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Lawsuit against O.C. lender illustrates dangers of 'hard-money' lending

Point Center Financial, owned by Dan J. Harkey, is being sued by more than 50 investors whose nest eggs helped fund loans to developers that largely have soured in the tanking real estate market.

May 04, 2009|Stuart Pfeifer

Lloyd Charton recalls a fateful knock on the door. At his Dana Point home stood a cheerful man with an impressive knowledge of Charton's personal life. It was a neighbor, Dan J. Harkey.

Harkey congratulated him on his retirement and asked about a recent vacation. He told him about his company, Point Center Financial Inc., which raised money from private investors and lent it to real estate developers.

It was Charton's introduction to the little-known and risky world of "hard-money" lending, a lightly regulated segment of the real estate business marked by short-term loans with high interest rates and fees.

In the years that followed, Charton invested more than $1.2 million with his neighbor, earning handsome returns, for a time.

Then, as the real estate market soured in 2007, borrowers started to default on their loans. Today, Harkey acknowledges that at least 60% of the loans are in default. He faces a lawsuit from more than 50 private investors -- including Charton -- whose nest eggs helped fund the bad loans.

Harkey, 62, who is married to Assemblywoman Diane Harkey (R-Dana Point), disputes the claims of the investors and blames his Aliso Viejo company's downturn on the soured real estate market.

Whether or not the investors prevail in court, real estate experts say the dispute illustrates the perils inherent in hard-money lending, which is often a final option for borrowers who can't qualify for bank loans.

The term "hard-money" lending can be traced to the Great Depression when private individuals started lending money because of the banking crisis, said Leonard Rosen, whose La Jolla-based company, Pitbull Mortgage School, teaches mortgage brokers about hard-money loans.

"No one really knows the reason they used 'hard money' as a term. It could be that it was hard to get, hard to find or because it was hard cash," Rosen said. "I'm not an advocate for hard-money lending. But it's something that has its place as long as it's done responsibly. There are some people who should not be in the lending business at all."

Hard-money lenders rely almost exclusively on the value of property used as collateral, expecting to profit when loans are repaid or to foreclose when they're not. In a good economy, investors can make significant gains. Harkey said he paid investors 9% annually, sometimes more.

With those hefty payouts comes risk. If the real estate market crashes, hard-money lenders can end up with foreclosed properties suddenly worth far less than the money they lent. And investors, once confident that their loans to developers were backed up by property, can find that their holdings are now of little value.

The estimated billions of dollars in hard-money loans fall outside the purview of regulators like the Federal Reserve and the Office of Thrift Supervision, putting significant responsibility on lenders to act in the best interests of investors.

"Those who invest their money with hard-money lenders are taking on significant risk. That's why they would expect a significant return relative to other investments," said Stuart Gabriel, a UCLA finance professor and director of the university's Ziman Center for Real Estate. "If they need to take the property back, there's legal risk and marketing risk. There can be very significant losses."

At the peak of the real estate boom, Harkey said, he managed $500 million from 3,000 private investors. The company, he said, made millions of dollars by charging fees to borrowers and by keeping a portion of the interest payments.

His company's website lists several examples of hard-money success stories: apartment buildings, a medical center, an automobile dealership, all launched with Point Center loans that were fully repaid.

Harkey often described himself as a self-made man who reached unlikely success after a childhood of poverty in Belleville, Ark., where his home was on a dirt road and lacked indoor plumbing.

His adult life, thanks to success with Point Center Financial, included all the trappings of comfort and luxury: a multimillion-dollar home in a gated Orange County beach community (Magic Johnson has a place next door), a Learjet for business trips and a fleet of luxury cars including a Bentley, a Porsche and a Jaguar. Harkey's wife was elected last year to the California State Assembly, giving the family political muscle to accompany its financial might.

"I hate the phrase 'rags to riches,' but that's kind of what it was," Harkey said in an interview.

Harkey's path to the hard-money lending industry started when he was teaching school in south Orange County. The mothers of some students invited him to work part time selling real estate and brokering loans. He went to real estate school, passed a test for his license and within a couple of years was making more money from his part-time job than he was teaching.

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