It is no secret that hard money lenders do not look at loan-to-value (LTV) the same way most traditional lenders look at it. This is by design. Because hard money lenders rely almost exclusively on the value of collateral to determine whether or not to approve a loan, they have to give LTV consideration beyond mere market value.
For example, consider Salt Lake City-based Actium Partners. They might be working with a client on bridge loans for a real estate deal. The client has offered another piece of property as collateral. Actium will likely be more conservative in their valuation than local brokers. This is fairly common. Hard money lenders are almost always more conservative than brokers.
A good hard money lender will consider broker opinions when determining the value of a piece of collateral. But broker opinions are only one small part of the equation. Lenders also utilize professional appraisals, tax records, and other resources. They also analyze the current market in hopes of determining how easily they can sell a piece of foreclosed property and how much it would cost them to do so.
The Broker’s Perspective
The differences in valuations between hard money lenders and real estate brokers boils down to motivation. From the brokers perspective, the market reigns supreme. A piece of property is worth whatever someone is willing to pay for it. As such, brokers are motivated to be a bit more liberal with their valuations.
A broker is more likely to value a piece of property on the higher end. Some might even inflate prices just to establish a higher starting point for negotiations. A higher starting point can lead to a higher sale price and more commission for the broker.
None of this is inherently disingenuous as long as a piece of property is presented truthfully and transparently. Rather, a higher valuation just sets a higher bar for negotiating the eventual sale price. Brokers are motivated to be more liberal in their valuations because they can increase their commissions that way.
The Lender’s Perspective
The other side of that coin is the more conservative valuation of a hard money lender. Such a lender is not worried about broker commissions. He or she is only concerned with recovering what is loaned should a borrower default. Being more conservative better protects the lender’s interests.
Where a broker can afford to look at mere market value, hard money lenders have to consider other things. For example, foreclosing on a piece of property automatically incurs court costs. There will be additional legal costs involved in any eventual sale of that property.
Lenders must consider marketing and sales costs, too. They have to consider the time and effort required to sell a piece of property. All of this adds up to additional costs that take away from the eventual sale price. To the lender, a collateralized property has a lower cash value due to the time and expense of disposing of that property.
Entirely Different Motivations
As you can see, hard money lenders and brokers have entirely different motivations when it comes to valuing property. From the borrower’s perspective, it helps to understand these motivations. They explain why a broker who analyzes a piece of collateral offers a higher valuation compared to a lender with a more conservative number.
Valuation comes down to sale price for the broker and cash value for the lender. They are two different thresholds that require different ways of thinking. And while that may seem like a foreign concept to borrowers, that is the way the industry works.
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