 to open the loan. Correct, before you've even 00:08:18.279 --> 00:08:21.540 made your first interest payment. Wow. So you've 00:08:21.540 --> 00:08:25.120 got the 14 % interest. Plus legal fees. Plus 00:08:25.120 --> 00:08:27.639 processing fees, appraisal fees. This sounds, 00:08:27.779 --> 00:08:30.379 I mean, honestly, it sounds extortionate. If 00:08:30.379 --> 00:08:31.819 I'm a business owner, why would I ever agree 00:08:31.819 --> 00:08:33.299 to this? It really sounds like I'm being taken 00:08:33.299 --> 00:08:35.279 advantage of. It does sound that way. But only 00:08:35.279 --> 00:08:37.519 if you're comparing it to, say, a 30 -year home 00:08:37.519 --> 00:08:39.980 mortgage. You have to remember the duration of 00:08:39.980 --> 00:08:41.759 these loans. Right. You're not taking out a hard 00:08:41.759 --> 00:08:43.960 money loan for 30 years. No. God, no. You'd be 00:08:43.960 --> 00:08:47.299 bankrupt. These are incredibly short term. We 00:08:47.299 --> 00:08:51.340 are talking six months, 12 months, maybe 24 months 00:08:51.340 --> 00:08:54.100 on the long end. It's a sprint. It is a sprint. 00:08:54.320 --> 00:08:56.559 It's designed to be a bridge. You get in, you 00:08:56.559 --> 00:08:58.899 use the money to fix the property, you sell it, 00:08:58.960 --> 00:09:02.080 or you refinance into a cheaper long -term loan 00:09:02.080 --> 00:09:05.000 and you get out. You pay that hard money loan 00:09:05.000 --> 00:09:07.500 off as fast as humanly possible. So you're not 00:09:07.500 --> 00:09:10.120 actually paying 14 % interest for a decade. You're 00:09:10.120 --> 00:09:12.379 paying it for maybe six or eight months while 00:09:12.379 --> 00:09:14.559 you do the work. Exactly. You have to think of 00:09:14.559 --> 00:09:17.120 it as a convenience fee for getting access to 00:09:17.120 --> 00:09:19.980 that capital so quickly when no one else would 00:09:19.980 --> 00:09:22.940 give it to you. That's a good frame. Now, I noticed 00:09:22.940 --> 00:09:24.500 something interesting in the research about the 00:09:24.500 --> 00:09:27.039 geography of all this. The sources mentioned 00:09:27.039 --> 00:09:29.879 that this term hard money and this whole style 00:09:29.879 --> 00:09:32.759 of lending, it's almost exclusively a North American 00:09:32.759 --> 00:09:35.220 thing. It is, yeah. You find it almost exclusively 00:09:35.220 --> 00:09:37.580 in the United States and Canada. Why is that? 00:09:37.720 --> 00:09:40.299 Why don't they have hard money lenders in London 00:09:40.299 --> 00:09:43.480 or Paris or Tokyo? I mean... There are private 00:09:43.480 --> 00:09:46.179 lenders everywhere in the world, of course. But 00:09:46.179 --> 00:09:49.120 this specific systematized industry of hard money 00:09:49.120 --> 00:09:51.580 for real estate flipping and distressed assets 00:09:51.580 --> 00:09:54.500 is very much a product of the U .S. and Canadian 00:09:54.500 --> 00:09:57.179 legal and economic ecosystem. And it comes down 00:09:57.179 --> 00:09:59.759 to the laws. It comes down to foreclosure law, 00:09:59.899 --> 00:10:03.029 really. In the U .S., generally speaking, if 00:10:03.029 --> 00:10:05.190 you don't pay your mortgage, the lender has a 00:10:05.190 --> 00:10:08.990 relatively clear, defined, and most importantly, 00:10:09.110 --> 00:10:12.190 fast legal path to take that property back and 00:10:12.190 --> 00:10:14.049 sell it to get their money. So our system is 00:10:14.049 --> 00:10:16.070 pretty lender friendly. It's relatively lender 00:10:16.070 --> 00:10:18.909 friendly, yes. In a lot of European countries, 00:10:19.049 --> 00:10:21.710 for example, tenant protections and borrower 00:10:21.710 --> 00:10:23.830 protections are much, much stronger. It can take 00:10:23.830 --> 00:10:26.769 years, I mean literally years, to foreclose on 00:10:26.769 --> 00:10:29.710 a property. Ah, I see. So if I'm a lender in... 00:10:30.029 --> 00:10:33.590 say, France, I can't really lend based on the 00:10:33.590 --> 00:10:36.289 hard asset because I might never actually be 00:10:36.289 --> 00:10:38.649 able to get my hands on it if the borrower defaults. 00:10:38.669 --> 00:10:40.389 You've got it. If your collateral is going to 00:10:40.389 --> 00:10:42.769 be locked up in legal purgatory for five years, 00:10:42.889 --> 00:10:45.490 your entire asset -based model just completely 00:10:45.490 --> 00:10:48.909 falls apart. The liquidity of the U .S. real 00:10:48.909 --> 00:10:50.870 estate market is what allows this industry to 00:10:50.870 --> 00:10:53.429 even exist. It has a very, I don't know, cowboy 00:10:53.429 --> 00:10:55.750 capitalism feel to it. Like, I need money to 00:10:55.750 --> 00:10:57.970 build this saloon. Here's the deed to my land. 00:10:58.090 --> 00:11:00.299 Now give me the cash. There is a bit of that 00:11:00.299 --> 00:11:03.179 frontier spirit to it, for sure. It's all about 00:11:03.179 --> 00:11:05.779 speed and opportunity, and it's completely separate 00:11:05.779 --> 00:11:09.200 from the slow bureaucratic machinery of traditional 00:11:09.200 --> 00:11:12.080 banking. OK, so we know what it is. It's asset 00:11:12.080 --> 00:11:14.960 based. It's expensive. It's short term. But I 00:11:14.960 --> 00:11:17.580 want to circle back to the why. We use the zombie 00:11:17.580 --> 00:11:19.539 house example, but let's really drill down on. 00:11:20.250 --> 00:11:23.350 the borrower's motivation because paying 14 interest 00:11:23.350 --> 00:11:26.490 plus points still stings it does sting but let's 00:11:26.490 --> 00:11:28.350 look at the alternative if you have that zombie 00:11:28.350 --> 00:11:30.330 house deal the one with the guaranteed hundred 00:11:30.330 --> 00:11:32.850 thousand dollar profit margin and you can't get 00:11:32.850 --> 00:11:34.690 the money from a bank what's your profit it's 00:11:34.690 --> 00:11:37.590 zero i lose the deal right so the choice isn't 00:11:37.590 --> 00:11:40.289 between a cheap loan and an expensive loan the 00:11:40.289 --> 00:11:43.110 choice is between an expensive loan and no loan 00:11:43.110 --> 00:11:46.590 at all so would you rather have a hundred percent 00:11:46.590 --> 00:11:48.950 of zero or would you rather pay a lender say 00:11:49.639 --> 00:11:52.299 $15 ,000 in interest and fees and walk away with 00:11:52.299 --> 00:11:54.820 $85 ,000 in your pocket. When you put it like 00:11:54.820 --> 00:11:56.840 that, it's a no -brainer. It's just a cost of 00:11:56.840 --> 00:11:59.259 doing business. For an investor, it's a line 00:11:59.259 --> 00:12:02.379 item on a spreadsheet. It's like buying lumber 00:12:02.379 --> 00:12:05.379 or drywall. You don't complain that lumber costs 00:12:05.379 --> 00:12:08.059 money. You just need it to build the house. Hard 00:12:08.059 --> 00:12:11.580 money is just another raw material. So the two 00:12:11.580 --> 00:12:14.919 main drivers seem to be speed and flexibility. 