With the financial uncertainty of 2017 raising questions about conventional lenders of commercial loans, commercial real estate investors are increasingly turning to alternative financing. In particular: hard money lenders and real estate crowdfunding. While these two options have grown in popularity year over year as viable alternatives to conventional lending, many investors are still a bit fuzzy on what differentiates the two.
1. Who actually finances these commercial mortgages?
The best place to begin differentiating between real estate crowdfunding and hard money lenders lies with who funds these commercial loans. It’s an important distinction, as commercial mortgages can range from hundreds of thousands of dollars to many millions.
Real Estate Crowdfunding: Similar to the famous media-oriented platforms such as Kickstarter and GoFundMe, real estate crowdfunding involves soliciting funds from accredited investors for various real estate projects. The individual totals are pooled together and comprise the loan amount, known as “equity financing”. The investors can be anyone, assuming they meet the individual real estate crowdfunding site’s requirements for income and net worth.
Hard Money Lenders:
As opposed to real estate crowdfunding, hard money lending involves a company offering a loan to a borrower, using the borrower’s real estate as collateral
, rather than pooling together monies from many investors. For this reason, this method appears (at a distance) more similar to how conventional lenders finance commercial mortgages. However, in this case a company determines the advance rate based on the value of the borrower’s real estate collateral, funding the commercial loan accordingly.
2. Who bears the risk for these commercial loans?
Commercial mortgages of all types are associated with risk for the lender, but the ways in which this risk is divvied up differs between real estate crowdfunding and hard money lenders. If a borrower doesn’t follow through with their project plans or something else falls through, who bears the risk?
Real Estate Crowdfunding: With many investors crowdfunding the commercial loan, the risk associated is spread out accordingly. Think of it this way: Rather than taking on the full risk of a $1 million loan, an investor of $10,000 is only taking on 1/100th of the risk. Minimum investments vary between real estate crowdfunding sites, but these loans can be unsecured or secured, using the borrower’s real estate as collateral.
Hard Money Lenders:
Because a single company is financing commercial mortgages, only one party bears the full risk of the loan. As we touched on earlier, the company determines the advance rate using the value of the borrower’s real estate as collateral
. The loaned funds are a percentage, usually 50% to 65% of the total collateral value, which allows the hard money lender to maintain financial protection in case the borrower’s project falls through. In that sense, the borrower ultimately takes financial responsibility for the commercial mortgage.
3. Who can qualify to receive these commercial loans?
Though both real estate crowdfunding and hard money lending assist borrowers in securing commercial mortgages, the lending process itself differs, and impacts who is best suited for which type of alternative financing.
Real Estate Crowdfunding: Because borrowers are capitalizing their real estate projects through equity financing, real estate crowdfunding sites are often focused on creating returns for their investors. For this reason, they have a range of qualifications to ensure they’re taking on good commercial loan opportunities. However, assuming they are willing to take on the borrower’s loan, the process usually takes less time than a conventional loan might, as their pool of investors can be rapidly solicited.
Hard Money Lenders: As opposed to traditional bank loans, the credit history of the borrower doesn’t usually factor in for hard money lenders. The loan term is generally much shorter with hard money lending, and since the loan amount is based on a percentage of the real estate’s total collateral value, they don’t need to factor things like bad credit. Most hard money lenders only require basic information, as well as information on the collateral, to complete the loan. This also makes the process speedier than either conventional lending or real estate crowdfunding.
Hard Money Lenders and Real Estate Crowdfunding: What’s the best option?
The short answer: It depends. Real estate crowdfunding gives borrowers access to qualified investors to fund qualified projects, while hard money lenders can give those experiencing hard times a chance to secure a loan fast using their real estate as collateral.
Everyone’s situation is different, but one thing remains the same: You deserve a commercial financing
option that works for you.