Asset-based lending in real estate finance, also referred to as equity-based lending, involves extending a loan that is secured by real estate assets. These assets can include commercial, residential, and industrial properties, as well as land.
For asset-based mortgage lenders, the main criteria for loan approval are the value of the real estate and the amount of the down payment — or the borrower’s equity in the case of a refinance transaction.
To say it another way: in asset-based lending, the focus is on the collateral and not primarily on the borrower. In contrast, conventional lenders, such as banks and credit unions, are more concerned with the borrower’s credit record, income, balance sheet, and cash flow.
In addition, since the lender is generally either an individual or a company specializing in asset-based loans rather than a bank or credit union, these kinds of real estate loans are often referred to as “hard money loans.”
How Does Asset-Based Lending Work?
During the underwriting process, an asset-based lender evaluates the value of the real estate, the borrower’s equity, the proposed loan amount, and the lender’s ability to recover its funds from the collateral if the borrower defaults. An appraisal, title report, and other property-related disclosures may be part of this evaluation.
The amount a lender is willing to advance is often tied to the property’s value and the applicable advance rate. This is sometimes referred to as the borrowing base or borrowing capacity.
Advantages of Asset-Based Real Estate Loans
One of the great advantages of asset-based real estate loans is the speed with which these transactions can be completed. Since the focus is on the value of the real estate or the owner’s equity in the property, asset-based lenders are able to fund loans much faster than conventional lenders.
This emphasis on value or equity allows lenders to place less emphasis on issues such as faulty credit scores, insufficient income, and other blemishes on a borrower’s record.
The different criteria for extending an asset-based real estate loan also means a vastly reduced amount of paperwork, another factor that helps expedite the lending process. Where a bank would probably require more than a dozen pieces of documentation before extending a loan, hard money lenders usually require no more than five or six pieces of documentation before signing an asset-based lending agreement. These would include the contract to purchase the property, if applicable; personal identification; a title report; proof of rents and funds to purchase; an appraisal; and, possibly, a credit report.
Depending on the transaction, an asset-based lender or broker may also request financial statements, information about existing liens, insurance documentation, leases, or additional disclosures. The exact requirements vary by lender, property type, and loan structure.
An additional advantage is that because asset-based lending for real estate is often structured as a line of credit, borrowers only have to repay if they actually draw on that line of credit. In contrast, term loans from a traditional lender must be repaid in full with interest, whether the loan is used or not.
Incidentally, this choice to use or not use borrowed funds as circumstances warrant makes an asset-based loan a great option for a company that may have intermittent needs, such as investing in additional inventory during a busy season and supplementing payroll during a slower season.
This flexibility can make asset-based financing useful for working capital, time-sensitive acquisitions, and other short-term business needs. However, borrowers should carefully review whether the loan is structured as a true revolving line of credit, a term loan, or another type of financing.
Disadvantages and Risks of Asset-Based Lending
Interest and fees comprise the greatest disadvantage of asset-based loans. Asset-based interest rates are higher than those charged on long-term loans extended by conventional lending institutions and usually range from a low of 7% up to around 17%.
While the interest rates are higher, it is essential to remember that asset-based loans are intended for short-term use only. The speed of approval and the funding provided by an asset-based lending agreement, as well as the flexibility of the lending criteria, may make up for the higher interest rates.
Fees on the loan can be higher as well, depending on the type of loan being sought.
Borrowers should also understand what happens if the property value declines, the borrowing base changes, the borrower misses a payment, or the loan’s exit strategy fails. Depending on the loan documents, the lender may have significant rights involving the collateral, cash flow, default remedies, and foreclosure.
Before signing, borrowers should review the interest rate, fees, maturity date, repayment schedule, extension rights, prepayment provisions, personal guarantees, default provisions and the lender’s rights in the event of a default.
Real Estate Investors and Asset-Based Lending
Many real estate investors utilize asset-based lending to obtain fast approval and funding with relatively few requirements and less documentation. If necessary, an asset-based lending agreement can be worked out in a matter of a few days, whereas securing that same loan from a bank could take two to three months for the approval and funding process to be fully completed.
For real estate investors, asset-based loans may provide a financing option when speed, flexibility, or the property’s value is more important to the lender than the borrower’s traditional income or credit profile.
New Home Construction and Other Real Estate Projects
Asset-based lenders also provide funds for new home construction to contractors, often allowing them to borrow up to 60% of the land value and 100% of the construction costs. Plus, for escrows over a certain amount — $100,000, for example — the borrower will only be required to pay interest on the funds as they are drawn.
In this type of arrangement, the loan may be funded in stages as construction progresses. Borrowers should understand the lender’s draw requirements, inspection process, interest calculations, and conditions for future advances.
In addition to new home construction, asset lenders often fund a variety of other projects. These include fix-and-flip loans, bridge loans, purchase loans, cash-out and refinance loans, investment property loans and distressed property loans secured by real estate.
Asset-Based Lending for Primary Residences
Very few asset-based lenders provide primary residence, consumer-purpose loans. The reason: Consumer-purpose loans are subject to additional government regulations, require more licensing and involve a more extensive underwriting process.
The exception to this generalization regarding primary residences is that asset-based lenders may consider short-term loans to borrowers with a reasonable financial exit strategy. The borrower must be in a position that will allow them to refinance into a long-term conventional loan in the next one to three years.
How a Real Estate Attorney Can Help with Asset-Based Lending
An attorney is not required to negotiate, draft or close a real estate transaction, but you may still find professional legal assistance to be highly beneficial.
While asset-based loans can usually be completed in a shorter time and with far less paperwork than a conventional loan, they are not without their complications. Thus, you may consider hiring an experienced attorney to guide you through the process, from structuring the transaction and negotiating term sheets to completing the closing process, to make sure everything is done correctly and to your satisfaction.
An experienced real estate attorney can help review loan documents, identify potential risks, negotiate business and legal terms, evaluate title and lien issues, and coordinate the closing process. Legal guidance can be especially valuable when the transaction involves construction financing, investment property, a bridge loan, refinancing, multiple owners, or a complicated exit strategy.
Hammerle Morris Can Help with Real Estate Transactions
Asset-based lending can provide speed and flexibility, but the loan documents and collateral requirements deserve careful review. If you are considering an asset-based loan, hard money loan, bridge loan or other real estate financing option, contact the experienced real estate lawyers at Hammerle Morris for guidance.
Our attorneys can help you understand the proposed terms, evaluate potential risks, and move your transaction toward closing.
Virginia Hammerle is a licensed Texas attorney whose practice includes estate planning, probate, guardianship, and litigation.
This article is for informational purposes only and does not constitute legal advice.