00:12:15.820 --> 00:12:17.860 Let's talk about speed first. How much faster 00:12:17.860 --> 00:12:20.159 are we really talking here? We touched on it, 00:12:20.200 --> 00:12:22.950 but it's worth hammering home. A typical bank 00:12:22.950 --> 00:12:26.090 loan is going to take you 45 to 60 days, best 00:12:26.090 --> 00:12:29.090 case scenario. Right. A hard money loan can fund 00:12:29.090 --> 00:12:32.269 in 7 to 10 days. I've seen them close in 48 hours. 00:12:32.570 --> 00:12:35.269 That is lightning fast. It's unbelievable. And 00:12:35.269 --> 00:12:37.450 in a competitive real estate market, that speed 00:12:37.450 --> 00:12:41.029 is currency. If you're bidding against five other 00:12:41.029 --> 00:12:43.490 investors for that same property, being able 00:12:43.490 --> 00:12:45.289 to go to the seller and say, I can close in one 00:12:45.289 --> 00:12:47.610 week all cash because hard money is treated as 00:12:47.610 --> 00:12:49.970 cash, that often gets you a discount on the purchase 00:12:49.970 --> 00:12:52.330 price. Oh, that's a great point. So the speed 00:12:52.330 --> 00:12:54.509 itself can actually save you money on the acquisition. 00:12:54.789 --> 00:12:58.190 Very often, yes. You might end up paying 14 % 00:12:58.190 --> 00:13:00.649 interest, but you got the house for $10 ,000 00:13:00.649 --> 00:13:02.690 less than the other guy because you could close 00:13:02.690 --> 00:13:05.769 in a week. It all balances out in the end. Okay. 00:13:05.850 --> 00:13:07.950 And then there's flexibility. This is the documentation 00:13:07.950 --> 00:13:10.429 part you mentioned. Right. The dreaded checklist. 00:13:10.669 --> 00:13:13.330 Banks live and die by the checklist. And if you're 00:13:13.330 --> 00:13:15.570 self -employed, if you have irregular income, 00:13:15.690 --> 00:13:17.370 if you're a freelancer, if your income comes 00:13:17.370 --> 00:13:21.379 from 10 different projects, banks hate you. I 00:13:21.379 --> 00:13:23.379 feel that on a personal level. A lot of people 00:13:23.379 --> 00:13:26.220 do. You could be making fantastic money, but 00:13:26.220 --> 00:13:29.100 if it doesn't show up neatly on a W -2 form from 00:13:29.100 --> 00:13:31.860 a single employer every two weeks, the bank's 00:13:31.860 --> 00:13:34.580 algorithm just sees you as a huge risk. So how 00:13:34.580 --> 00:13:36.820 are hard money lenders different? They're often 00:13:36.820 --> 00:13:41.379 private individuals or small local funds. They 00:13:41.379 --> 00:13:44.159 can use common sense. They can sit across a table 00:13:44.159 --> 00:13:46.740 from you and say, OK, I see your tax return is 00:13:46.740 --> 00:13:48.759 a mess, but I also see you have a ton of cash 00:13:48.759 --> 00:13:50.860 in the bank and this house you found is a grand 00:13:50.860 --> 00:13:52.879 slam deal. Let's do it. There's no corporate 00:13:52.879 --> 00:13:54.559 headquarters in New York City telling them no. 00:13:54.679 --> 00:13:56.919 Exactly. They can underwrite the story of the 00:13:56.919 --> 00:13:59.159 deal, not just the borrower's HICO score. Now, 00:13:59.200 --> 00:14:01.820 I want to clarify something here because the 00:14:01.820 --> 00:14:05.450 research brings up bridge loans constantly. And 00:14:05.450 --> 00:14:07.690 it feels like people use these terms, hard money 00:14:07.690 --> 00:14:10.509 and bridge loan, interchangeably. Are they the 00:14:10.509 --> 00:14:12.870 same thing? They are cousins, very close cousins, 00:14:12.970 --> 00:14:15.789 maybe even siblings. They share a ton of DNA. 00:14:16.190 --> 00:14:19.350 A hard money loan is very similar to a bridge 00:14:19.350 --> 00:14:22.090 loan in terms of the lending criteria and the 00:14:22.090 --> 00:14:25.570 costs to the borrower. Are both short term, asset 00:14:25.570 --> 00:14:29.639 based. Higher interest. Correct. But there is 00:14:29.639 --> 00:14:32.279 a bit of a nuance, a vibe shift, if you will. 00:14:32.379 --> 00:14:35.159 A vibe shift. Yeah. A bridge loan usually sounds 00:14:35.159 --> 00:14:38.860 a bit more. polished, a little more corporate. 00:14:39.379 --> 00:14:42.320 It often refers to a commercial property or an 00:14:42.320 --> 00:14:44.019 investment property that's just in a state of 00:14:44.019 --> 00:14:45.899 transition. OK, give me an example of that. Let's 00:14:45.899 --> 00:14:47.759 say you buy a small apartment building. It's 00:14:47.759 --> 00:14:49.679 in decent shape, but it's only 50 percent full 00:14:49.679 --> 00:14:52.100 because the last owner was lazy and didn't market 00:14:52.100 --> 00:14:54.740 the empty units. Right. A regular bank won't 00:14:54.740 --> 00:14:56.759 give you a standard commercial loan on that building 00:14:56.759 --> 00:14:58.799 because the income isn't high enough yet. It 00:14:58.799 --> 00:15:00.700 doesn't cash flow properly. So you're stuck. 00:15:00.860 --> 00:15:03.169 You need a bridge. You get a bridge loan for 00:15:03.169 --> 00:15:06.450 12 or 18 months. You use that money to do some 00:15:06.450 --> 00:15:08.789 light renovations on the empty units. You hire 00:15:08.789 --> 00:15:11.429 a leasing agent. You get the building to 95 percent 00:15:11.429 --> 00:15:14.470 occupancy. Now the building is stabilized and 00:15:14.470 --> 00:15:16.809 making great money. And then you go to the bank. 00:15:16.970 --> 00:15:18.870 Then you go to a regular bank. You get a cheap 00:15:18.870 --> 00:15:21.370 30 year loan and you use that to pay off the 00:15:21.370 --> 00:15:24.269 expensive bridge loan. You've successfully bridged 00:15:24.269 --> 00:15:27.129 the gap from instability to stability. That makes 00:15:27.129 --> 00:15:29.710 perfect sense. Bridge loans are for properties 00:15:29.710 --> 00:15:31.940 in transition. Yeah. So what makes hard money 00:15:31.940 --> 00:15:35.059 different? What's its vibe? The distress factor. 00:15:35.399 --> 00:15:38.360 Hard money, as a term, often implies a situation 00:15:38.360 --> 00:15:41.419 that is a little more dire, a little grittier. 00:15:41.580 --> 00:15:44.139 OK, here comes the drama. This is where we get 00:15:44.139 --> 00:15:46.620 into the historical roots of the industry. Hard 00:15:46.620 --> 00:15:49.279 money isn't just an asset -based loan for a simple 00:15:49.279 --> 00:15:52.000 transition. It often involves a distressed financial 00:15:52.000 --> 00:15:55.159 situation. Like what? Like being in arrears on 00:15:55.159 --> 00:15:57.500 an existing mortgage. So the borrower is already 00:15:57.500 --> 00:15:59.659 behind on their payments to another bank. Exactly. 