How Asset-Based Lending (ABL) Works for Real Estate
Hard money lenders are able to loan money to builders and house flippers for real estate projects for several reasons - including the fact that they’re not subject to nearly as many regulations and constraints as banks.
Another reason is that they use asset-based lending (ABL), also known as asset-backed lending. When a hard money lender gives a loan for a real estate project, the borrower puts up the real property itself as collateral. This is also where we get the term “hard money loan,” since it is a loan backed by a hard asset.
ABL is common in many areas of business. Some asset-based lending companies lend to many different types of businesses, while others focus on one or a few industries. This focus of this article is on asset-based lending for real estate.
What is an “asset-based loan”?
An asset-based loan is a loan secured by an asset. A borrower obtaining an asset-based loan must put up something of significant value as collateral since that will be the lender’s main recourse if the business defaults on the loan. Asset-based lenders, such as a hard money lender, can serve businesses and individuals.
Photo by Tiger Lily from Pexels
Although not always the case for hard money real estate loans, businesses may use accounts receivable, inventory, equipment, or other assets to secure the loan. Asset-based lenders often prefer more liquid collateral, as opposed to something that might be difficult to convert into cash. Liquid assets are not always readily available for this purpose though. In asset-based loans for real estate projects, the property that the borrower intends to buy serves as the collateral.
You might have noticed that, so far, this does not sound any different from other collateral-based loans, including traditional mortgages. There are some obvious similarities, but also some important differences.
How is an asset-based loan different from a traditional loan?
Perhaps the key difference between asset-based lending and what we might think of as more traditional lending involves how lenders assess risk. I.e., how they make decisions on whether to approve a loan application.
Traditional lenders take risks on borrowers. Asset-based lenders take risks on property.
Here are some specific ways that traditional lenders are different from private hard money lenders offering asset-based loans:
Traditional lenders, like banks, require collateral for many traditional loans - including traditional mortgage loans - but the collateral is not their first concern.
A traditional lender’s focus is on the borrower’s creditworthiness, income, debt-to-income ratio, and more. They’ll look at a loan applicant’s credit score, credit history, employment history, income history, and other aspects of their current and past financial situation.
Traditional lenders foreclose on the collateral if the borrower defaults, and they may still pursue the borrower if selling the foreclosed property does not cover the balance of the debt.
Even if the prospective borrower is a business, they might want to know about the credit history of the business owners.
Photo by Dylan Gillis on Unsplash
Asset-based lenders focus primarily on the nature and value of the asset that the borrower is pledging as collateral for the loan. The risk of default is still important, but lenders want to be as certain as possible that the asset will be enough to cover the debt if that happens. This is why many asset-based lenders prefer liquid assets, since they are easily convertible to cash. Physical assets, such as equipment or real property, present a greater risk for the lender.
The value of liquid assets vs. hard assets
Suppose, for example, that a borrower offers a bank account with a balance of $500,000 as collateral. An asset-based lender might be willing to issue them a loan or line of credit for $500,000. If the borrower offers equipment valued at $500,000, the loan is likely to be less than that amount, because $500,000 worth of equipment will not convert directly into $500,000 in cash. The lender would have to incur expenses to take possession of the equipment and maintain it while trying to sell it.
“As-is” value is a key component of asset-based lending
Asset-based lenders in real estate, including hard money lenders, look at two measurements of the value of real property that will serve as collateral for a loan. First, they look at what the property is currently worth, or its “as-is value.” Then, they look at the property’s “after-repair value” (ARV), which is the borrower’s estimate of how much the property will be worth once they have completed their planned repairs, improvements, or renovations. Hard money lenders must consider how much the property might be worth at every stage of the project should the borrower default.
Read more: How to Calculate ARV
When is asset-based lending advantageous?
Asset-based loans can be available much more quickly than more traditional types of loans. They typically require less paperwork since asset-based lenders are not as interested in borrowers’ personal financial history. Lenders do, however, want extensive information about the assets that will secure the loan.
This type of arrangement can work well for stable businesses that have an immediate or short-term need for financing. For example, a business can use an asset-based loan to cover an anticipated short-term gap in revenue, make an unexpected purchase of large equipment, or handle other matters where time is of the essence.
What makes an asset-based loan appealing to hard money lenders?
Hard money lenders pay especially close attention to the real estate that’s the subject of a borrower’s plans. They have to make a decision based on the property’s ARV - which is the estimated value it’ll have when the borrower’s project is complete.
Calculating ARV with as much precision as possible is therefore indispensably important when qualifying for a hard money loan. In the case of real estate, higher ARVs (and a history of successful projects of similar size) gives the asset-based lender more confidence to lend money.
Find out if asset-based lending is right for you
Hard money lending can provide developers, builders, and house flippers with fast and flexible financing for their real estate projects.
Applying with Capstone Capital Partners is simple! You can expect friendly service from beginning to end. Get started on your free pre-approval and speak with hard money experts about the best way forward for your real estate project.
