Conventional business loans and home mortgages are not the norm among property investors looking to finance acquisitions. Unconventional lending is. And more often than not, real estate investors look to hard money to close their deals. If you are interested in an explanation, the short answer is that banks are risk averse.
In Salt Lake City, UT, real estate investors make up the bulk of the business for Actium Partners. Actium also writes loans in Idaho and Colorado. Real estate is their primary focus. Moreover, they only make loans for commercial properties. Actium doesn’t do residential deals for the same reason banks stay away from real estate investments in general: an aversion to risk.
A Definition of Risk Aversion
A basic definition of risk aversion might make the information in this post more understandable. So here’s the simplest of definitions, compliments of Investopedia:
“Risk aversion is the tendency to avoid risk. The term risk-averse describes the investor who chooses the preservation of capital over the potential for a higher-than-average return.”
A risk-averse investor would rather hold onto his money and put it into safer investments even though he stands to make a lower return. Banks are no different. They would rather stick with conventional lending that offers some semblance of stability and less risk, even though there is more money to be made in other ventures.
The Problem with Real Estate Investing
Real estate has historically been one of the most profitable investments. Over the last five or six decades, plenty of people have made a bundle in real estate. So why are banks afraid of it? Why does their aversion to risk keep them out of the property investment game?
There are two big challenges with real estate: future market conditions and the unknown. In terms of the former, it is all well and good to invest in real estate when the market is fairly stable. But no one can predict where the market will go 12, 18, or even 24 months down the road.
Banks are hesitant to sink hundreds of thousands of dollars into a commercial property that may not be worth the paper its title is printed on at some point in the future. They also don’t want the risk of default. When a borrower defaults, the bank almost always loses money.
In terms of the unknown, investors never truly know what they are getting until after they close the deal and take possession of a property. That is where money pit stories come from. Unsuspecting buyers put down good money only to discover their newly acquired properties are hazards. They need to spend a ton of money on repairs just to bring the properties up to code.
Hard Money Lenders Are Less Risk-Averse
On the other hand, hard money lenders are less averse to risk. That is certainly true with Actium Partners. They are more willing to invest in real estate transactions despite the risks because they stand to make a much better return than they would on conventional loans.
To mitigate the risks, hard money lenders charge higher interest rates and offer lower terms. They also offer lower LTVs than conventional lenders. This means borrowers need to put up larger downpayments. To top it all off, hard money lenders move very swiftly when loans go into default. They have no trouble seizing assets used to back loans and sell them to recover their money.
Hard money is the preferred funding option for real estate investments because banks are risk averse. What is too risky for a bank is par for the course for hard money lenders.