00:16:00.220 --> 00:16:02.200 Or they're in the middle of bankruptcy proceedings. 00:16:02.399 --> 00:16:05.460 Or, most commonly, they are facing active foreclosure 00:16:05.460 --> 00:16:09.100 proceedings. Wow. Okay, so if I'm in foreclosure, 00:16:09.240 --> 00:16:12.120 a traditional bank won't touch me with a 50 -foot 00:16:12.120 --> 00:16:14.820 pole. They will run in the other direction. A 00:16:14.820 --> 00:16:16.919 traditional bank sees a foreclosure notice, and 00:16:16.919 --> 00:16:19.639 they see a four -alarm fire. A hard money lender 00:16:19.639 --> 00:16:22.799 sees a foreclosure notice, and they see equity. 00:16:23.259 --> 00:16:25.399 Explain that. How do they see equity in a disaster? 00:16:25.799 --> 00:16:28.200 Okay, let's say you own a building that's worth 00:16:28.200 --> 00:16:30.750 a million dollars. but you fell on hard times, 00:16:30.809 --> 00:16:33.529 lost a big client, whatever. You owe the bank 00:16:33.529 --> 00:16:36.870 $400 ,000 on your mortgage, and you haven't been 00:16:36.870 --> 00:16:39.269 able to make a payment in six months? The bank 00:16:39.269 --> 00:16:41.330 is about to foreclose and option it off on the 00:16:41.330 --> 00:16:43.610 courthouse steps. You're about to lose everything. 00:16:43.850 --> 00:16:46.429 A nightmare scenario. Right. A hard money lender 00:16:46.429 --> 00:16:48.710 looks at that exact same situation and says, 00:16:48.750 --> 00:16:51.970 wait a minute. You owe the bank $400 ,000, but 00:16:51.970 --> 00:16:54.450 the building is worth a million. There is $600 00:16:54.450 --> 00:16:57.330 ,000 of equity trapped in that property. That's 00:16:57.330 --> 00:16:59.690 real tangible value. It's real money. So the 00:16:59.690 --> 00:17:01.250 hard money lender comes to you and says, look, 00:17:01.389 --> 00:17:05.410 I will lend you $450 ,000. We'll use $400 ,000 00:17:05.410 --> 00:17:07.349 to pay off the bank immediately and stop the 00:17:07.349 --> 00:17:09.930 foreclosure. You'll have $50 ,000 left over to 00:17:09.930 --> 00:17:11.769 make some repairs, clean the place up, and sell 00:17:11.769 --> 00:17:14.089 it properly on the open market. So they act as 00:17:14.089 --> 00:17:16.150 a lifeline. A very, very expensive lifeline. 00:17:16.210 --> 00:17:18.869 But yes, the industry really developed historically 00:17:18.869 --> 00:17:22.089 as exactly that, a lender of last resort for 00:17:22.089 --> 00:17:24.410 property owners who needed to access their equity 00:17:24.410 --> 00:17:26.710 when all the traditional doors were slammed in 00:17:26.710 --> 00:17:29.089 their face. So if I'm hearing this right, the 00:17:29.089 --> 00:17:32.130 hard money lender's pitch is basically, I see 00:17:32.130 --> 00:17:35.230 you're in a tough spot, but I also see you have 00:17:35.230 --> 00:17:37.710 a valuable asset. I'll give you the cash you 00:17:37.710 --> 00:17:40.690 need, but the deal is, if you don't pay me back 00:17:40.690 --> 00:17:44.069 on my terms, I'm taking that asset. That is the 00:17:44.069 --> 00:17:46.690 fundamental tradeoff. And that brings us perfectly 00:17:46.690 --> 00:17:48.789 to the mechanics of how they protect themselves. 00:17:49.150 --> 00:17:51.410 Because if your business model is lending to 00:17:51.410 --> 00:17:54.390 people in bankruptcy or in foreclosure or to 00:17:54.390 --> 00:17:56.809 flippers who are taking on risky gut renovations, 00:17:56.869 --> 00:17:58.670 how do you make sure you don't lose your shirt 00:17:58.670 --> 00:18:01.329 every other deal? Right. If the borrower is inherently 00:18:01.329 --> 00:18:04.329 risky, the lender must have a massive safety 00:18:04.329 --> 00:18:07.099 net built in. They do. And it's a three letter 00:18:07.099 --> 00:18:10.119 acronym. LTV, the loan to value ratio. This is 00:18:10.119 --> 00:18:12.140 the golden ratio, the holy grail of the hard 00:18:12.140 --> 00:18:15.019 money world. OK, let's break down LTV. It sounds 00:18:15.019 --> 00:18:17.119 like something from a math class, but I have 00:18:17.119 --> 00:18:18.900 a feeling this is where the rubber really meets 00:18:18.900 --> 00:18:21.279 the road on these deals. It's the only number 00:18:21.279 --> 00:18:23.680 that truly matters in the end. And the formula 00:18:23.680 --> 00:18:26.400 is super simple. It's just the loan amount divided 00:18:26.400 --> 00:18:28.420 by the value of the property. Simple enough. 00:18:28.660 --> 00:18:32.450 But. Here is the kicker. A traditional bank on 00:18:32.450 --> 00:18:35.910 a primary residence might lend you 80, 90, sometimes 00:18:35.910 --> 00:18:39.150 even 95 percent of a home's value. Right. I just 00:18:39.150 --> 00:18:41.569 have to put down 5 or 10 percent and the bank 00:18:41.569 --> 00:18:43.609 covers the entire rest of it. In the hard money 00:18:43.609 --> 00:18:46.710 world, that never, ever happens. There is no 00:18:46.710 --> 00:18:49.589 such thing as 100 percent LTV or even 90 percent. 00:18:49.910 --> 00:18:52.650 Most hard money lenders will cap their LTV at 00:18:52.650 --> 00:18:54.930 around 65 percent of the property's current value. 00:18:55.150 --> 00:18:58.430 65. That's a massive buffer. It is an enormous 00:18:58.430 --> 00:19:00.819 cushion. And it's completely intentional. If 00:19:00.819 --> 00:19:03.980 a property is worth $100 ,000 today, the absolute 00:19:03.980 --> 00:19:06.259 most a hard money lender will give you is $65 00:19:06.259 --> 00:19:09.460 ,000. So where does the other $35 ,000 come from? 00:19:09.900 --> 00:19:11.880 For the purchase. That comes from you. That's 00:19:11.880 --> 00:19:13.440 the borrower's contribution. You have to have 00:19:13.440 --> 00:19:16.079 significant skin in the game. Skin in the game. 00:19:16.279 --> 00:19:18.859 These loans are for professional investors, and 00:19:18.859 --> 00:19:21.059 the lenders will always require a much higher 00:19:21.059 --> 00:19:23.799 down payment or for you to already have a lot 00:19:23.799 --> 00:19:26.140 of existing equity. They want to know that if 00:19:26.140 --> 00:19:28.259 you decide to just walk away from the project, 00:19:28.539 --> 00:19:30.660 you are leaving a big chunk of your own money 00:19:30.660 --> 00:19:32.799 on the table. That makes a lot of sense. It keeps 00:19:32.799 --> 00:19:35.019 the borrower motivated to actually see the project 00:19:35.019 --> 00:19:38.289 through to the end. If I have $35 ,000 of my 00:19:38.289 --> 00:19:40.829 own cash tied up in a deal, I'm not going to 00:19:40.829 --> 00:19:42.509 just disappear. You're going to answer your phone 00:19:42.509 --> 00:19:44.809 when the lender calls. But it also protects the 00:19:44.809 --> 00:19:48.410 lender in the absolute worst case scenario. Which 00:19:48.410 --> 00:19:50.670 is foreclosure. Right. So let's say you default 00:19:50.670 --> 00:19:52.890 on that loan. The lender has to take the house 00:19:52.890 --> 00:19:54.890 back. Now they own a house that's worth $100 00:19:54.890 --> 00:19:58.109 ,000, but they only have a $65 ,000 loan on it. 00:19:58.170 --> 00:20:00.210 Even if the real estate market suddenly crashes 00:20:00.210 --> 00:20:02.829 and the value of that house drops to $80 ,000. 