A Commercial Hard Money Suicide

Commercial lenders are suffering in this economy as well – just not as publicly it appears.

Last month one of the most prolific Hard Money Lenders on the Commercial Real Estate side of the house killed himself. A Hard Money Lender lends money to real estate investors for very short time frames at astronomically high interest rates – and some investors hyperventilate at the chance to borrow.

It looks like he got overexposed to the overheated Phoenix real estate market.

The market softened significantly, which caused his borrowers to begin defaulting on their notes. At the same time, his investors started to get appropriately gun-shy about the market, and they stopped investing. Which meant that he had to cover the interest payments on the defaulted loans.

He then committed the cardinal sin in real estate.

After offering his initial investors first lien position on properties, in his haste to attract new money, he gave new investors the coveted first lien position and basically displaced the prior investors.

First lien position gives someone first claim on the property in the event of a default. It’s the least risky debt-based way to own real estate, and therefore gets a lower return on investment. In contrast, second lien position can earn rates of return up to double that of first position due to the additional risk.

You can imagine how his initial investors reacted! Although he may be better off this way, because when his investors found out that they had been displaced, they would have beaten him senseless with baseball bats a la Robert De Niro as Al Capone in the Untouchables.

And his company filed for bankruptcy three weeks later.