Alternative financing (also known as marketplace lending) is a formative factor in how the US real estate market has evolved since the great financial meltdown of 2008. Real estate construction activity in the country has seen yearly growth since 2009 (US Census Bureau) with alternative financing contributing to the expansion.
Nonetheless, alternative financing remains a new concept to many real estate developers who haven’t been exposed to its benefits. The following are some of the more common questions about alternative financing, bridge loans, hard money, and mezzanine loans.
Why do I need Alternative Financing for my Real Estate Development Project?
You may need alternative financing for your real estate development project for a wide variety of reasons. These reasons revolve around the limitations of conventional financing and the advantages of alternative funding options. Consider the following.
- Time-Consuming Approval Process: The approval process for conventional financing is very time-consuming compared to alternative financing. Approvals and the time it takes to close are fast by comparison.
- Loan-to-Value Ratios: The Loan-to-Value (LTV) ratio you’ll get with conventional financing will only go as high as about 60-70 percent. This means that you’ll have to spend more out of your own pocket to realize your real estate development objectives. Alternative financing allows LTV ratios of up to 80 percent.
- Timing and Prepayments: Conventional financing is inherently long-term in nature. Most conventional lenders will discourage you from closing out the loan early by way of prepayment penalties. Those prepayments could be 1-5 years worth of interest payments depending on the remaining lifetime of the loan. There are shorter prepayment penalties in alternative financing due to the short-term nature of the loans. If the alternative lender does require prepayment penalties, they will typically range from 3-6 months’ worth of interest payments.
- Flexibility: Alternative financing institutions are generally more accommodating and adaptive than conventional financing institutions. This means that alternative financiers may be more versatile with regard to the terms and conditions of the financing agreement.
How do I Find Trustworthy Sources of Alternative Financing as a Real Estate Developer?
Alternative financing is a booming sector within the real estate financing industry. There are a plethora of marketplace lending platforms to choose from. Some of the things you should look for in a trustworthy lender include:
- Track record of success: The best way to analyze an alternative financing institution is to see how long they have been in business and their rate of success is financing new deals through the years. This sector is fairly volatile. This means that unreliable stakeholders tend to fade away sooner rather than later.
- Borrower Assessment Systems: The most reliable sources of alternative financing will have in-depth borrower assessment systems that are comparable to conventional financing evaluation models. Simultaneously, you also want to see quick turnaround times as it demonstrates the maturity of operations.
- Loan Underwriting Prerequisites: Loan underwriting is another area you should evaluate. What kind of project review process do they have in place? Do they check aspects such as architectural plans, zoning laws, budgetary constraints, project timelines, projected values, and demographical details of the market? You will want to know what will be required to process your loan before you select a marketplace lending platform as each platform has varying requirements.
- Experienced Management and Staff: Investigate the experience of the fund’s leadership. If the alternative financing source has experienced leadership in the real estate industry, you can be sure of its reliability and trustworthiness.
At What Point in the Real Estate Development Process Should we Seek a Bridge Loan?
Bridge loans are most useful at the very beginning of a real estate development project. You take bridge loans when you’re expecting some funds to become available but need to start a real estate development project immediately.
For example, if you’ve applied for conventional financing and are waiting to get approval, then you can use bridge loans up until those funds get released. Similarly, if you have funds that are occupied in another project, then you can take a bridge loan up until those funds become available. There are many online marketplace lending platforms that offer short-term bridge loans to meet this specific need.
Is a Hard Money Loan a bad Idea for my Real Estate Development Business?
No, hard money loans are designed for real estate development projects that conventional financing institutions do not fund. Most hard money lenders will fund real estate projects on overly distressed assets or assets that have varying market conditions that make them less appealing to a conventional lender. It is important to note that due to the convenience, and speed of a hard money loan, interest rates are usually much higher than a longer-term conventional loan.
You can use hard money loans to start work on your asset. Once your work on the real estate asset has made it viable enough for conventional financing institutions to back you, you can exit the hard money loan. If done right, this method will still leave you with sufficient working capital.
What is a Mezzanine Loan and how do I Find a Lender?
Mezzanine loans are a mix of equity-based financing and loans. Essentially, when you take out a mezzanine loan, you’re giving the lender the right to convert some or all of the loan value into equity in your business. The lender can exercise that right only when you default on your payments of the loan. Mezzanine lenders tend to look for high-worth borrowers or borrowers with significant assets. There are dedicated mezzanine lenders in the US in the form of traditional funding sources, such as banks, and alternative sources, such as marketplace lending platforms.
What Steps Should I Take to Prepare to Apply for Alternative Financing?
The qualification criteria and the approval process for alternative financing vary. Here are some of the requirements to consider.
- Collect The Right Documents: Even though alternative financing is easier than conventional financing, you’re going to need the right documents for approval. You should prepare ownership/entity documents of your business, and your entity balance sheets, along with the relevant plans and proof of liquidity.
- Create A Project Plan: You will need to have an effective and approved loan exit strategy as well as a renovation/conversion plan in order to secure funding.
- Present A Memorandum Or Pitch Deck: You may have a face-to-face meeting with the lender where you’ll have to present your project plan. Creating a memorandum or a pitch deck will make this meeting more productive.
- Focus on Your Staff: Like conventional financing institutions, alternative financing institutions also get swayed by the quality of your workforce. The talent and experience of your staff and vendors speak to your commitment to your business. Building a strong team that will attract and build investor confidence.
What are the Disadvantages of Conventional Commercial Real Estate Financing?
Conventional commercial real estate financing is governed by stringent regulations. Between heavy demand for financing in the growing US commercial real estate market and tougher regulations, conventional financing institutions are under pressure. The following disadvantages are the consequence of these factors.
- Conventional commercial real estate financing has to conform to the High Volatility Commercial Real Estate (HVCRE) regulations. This is why the qualification criteria for conventional commercial real estate financing are particularly stringent. As a result, only larger players with heavy-duty balance sheets and long-standing track records in the market are able to get approval.
- Conventional commercial real estate lenders give preference to bigger players and don’t entertain newer entrants as frequently.
- The approval process for conventional financing is time-consuming and the requisite documentation is stringent.
- Conventional commercial real estate financing offers a lower Loan-to-Value ratio of up to 70%.
Insufficient Working Capital Will Never Hold You Back Again
Whether you’re a new stakeholder in the market or a seasoned commercial real estate developer, it is likely that you’ve struggled with access to funding. It is likely that you’ve also faced challenges in securing the working capital necessary to maintain brisk growth. Alternative financing through marketplace lending has the potential to resolve such issues and facilitate growth for your real estate business. You can acquire the capital needed to seize on fleeting commercial real estate development opportunities quickly.
Sharestates has closed over $1 Billion across 1,000+ real estate loans since 2015 – making it one of the largest alternative sources of financing in the real estate space. To speak to a Sharestates loan specialist, submit your contact information today!