00:20:02.930 --> 00:20:06.079 They can still sell it for $80 ,000. pay off 00:20:06.079 --> 00:20:09.359 their $65 ,000 loan, and still walk away with 00:20:09.359 --> 00:20:11.680 a profit after covering legal fees. Exactly. 00:20:11.880 --> 00:20:15.660 That low LTV is designed to absorb market volatility, 00:20:15.980 --> 00:20:19.380 holding costs, and the legal expenses of a foreclosure. 00:20:19.480 --> 00:20:21.599 It's a huge margin of safety. Now, this brings 00:20:21.599 --> 00:20:23.940 up a really technical but important point that 00:20:23.940 --> 00:20:25.660 came up in the listener feedback in the research. 00:20:26.299 --> 00:20:29.289 Value is a subjective thing. If I'm flipping 00:20:29.289 --> 00:20:31.269 a house, there are really two values, aren't 00:20:31.269 --> 00:20:33.349 there? There's what the house is worth now in 00:20:33.349 --> 00:20:35.490 its dumpy condition and what it's going to be 00:20:35.490 --> 00:20:38.869 worth after I fix it up. Yes. And that is the 00:20:38.869 --> 00:20:40.910 critical distinction between the as -is value 00:20:40.910 --> 00:20:44.589 and the ARV, which stands for after -retire value. 00:20:44.849 --> 00:20:47.230 This seems absolutely crucial. Which one of those 00:20:47.230 --> 00:20:49.569 values do they lend on? It really depends on 00:20:49.569 --> 00:20:51.529 the specific lender and the deal. But this is 00:20:51.529 --> 00:20:53.630 where the industry has gotten a lot more sophisticated 00:20:53.630 --> 00:20:57.109 over the years. Many of the best hard money lenders 00:20:57.109 --> 00:21:00.490 will actually lend based on the ARV, the future 00:21:00.490 --> 00:21:02.309 value. Wait a minute. That sounds incredibly 00:21:02.309 --> 00:21:04.829 risky. They're lending you money based on a value 00:21:04.829 --> 00:21:06.990 that doesn't even exist yet. It sounds risky, 00:21:07.089 --> 00:21:09.130 but they control the process very, very carefully. 00:21:09.740 --> 00:21:12.319 Let's go back to our zombie house example. Purchase 00:21:12.319 --> 00:21:15.380 price is $100. The renovation budget is $50. 00:21:15.779 --> 00:21:19.359 The future value, the ARV, is $250 ,000. Got 00:21:19.359 --> 00:21:21.440 it. A lender might come in and say, okay, our 00:21:21.440 --> 00:21:25.039 rule is we'll lend you 70 % of the ARV. So 70 00:21:25.039 --> 00:21:30.160 % of $250 ,000 is $175 ,000. Wow. Okay. That's 00:21:30.160 --> 00:21:32.059 enough to cover the entire purchase price and 00:21:32.059 --> 00:21:35.240 the renovation costs. It is. But, and this is 00:21:35.240 --> 00:21:38.059 a very, very big but, they do not just hand you 00:21:38.059 --> 00:21:41.140 a check for $175 ,000 and say, good luck, hope 00:21:41.140 --> 00:21:43.660 you actually fix the house. So what do they do? 00:21:43.720 --> 00:21:45.400 How do they manage that? They'll give you the 00:21:45.400 --> 00:21:48.200 money to buy the house, so the $100 ,000, but 00:21:48.200 --> 00:21:50.519 they hold the renovation money, the other $75 00:21:50.519 --> 00:21:52.819 ,000 in this case, in a separate escrow account. 00:21:53.329 --> 00:21:55.890 And they only release it to you in stages, which 00:21:55.890 --> 00:21:59.490 are called draws. Draws? Yes. So you go out and 00:21:59.490 --> 00:22:01.529 you fix the roof. Then you call the lender. The 00:22:01.529 --> 00:22:03.670 lender sends an inspector to the property to 00:22:03.670 --> 00:22:06.029 verify that, yes, a new roof has been installed 00:22:06.029 --> 00:22:08.670 and the work is done correctly. Then they release 00:22:08.670 --> 00:22:10.950 the money to you for the roof. Then you do the 00:22:10.950 --> 00:22:14.069 kitchen. They inspect. They pay you for the kitchen. 00:22:14.529 --> 00:22:16.589 I see. So they're drip feeding you the renovation 00:22:16.589 --> 00:22:19.470 money to ensure that the value is actually being 00:22:19.470 --> 00:22:21.630 added to the property step by step. Precisely. 00:22:22.000 --> 00:22:24.180 They are managing their risk throughout the entire 00:22:24.180 --> 00:22:27.160 construction process. Their LTV is always protected 00:22:27.160 --> 00:22:29.839 because the loan amount never gets too far ahead 00:22:29.839 --> 00:22:32.700 of the actual current value of the house. That 00:22:32.700 --> 00:22:35.099 is incredibly structured. It's so much more than 00:22:35.099 --> 00:22:37.319 just, here's a bag of cash, see you in six months. 00:22:37.400 --> 00:22:40.940 Oh, no. It is a very, very tightly managed process. 00:22:41.160 --> 00:22:44.039 And speaking of value, they're also very specific 00:22:44.039 --> 00:22:46.099 about how they determine it in the first place. 00:22:46.299 --> 00:22:48.339 They don't just take your word that the house 00:22:48.339 --> 00:22:51.799 will be worth $250 ,000. Right. The notes mention 00:22:51.799 --> 00:22:54.599 something called liquidation value. That sounds 00:22:54.599 --> 00:22:57.740 ominous again. It sounds ominous, but it's just 00:22:57.740 --> 00:23:00.420 realistic. They aren't interested in what the 00:23:00.420 --> 00:23:02.660 property might sell for in a perfect market with 00:23:02.660 --> 00:23:05.759 six months of marketing, professional staging 00:23:05.759 --> 00:23:08.000 and, you know, fresh baked cookies in the oven 00:23:08.000 --> 00:23:10.480 for every showing. They're interested in the 00:23:10.480 --> 00:23:12.819 fire sale price. They're interested in what they 00:23:12.819 --> 00:23:15.059 can sell it for quickly if things go horribly 00:23:15.059 --> 00:23:17.079 wrong and they have to take it back. So how do 00:23:17.079 --> 00:23:19.160 they figure out that number? It can't just be 00:23:19.160 --> 00:23:22.319 a guess. No, it's all data driven. They use a 00:23:22.319 --> 00:23:25.480 few common methods. One is a BPO, which is a 00:23:25.480 --> 00:23:27.759 broker price opinion. What's that? It's kind 00:23:27.759 --> 00:23:29.720 of like an appraisal light. They pay a local 00:23:29.720 --> 00:23:32.259 real estate agent a small fee to drive by the 00:23:32.259 --> 00:23:35.400 property, look at the condition, pull some recent 00:23:35.400 --> 00:23:37.339 comparable sales in the neighborhood and give 00:23:37.339 --> 00:23:39.339 a quick professional opinion of what it would 00:23:39.339 --> 00:23:41.359 sell for. And it's faster than a full appraisal, 00:23:41.359 --> 00:23:43.920 I assume. Much faster and cheaper. A full appraisal 00:23:43.920 --> 00:23:47.099 can take weeks. A BPO can be done in 48 hours. 