Asset-Based Lending for Real Estate

Real estate investing often requires quick access to capital, but qualifying for a traditional loan isn’t always possible, or practical. Asset-based lending offers an alternative by allowing investors to borrow against the value of real estate or other assets instead of relying primarily on income or credit history. Understanding how these loans work, along with their benefits and risks, can help you determine whether asset-based financing fits your investment strategy.

For help with building your own portfolio, consider working with a financial advisor.

What Is Asset-Based Lending?

Asset-based lending is a type of financing in which a borrower uses valuable assets as collateral to secure a loan. While businesses often use asset-based loans to finance operations with inventory, equipment or accounts receivable, real estate investors can use a similar approach by borrowing against the value of investment properties or other real estate assets. Because the loan is backed by collateral, lenders may be willing to extend financing even when a borrower has limited cash flow or doesn’t qualify for traditional unsecured loans.

In real estate, asset-based lending is commonly used to purchase, renovate or refinance investment properties. Rather than focusing primarily on a borrower’s income, lenders place significant weight on the value and marketability of the underlying property. The amount a borrower can receive is often based on a loan-to-value (LTV) ratio, meaning the lender will finance only a percentage of the property’s appraised value to help limit its risk.

Asset-based loans may be offered by banks, private lenders and hard money lenders, depending on the type of property and financing needed. These loans often have faster approval times than conventional mortgages, making them attractive to investors looking to move quickly on opportunities. However, that convenience may come with higher interest rates, shorter repayment terms and additional fees.

While asset-based lending can provide flexible access to capital, borrowers should carefully evaluate the costs and risks before using their real estate as collateral. If the borrower defaults on the loan, the lender may have the right to seize or foreclose on the pledged property. For that reason, asset-based lending is generally best suited for investors with a clear repayment strategy and a well-defined investment plan.

Collateral and Loan-To-Value Ratio

Since asset-based loans are secured, they generally have lower interest rates than unsecured loans or business credit cards. However lenders do prioritize collateral that is more liquid. With an asset-based loan, lenders will give larger loans at lower interest rates when the business secures that loan with a more liquid asset.

For example, a business that secures its loan with a stock portfolio or its accounts receivable portfolio will typically get better terms than if they secure the loan with industrial equipment or real estate. The former is more liquid and easily marketable, so it is more likely to hold its value. The latter is harder to sell, and so is more likely to add costs if the lender has to collect.

Lenders price asset-based loans on what’s called “loan-to-value ratio.” This is the ratio between the value of the loan and the value of the asset used as collateral. In a standard asset-based loan, the lender will give a higher loan-to-value ratio for more liquid collateral.

For example, say that your business wants to take out an asset based loan. You have two assets that you can use as collateral. First, you can use your accounts receivable. You have $100,000 in pending payments from customers that you can stake as collateral. Second, you have a pair of trucks that are collectively worth $120,000 together.

As a cash asset, the accounts receivable is a far more liquid asset. So your lender may agree to an 80% loan-to-value ratio, extending you an asset-based loan worth up to $80,000.

The trucks are less liquid than accounts receivable. If your lender has to collect, they will incur additional costs in getting and selling those trucks. So they may agree to a 60% loan-to-value ratio for an asset-based loan secured by the trucks, extending you a loan of up to $72,000.

Asset-Based Lending In Real Estate

Asset-based loans are relatively common in commercial and investment real estate. One of the features of some real estate firms is that they tend to be property-heavy and cash-light. Buying real estate costs an enormous amount of money, so it’s common for a firm to spend that money on its next investment property. This can frequently leave real estate firms cash-light when they need to pay bills or when they want to make a new purchase.

To solve this cash-flow issue, real estate firms will often use asset-based loans backed by their real estate holdings. The loan can change based on the underlying value of the property involved.

For example, a real estate firm might take out an asset-based loan secured by the market value of a property they own. Or it might take out a loan backed by the income of a rental unit. The sale-price of a property will typically generate lower loan-to-value ratios, since real estate sales are illiquid. The cash flow of an income-generating property will typically generate higher loan-to-value ratios, since this is highly liquid.

Regardless of the value, real estate firms have significant assets they can use to secure an asset-based loan.

Bottom Line

Asset-based lending can provide real estate investors with a flexible way to access capital by using property or other valuable assets as collateral. While these loans often offer faster funding and less emphasis on income than traditional financing, they may also come with higher costs and the risk of losing the pledged asset if the loan isn’t repaid. Carefully comparing lenders, understanding the loan terms and having a clear repayment strategy can help determine whether asset-based lending is the right fit for your real estate investment goals.

Real Estate Tips

• Real estate investing is a popular way to add diversity to your portfolio, and to create passive income.
• A financial advisor can help you make the investment choices that are best for you and your family. Finding a financial advisor doesn’t have to be hard. SmartAsset’s free tool matches you with vetted financial advisors who serve your area, and you can have a free introductory call with your advisor matches to decide which one you feel is right for you. If you’re ready to find an advisor who can help you achieve your financial goals, get started now.