00:23:47.200 --> 00:23:50.480 Again, speed is the name of the game. Or for 00:23:50.480 --> 00:23:53.200 a more complex deal, they'll order a full independent 00:23:53.200 --> 00:23:55.900 appraisal done by a licensed appraiser in that 00:23:55.900 --> 00:23:58.789 state. But the instruction is always. Give me 00:23:58.789 --> 00:24:01.890 the value for a quick sale, 30 to 60 days on 00:24:01.890 --> 00:24:04.130 market. So we have the mechanics down. It's a 00:24:04.130 --> 00:24:08.029 low LTV, high interest, short term loan, often 00:24:08.029 --> 00:24:10.430 with escrowed renovation funds. It's a machine. 00:24:10.630 --> 00:24:12.930 It's a machine designed to monetize risk in a 00:24:12.930 --> 00:24:15.369 very specific way. But where did this machine 00:24:15.369 --> 00:24:17.809 even come from? Was there like a specific moment 00:24:17.809 --> 00:24:20.230 in history where someone woke up and said, I'm 00:24:20.230 --> 00:24:21.690 going to start a hard money lending company? 00:24:21.910 --> 00:24:24.049 We can trace the origins of the modern industry 00:24:24.049 --> 00:24:29.200 back to the late 1950s. The 50s. That seems counterintuitive. 00:24:29.559 --> 00:24:32.160 I always think of the 50s as this golden age 00:24:32.160 --> 00:24:34.720 of traditional banking. You get a free toaster 00:24:34.720 --> 00:24:36.759 when you open a savings account. It was, but 00:24:36.759 --> 00:24:39.319 the credit industry in the U .S. was also undergoing 00:24:39.319 --> 00:24:42.599 some really drastic changes. As the post -war 00:24:42.599 --> 00:24:44.799 economy boomed and real estate development took 00:24:44.799 --> 00:24:48.220 off, there was this huge demand for capital that 00:24:48.220 --> 00:24:50.900 the traditional, very conservative banks just 00:24:50.900 --> 00:24:53.779 weren't meeting. The last resort option that 00:24:53.779 --> 00:24:56.400 we talked about earlier. Exactly. It really started 00:24:56.400 --> 00:25:00.299 out as private, wealthy individuals. You know, 00:25:00.299 --> 00:25:02.759 doctors, lawyers, successful business owners 00:25:02.759 --> 00:25:05.980 lending their own excess cash to local developers 00:25:05.980 --> 00:25:08.880 they knew. It was very informal. A lot of handshake 00:25:08.880 --> 00:25:11.200 deals. The guys in the trench coats. Maybe not 00:25:11.200 --> 00:25:12.819 trench coats, but definitely guys at the country 00:25:12.819 --> 00:25:15.460 club and in cigar bars. But if we fast forward 00:25:15.460 --> 00:25:18.299 to today, the industry is having a bit of an 00:25:18.299 --> 00:25:21.640 identity crisis. An identity crisis. How so? 00:25:21.880 --> 00:25:23.779 Well, remember how we started this whole deep 00:25:23.779 --> 00:25:25.740 dive saying hard money sounds like something 00:25:25.740 --> 00:25:28.380 out of a crime film? Yeah, the broken kneecaps? 00:25:28.539 --> 00:25:30.339 Well, the industry has finally realized that, 00:25:30.420 --> 00:25:32.779 too, and they really don't like it. They want 00:25:32.779 --> 00:25:36.119 a makeover. They want a full rebrand. The consensus 00:25:36.119 --> 00:25:38.220 in the industry over the last few years is that 00:25:38.220 --> 00:25:41.539 the term hard money just doesn't accurately describe 00:25:41.539 --> 00:25:44.640 the direction, the structure, or the attitude 00:25:44.640 --> 00:25:47.440 of the profession anymore. It sounds rough. It 00:25:47.440 --> 00:25:49.579 sounds predatory. It sounds unsophisticated. 00:25:50.039 --> 00:25:51.839 So what do they want to be called instead? Soft 00:25:51.839 --> 00:25:56.319 money? Fluffy money? Laughs. Not quite. In March 00:25:56.319 --> 00:25:59.359 of 2022, the National Private Lenders Association, 00:25:59.779 --> 00:26:02.299 the MPLA, they passed an official resolution. 00:26:02.700 --> 00:26:05.160 An official resolution. That sounds very serious, 00:26:05.180 --> 00:26:07.960 like something the UN would do. It was very serious 00:26:07.960 --> 00:26:10.839 for them. The resolution encouraged all industry 00:26:10.839 --> 00:26:13.279 participants to completely drop the term hard 00:26:13.279 --> 00:26:15.619 money. And replace it with what? They suggested 00:26:15.619 --> 00:26:18.470 alternatives like private lending. bridge lending 00:26:18.470 --> 00:26:21.490 or my personal favorite transitional lending 00:26:21.490 --> 00:26:23.690 transitional lending yeah that sounds so much 00:26:23.690 --> 00:26:25.710 more professional very corporate it sounds like 00:26:25.710 --> 00:26:27.230 something you'd discuss in a glass conference 00:26:27.230 --> 00:26:30.069 room not a back alley It does. And the other 00:26:30.069 --> 00:26:32.609 big trade group, the American Association of 00:26:32.609 --> 00:26:35.849 Private Lenders, the AAPL. Not the phone company. 00:26:36.049 --> 00:26:38.349 No, not the phone company. They published this 00:26:38.349 --> 00:26:41.289 big article called The Demise of Hard Money in 00:26:41.289 --> 00:26:45.309 a Private Lending World. Their entire 2021 national 00:26:45.309 --> 00:26:48.650 conference was basically focused on this exact 00:26:48.650 --> 00:26:51.769 terminology shift. It's fascinating, isn't it? 00:26:51.809 --> 00:26:53.349 They're trying to gentrify the name of their 00:26:53.349 --> 00:26:55.529 own industry. That's a great way to put it. As 00:26:55.529 --> 00:26:57.970 the industry has matured, institutional cap... 00:26:57.960 --> 00:27:00.099 We're talking Wall Street money, hedge funds, 00:27:00.279 --> 00:27:02.900 pension funds has started pouring into the space. 00:27:03.039 --> 00:27:05.640 And you can't go to a pension funds board and 00:27:05.640 --> 00:27:07.960 pitch them on investing in a hard money fund. 00:27:08.160 --> 00:27:10.460 It just sounds too risky. But if you pitch them 00:27:10.460 --> 00:27:14.400 on a private credit fund or a transitional asset 00:27:14.400 --> 00:27:16.779 based lending strategy. Now, that sounds like 00:27:16.779 --> 00:27:19.420 a smart, sophisticated portfolio diversification. 00:27:19.700 --> 00:27:22.460 But here's the real question. Does changing the 00:27:22.460 --> 00:27:25.160 name. actually change the reality of the deal? 00:27:25.299 --> 00:27:28.119 No, not at all. It's still 14 % interest, right? 00:27:28.220 --> 00:27:31.240 In most cases, yes. It's still a 65 % LTV. Yes. 00:27:31.440 --> 00:27:34.279 And it's still ultimately based on the liquidation 00:27:34.279 --> 00:27:37.440 value of the asset if the borrower defaults. 00:27:37.660 --> 00:27:40.240 Absolutely. You can put a new, fancier wrapper 00:27:40.240 --> 00:27:42.740 on the candy bar, but the candy inside is exactly 00:27:42.740 --> 00:27:46.259 the same. It is high cost, high risk, asset -based 00:27:46.259 --> 00:27:48.619 capital. So speaking of the rules of this game. 00:27:49.390 --> 00:27:51.849 How regulated is this industry? Is it the Wild 00:27:51.849 --> 00:27:54.009 West or are there sheriffs watching over it? 00:27:54.069 --> 00:27:56.869 It's a mix. But generally speaking, the field 00:27:56.869 --> 00:27:59.589 has always been formally unregulated by state 00:27:59.589 --> 00:28:02.069 or federal laws in terms of its general operation. 00:28:02.309 --> 00:28:04.390 Formally unregulated. That's one of those phrases 00:28:04.390 --> 00:28:05.930 that always makes me a little nervous. Right. 00:28:06.029 --> 00:28:08.789 It means there isn't a federal hard money commission 00:28:08.789 --> 00:28:12.460 that's overseeing every single deal. A private 00:28:12.460 --> 00:28:14.759 lender doesn't have the same kind of direct oversight 00:28:14.759 --> 00:28:17.519 as, say, Bank of America. But that doesn't mean 00:28:17.519 --> 00:28:20.119 there are no rules. Not at all. The biggest catch, 00:28:20.359 --> 00:28:22.420 the biggest regulation they all have to follow 00:28:22.420 --> 00:28:25.660 is usury laws. Usury laws. That's a term you 00:28:25.660 --> 00:28:28.380 don't hear every day. That's like biblical. It 00:28:28.380 --> 00:28:30.819 is. It's an old concept, but it basically just 00:28:30.819 --> 00:28:32.819 means that there are legal limits on how much 00:28:32.819 --> 00:28:35.539 interest a lender can charge on a loan. And these 00:28:35.539 --> 00:28:37.940 limits are set by state governments. So a lender 00:28:37.940 --> 00:28:40.099 can't just decide to charge 50 percent interest. 00:28:40.599 --> 00:28:43.240 because they feel like it. In most states, no. 00:28:43.680 --> 00:28:46.380 And this creates this really interesting patchwork 00:28:46.380 --> 00:28:49.259 landscape across the country. For example, the 00:28:49.259 --> 00:28:51.519 sources we looked at mentioned that lending operations 00:28:51.519 --> 00:28:54.779 in states like Tennessee and Arkansas are described 00:28:54.779 --> 00:28:58.160 as virtually untenable for these firms. Really? 00:28:58.200 --> 00:29:00.839 Why those states specifically? It all comes down 00:29:00.839 --> 00:29:04.529 to the math of their state usury laws. In Arkansas, 00:29:04.630 --> 00:29:07.089 for example, the maximum interest rate you can 00:29:07.089 --> 00:29:09.569 charge is tied to the federal discount rate plus 00:29:09.569 --> 00:29:12.230 a certain percentage, often 5 percent. OK. So 00:29:12.230 --> 00:29:14.789 if the federal rate is really low, the legal 00:29:14.789 --> 00:29:17.029 maximum interest rate in Arkansas might be capped 00:29:17.029 --> 00:29:19.349 at, say, 10 or 11 percent. But the whole business 00:29:19.349 --> 00:29:21.650 model for hard money requires them to charge 00:29:21.650 --> 00:29:25.230 12, 13, 14 percent to cover their risk and make 00:29:25.230 --> 00:29:27.750 a profit. You've got it. If the state law says 00:29:27.750 --> 00:29:30.150 you can only charge 10 percent, but your business 00:29:30.150 --> 00:29:32.609 model requires 13 percent to even break even. 00:29:33.230 --> 00:29:35.390 simply cannot do business in that state you have 00:29:35.390 --> 00:29:37.730 to close up shop and go elsewhere so there are 00:29:37.730 --> 00:29:40.190 literally hard money deserts in the united states 00:29:40.190 --> 00:29:42.369 places where you can't get these loans yeah purely 00:29:42.369 --> 00:29:46.240 because of old state laws yes The geography of 00:29:46.240 --> 00:29:48.440 the industry is heavily dictated by these old 00:29:48.440 --> 00:29:51.720 interest rate laws. But the biggest shift, the 00:29:51.720 --> 00:29:54.819 one event that truly caused this industry to 00:29:54.819 --> 00:29:57.799 explode in modern times, wasn't a state law. 00:29:57.980 --> 00:30:02.160 It was the direct aftermath of the 2009 mortgage 00:30:02.160 --> 00:30:05.900 crisis. And there it is. The aha moment of the 00:30:05.900 --> 00:30:08.700 episode. It always comes back to 2009. It has 00:30:08.700 --> 00:30:11.779 to because the hard money or private lending 00:30:11.779 --> 00:30:14.680 mortgage market has expanded exponentially since 00:30:14.680 --> 00:30:16.759 the passing of the Dodd -Frank Act. OK, Dodd 00:30:16.759 --> 00:30:18.180 -Frank. We hear that name all the time. It was 00:30:18.180 --> 00:30:20.480 the massive piece of legislation that was the 00:30:20.480 --> 00:30:22.380 government's big response to the banks crashing 00:30:22.380 --> 00:30:25.079 the economy. Right. And its main goal was to 00:30:25.079 --> 00:30:27.279 stop banks from ever making those kinds of terrible 00:30:27.279 --> 00:30:29.720 loans again. Part of that response was a major 00:30:29.720 --> 00:30:32.890 update to the Truth in Lending Act or TILA. Sounds 00:30:32.890 --> 00:30:35.009 deadly enough. Truth in lending. It introduced 00:30:35.009 --> 00:30:37.630 a very powerful new rule called the ability to 00:30:37.630 --> 00:30:41.210 repay rule or ATR. Ability to repay. Yeah. That 00:30:41.210 --> 00:30:43.450 just sounds like basic common sense. You shouldn't 00:30:43.450 --> 00:30:45.309 lend money to people who can't possibly pay it 00:30:45.309 --> 00:30:48.390 back. In theory, yes, it's common sense. But 00:30:48.390 --> 00:30:50.569 in practice, it meant that mortgage originators 00:30:50.569 --> 00:30:53.250 were now legally required to rigorously evaluate 00:30:53.250 --> 00:30:56.029 and document a borrower's ability to repay a 00:30:56.029 --> 00:30:59.589 loan, specifically on primary residences. They 00:30:59.589 --> 00:31:01.569 have to document income, assets, employment, 00:31:01.869 --> 00:31:05.130 every little detail. No more NNG loans, no income, 00:31:05.289 --> 00:31:07.829 no job, no assets. Those were gone overnight. 00:31:08.049 --> 00:31:10.589 And here is the real kicker. Under Dodd -Frank, 00:31:11.259 --> 00:31:13.859 If a bank makes you a loan and you default and 00:31:13.859 --> 00:31:15.720 it turns out they didn't document your income 00:31:15.720 --> 00:31:18.299 perfectly according to the new rules, the bank 00:31:18.299 --> 00:31:21.500 can face enormous federal fines. The borrower 00:31:21.500 --> 00:31:23.720 can even sue the bank to stop the foreclosure. 00:31:23.819 --> 00:31:25.940 So the banks got scared. They got absolutely 00:31:25.940 --> 00:31:28.880 petrified. Overnight, they stopped lending to 00:31:28.880 --> 00:31:31.140 anyone who didn't fit into a perfect, easy to 00:31:31.140 --> 00:31:33.680 document box. If you were self -employed, suddenly 00:31:33.680 --> 00:31:35.619 you were too risky. If your income was irregular 00:31:35.619 --> 00:31:38.660 or commission -based, too risky. If you were 00:31:38.660 --> 00:31:40.559 a real estate investor with a complicated tax 00:31:40.559 --> 00:31:43.000 return showing lots of deductions, the bank just 00:31:43.000 --> 00:31:45.359 said no. It wasn't worth the potential legal 00:31:45.359 --> 00:31:47.319 risk of a federal fund. And that created a vacuum. 00:31:47.690 --> 00:31:51.650 A massive gaping vacuum. Suddenly, millions of 00:31:51.650 --> 00:31:54.430 people, legitimate business people, investors, 00:31:54.609 --> 00:31:57.250 entrepreneurs with good credit and real assets 00:31:57.250 --> 00:31:59.869 found themselves completely locked out of the 00:31:59.869 --> 00:32:02.029 traditional banking system. And the hard money 00:32:02.029 --> 00:32:04.309 lenders stepped in to fill that void. They did. 00:32:04.529 --> 00:32:07.309 But... and this is the most crucial part of the 00:32:07.309 --> 00:32:10.049 modern industry, they did it by avoiding the 00:32:10.049 --> 00:32:12.609 primary residence market entirely. How did they 00:32:12.609 --> 00:32:15.109 do that? They made a very strategic shift to 00:32:15.109 --> 00:32:18.710 focus specifically on business purpose or commercial 00:32:18.710 --> 00:32:20.730 loans. Okay, explain the difference. Why did 00:32:20.730 --> 00:32:23.109 that matter? Dodd -Frank and TILA and all those 00:32:23.109 --> 00:32:25.809 ability to repay rules are designed to protect 00:32:25.809 --> 00:32:28.710 consumers. They exist to protect the family buying 00:32:28.710 --> 00:32:31.150 a house to live in. Okay, that makes sense. But 00:32:31.150 --> 00:32:34.950 if you're an LLC buying a house specifically... 00:32:35.019 --> 00:32:37.380 renovate and flip for a profit, you are considered 00:32:37.380 --> 00:32:39.819 a commercial entity. You are a sophisticated 00:32:39.819 --> 00:32:43.059 borrower. The government basically assumes you're 00:32:43.059 --> 00:32:44.839 a professional and you know what you're doing. 00:32:45.000 --> 00:32:47.220 So those strict ability to repay rules don't 00:32:47.220 --> 00:32:49.680 apply to business loans. They do not apply. As 00:32:49.680 --> 00:32:51.519 a business borrower, you don't get those same 00:32:51.519 --> 00:32:54.220 consumer protections. And that means the lenders 00:32:54.220 --> 00:32:56.339 don't have the same restrictions or legal risks. 00:32:56.579 --> 00:32:59.829 Exactly. By sticking strictly to business and 00:32:59.829 --> 00:33:02.230 commercial loans, the private lenders completely 00:33:02.230 --> 00:33:04.710 avoid the risk of falling under those strict 00:33:04.710 --> 00:33:08.630 Dodd -Frank, TILA, and Hopia guidelines. It created 00:33:08.630 --> 00:33:10.890 this very clear dividing line in the market. 00:33:11.109 --> 00:33:14.470 The big banks handle the slow, document -heavy, 00:33:14.609 --> 00:33:17.470 highly regulated residential mortgages for homeowners. 00:33:18.130 --> 00:33:21.630 And the hard money lenders handle the fast, flexible, 00:33:21.849 --> 00:33:24.450 asset -based commercial and investment projects. 00:33:24.789 --> 00:33:27.750 This is truly fascinating. So if I were to call 00:33:27.750 --> 00:33:30.890 a hard money lender today about a property, would 00:33:30.890 --> 00:33:32.630 they actually ask me if I plan to live in the 00:33:32.630 --> 00:33:34.890 house? That will be one of the very first questions 00:33:34.890 --> 00:33:36.349 out of their mouth. And if you say, yes, this 00:33:36.349 --> 00:33:38.430 is for me and my family to live in, they will 00:33:38.430 --> 00:33:40.349 hang up the phone. Really? Just like that? Or 00:33:40.349 --> 00:33:42.630 they will very politely refer you to a traditional 00:33:42.630 --> 00:33:45.049 mortgage broker. They literally cannot and will 00:33:45.049 --> 00:33:47.710 not lend on owner -occupied homes because the 00:33:47.710 --> 00:33:50.029 compliance costs and legal risks are just far 00:33:50.029 --> 00:33:52.369 too high. They stay strictly in that business 00:33:52.369 --> 00:33:55.910 purpose lane. So. In a strange way, the very 00:33:55.910 --> 00:33:58.309 regulation that was designed to make the banking 00:33:58.309 --> 00:34:02.009 system safer for consumers actually triggered 00:34:02.009 --> 00:34:05.210 the massive boom in this alternative, high -interest, 00:34:05.430 --> 00:34:08.719 largely unregulated lending market. It is the 00:34:08.719 --> 00:34:12.019 classic law of unintended consequences. When 00:34:12.019 --> 00:34:14.099 you squeeze the balloon in one place, in this 00:34:14.099 --> 00:34:17.079 case, traditional banking, all the air just rushes 00:34:17.079 --> 00:34:19.260 to another part of the balloon. In this case, 00:34:19.280 --> 00:34:21.539 private lending. The demand for that capital 00:34:21.539 --> 00:34:24.019 never went away. It just had to move to a different 00:34:24.019 --> 00:34:26.440 provider who was willing to supply it. That's 00:34:26.440 --> 00:34:28.739 a perfect way to look at it. So let's just zoom 00:34:28.739 --> 00:34:30.559 out for a second. We have covered a ton of ground 00:34:30.559 --> 00:34:32.760 here today. We really have. We've defined what 00:34:32.760 --> 00:34:35.119 this stuff is. It's an asset -based loan secured 00:34:35.119 --> 00:34:38.630 by real estate. And the hard... refers to the 00:34:38.630 --> 00:34:40.550 property, the hard asset, not the difficulty 00:34:40.550 --> 00:34:42.889 level. Correct. Collateral is king. We've looked 00:34:42.889 --> 00:34:46.070 at how they manage their risk. That 65 % LTV 00:34:46.070 --> 00:34:48.750 cap is really the shield that protects the entire 00:34:48.750 --> 00:34:51.329 industry. They never lend the full value of the 00:34:51.329 --> 00:34:53.690 property, so the borrower always has significant 00:34:53.690 --> 00:34:56.150 skin in the game. Always. That's non -initiable. 00:34:56.329 --> 00:34:58.699 Then we walk through the history. All the way 00:34:58.699 --> 00:35:03.420 from the informal 1950s origins to this modern 00:35:03.420 --> 00:35:06.599 branding crisis where they are desperately trying 00:35:06.599 --> 00:35:08.820 to get everyone to stop saying hard money and 00:35:08.820 --> 00:35:11.239 start saying private lending. Right. The gentrification 00:35:11.239 --> 00:35:13.860 of the name. And finally, we saw how the 2009 00:35:13.860 --> 00:35:17.300 financial crisis and the Dodd -Frank Act essentially 00:35:17.300 --> 00:35:20.400 carved out the perfect modern niche for this 00:35:20.400 --> 00:35:23.239 industry by pushing the big banks out of the. 00:35:23.519 --> 00:35:26.980 messy but profitable lending space. It's a really 00:35:26.980 --> 00:35:29.900 fascinating ecosystem. It's this parallel financial 00:35:29.900 --> 00:35:32.280 system that operates right alongside the banks 00:35:32.280 --> 00:35:34.800 we all see on every street corner. But it plays 00:35:34.800 --> 00:35:36.980 by a completely different set of rules. It seems 00:35:36.980 --> 00:35:39.119 like it's a vital part of the economy, too. It's 00:35:39.119 --> 00:35:41.539 absolutely vital. Think about every house flipping 00:35:41.539 --> 00:35:43.820 show you've ever seen on TV. Think about that 00:35:43.820 --> 00:35:46.139 new apartment complex in your city that used 00:35:46.139 --> 00:35:48.880 to be an old rundown warehouse. Think about that 00:35:48.880 --> 00:35:51.019 zombie house in your own neighborhood that finally 00:35:51.019 --> 00:35:53.050 got fixed up and sold to a young family. The 00:35:53.050 --> 00:35:54.949 one we talked about at the beginning. Exactly. 00:35:55.170 --> 00:35:58.210 The chances are extremely high that a traditional 00:35:58.210 --> 00:36:00.809 bank did not fund that renovation. Private money 00:36:00.809 --> 00:36:03.190 did. Hard money did. That's a fantastic point. 00:36:03.570 --> 00:36:06.889 This industry is what fuels the renovation and 00:36:06.889 --> 00:36:09.469 revitalization projects that the big banks are 00:36:09.469 --> 00:36:12.269 now too risk averse to touch. Exactly. It provides 00:36:12.269 --> 00:36:15.269 essential liquidity to a segment of the market 00:36:15.269 --> 00:36:17.449 that would otherwise just freeze up and decay. 00:36:18.170 --> 00:36:21.389 Without the source of capital, millions of distressed 00:36:21.389 --> 00:36:23.510 or transitional properties would just sit there 00:36:23.510 --> 00:36:25.650 rotting because no one could get the cash to 00:36:25.650 --> 00:36:28.389 fix them. So for you, listening at home or in 00:36:28.389 --> 00:36:31.150 your car, why should you care about this? Maybe 00:36:31.150 --> 00:36:33.389 you're not planning on flipping houses. Maybe 00:36:33.389 --> 00:36:35.269 you're just a regular person with a regular job. 00:36:35.550 --> 00:36:38.190 Well, for one, whether you're an aspiring real 00:36:38.190 --> 00:36:40.750 estate flipper or maybe someone who's just looking 00:36:40.750 --> 00:36:42.789 for alternative places to invest your own money, 00:36:42.829 --> 00:36:44.829 because remember, you can also be the hard money 00:36:44.829 --> 00:36:47.190 lender. Wait, I can be the lender. I could be 00:36:47.190 --> 00:36:49.789 the one charging 14%. Absolutely. Many of these 00:36:49.789 --> 00:36:52.030 private lending funds raise their capital from 00:36:52.030 --> 00:36:54.590 individual accredited investors. You can put 00:36:54.590 --> 00:36:56.869 your money into a fund and they lend it out on 00:36:56.869 --> 00:37:00.289 these deals at 12 or 14 % and they pay you a 00:37:00.289 --> 00:37:03.309 return of 8 or 9%. It's a way to participate 00:37:03.309 --> 00:37:05.469 in the real estate market without ever having 00:37:05.469 --> 00:37:07.929 to swing a hammer. That is a whole other deep 00:37:07.929 --> 00:37:10.869 dive for another day. It is. But even if you 00:37:10.869 --> 00:37:13.550 never invest a dime. This is important because 00:37:13.550 --> 00:37:16.010 it explains how so much of the world around you 00:37:16.010 --> 00:37:18.650 actually gets built and rebuilt. It explains 00:37:18.650 --> 00:37:21.630 how projects get funded when the obvious answer 00:37:21.630 --> 00:37:24.530 from the bank is no. It explains the mechanics 00:37:24.530 --> 00:37:28.010 of risk and reward in their absolute rawest form. 00:37:28.230 --> 00:37:30.329 It's the engine of the alternative economy. It 00:37:30.329 --> 00:37:32.110 really is. So I want to leave everyone listening 00:37:32.110 --> 00:37:34.650 with one final thought to chew on. We talked 00:37:34.650 --> 00:37:37.130 a lot about the rebranding effort. The industry 00:37:37.130 --> 00:37:39.349 is trying so hard to be called private lending 00:37:39.349 --> 00:37:42.940 or transitional lending. It sounds softer. It 00:37:42.940 --> 00:37:44.780 sounds nicer, more professional. It definitely 00:37:44.780 --> 00:37:48.280 does. But does a softer name really change the 00:37:48.280 --> 00:37:51.360 hard reality of the transaction? At the end of 00:37:51.360 --> 00:37:53.840 the day, the entire model still relies on the 00:37:53.840 --> 00:37:56.900 liquidation value of your asset if you fail. 00:37:57.059 --> 00:37:59.260 That is the provocateur's question, isn't it? 00:37:59.320 --> 00:38:00.980 You can call it transitional lending. You can 00:38:00.980 --> 00:38:04.039 call it boutique capital solutions. But if you 00:38:04.039 --> 00:38:06.719 don't perform, the underlying mechanism is exactly 00:38:06.719 --> 00:38:09.389 the same. They are coming for the asset. The 00:38:09.389 --> 00:38:12.230 collateral is and always will be the king. It's 00:38:12.230 --> 00:38:14.070 something to think about. The next time you're 00:38:14.070 --> 00:38:16.789 stopped at a red light and you see one of those 00:38:16.789 --> 00:38:19.750 yellow corrugated plastic signs stapled to a 00:38:19.750 --> 00:38:22.090 telephone pole that just says, we buy houses 00:38:22.090 --> 00:38:25.389 for cash. There is a whole world of these hard 00:38:25.389 --> 00:38:28.289 money mechanics grinding away right behind that 00:38:28.289 --> 00:38:30.309 simple little sign. Indeed there is. Thanks for 00:38:30.309 --> 00:38:32.489 diving in with us on this. My pleasure. It was 00:38:32.489 --> 00:38:34.769 great. And we'll see you on the next Deep Dive.