Private Lending
I have a passion for real estate. I’ve owned rental properties and have successfully flipped houses for a significant profit. However, currently, I don’t have rental properties and am not flipping houses. The local real estate market is too competitive, and I avoid getting into bidding wars. I’ve recently discovered another way to invest in real estate through private lending.
I lend money to investors looking to purchase properties. I’ve made a total of 255,000𝑖𝑛𝑙𝑜𝑎𝑛𝑠𝑎𝑐𝑟𝑜𝑠𝑠𝑡ℎ𝑟𝑒𝑒𝑠𝑒𝑝𝑎𝑟𝑎𝑡𝑒𝑡𝑟𝑎𝑛𝑠𝑎𝑐𝑡𝑖𝑜𝑛𝑠.𝑇ℎ𝑒𝑠𝑒𝑙𝑜𝑎𝑛𝑠𝑔𝑒𝑛𝑒𝑟𝑎𝑡𝑒𝑜𝑣𝑒𝑟2,000 a month in interest income alone. My experience with private lending has been very positive, and I’m looking to invest in more transactions.
Private lending allows me to diversify my portfolio into real estate without the hassle of managing properties. I earn a substantial interest rate while helping investors meet their short-term capital needs.
One of my initial questions about private lending was:
Why would someone with good credit borrow from me at rates as high as 10% or more? Why don’t they just go to a bank?
There are good reasons why investors turn to private lending:
- Properties must be rent-ready: Most traditional lending institutions require a property to have a year of rental history before issuing a loan. Private loans fill this gap.
- Very short loan terms: Flippers usually want to be in and out of a property within a few months. Dealing with banks is too cumbersome for such short holds.
- Urgent need for capital: Banks can take weeks or even longer to disburse funds. Private lenders can often provide capital in just a few days.
Key Considerations:
- First Lien Position: The worst-case scenario for a private lender is the borrower defaulting. Always ensure you are in the first lien position. This way, if the borrower stops paying, you can foreclose on the property.
- Loan-to-Value Ratio: You want to be in the best position to recoup your funds in case of default. I require an LTV of no more than 70%. So, for a property worth 100,000,𝐼𝑤𝑜𝑢𝑙𝑑𝑛′𝑡𝑙𝑒𝑛𝑑𝑚𝑜𝑟𝑒𝑡ℎ𝑎𝑛70,000. This allows me to sell the property below market value to quickly recoup funds.
- Interest Rates: Rates typically start at 10% and can go as high as 18%. Many lenders also charge 1 to 10 points of interest. A point is 1% of the loan amount.
- Credit Score: This isn’t as important as you might think. Since you are in the first lien position, the deal is secured by the property.
Tax Advantages: Self-directed 401(k)s allow you to make private loans from a tax-sheltered account. If you have self-employment income, consider this option seriously.
Evaluating Deals:
- Experience: Has the borrower completed at least ten transactions, or is this their first? Does the borrower have the organization and professionalism? Have they written a business plan? Are there estimates for repairs?
- Crunch the Numbers: The property might not be in your area, and that’s okay. But you need to ensure the numbers are solid. Request photos of the property and research home sales in the area.
- What’s the Plan? How will the borrower handle the property:
- If it’s a flip, do they have contractors? If they are doing the work themselves, do they have the experience? Are local regulations permissive? Are permits required to be pulled?
- If the property will be rented, and the homeowner plans to refinance, what’s the timeline? What happens if the borrower can’t refinance? Would you have an opportunity to provide longer-term financing for the property?
Finding Opportunities:
Private loans are typically made between parties with existing relationships. The borrower might be a friend, family member, or someone with whom you have a business relationship.
I also encourage you to make connections outside of your normal network. A great way to do this is by being active in forums like BiggerPockets. While you must sign up for an account, membership is free.
Private Lending: Pros and Cons
Private lending is an excellent way to build wealth. Just remember to do your homework. Thoroughly understanding the deal before taking action is crucial. Do your due diligence!
Pros:
- Healthy Interest Rates: Short-term loans (1 year or shorter) start interest rates at 10% and go up from there. I’ll never complain about earning 10% interest.
- Control: The investment is directly under your control. You choose who to lend money to.
- Collateral: If the borrower stops repaying, they will lose the property and assets. This is a strong incentive for the borrower not to default.
Cons:
- Upfront Research: Private lending requires homework. You need to assess the deal and the borrower.
- Are you putting all your eggs in one basket? Diversification is important for any portfolio. Ensure a single loan doesn’t eat up a significant portion of your investment.
- Poor Liquidity: While private loans are short-term, your funds are tied up during the loan period.
If private lending sounds too cumbersome, crowdfunding is another way to dip into the real estate market without the hassle of owning actual property.
Crowdfunding: Pros and Cons
Crowdfunding platforms offer an innovative way to invest in real estate without the hassles of property ownership. Just remember to do your due diligence.
Pros:
- Experts back you: Deals offered by crowdfunding platforms are vetted by experts.
- Their REITs may perform better than traditional offerings: Due to the focused nature of Fundrise and RealtyMogul REITs, their returns may be better than traditional REITs.
- Diversification: I’m a big believer in index funds and the diversification they bring. Crowdfunding platforms, especially REITs, bring diversification to real estate.
- Access to real estate typically unavailable to retail investors: It’s hard for retail investors to buy commercial real estate and land.
Cons:
- Risk: Crowdfunding platforms are startups and haven’t been tested through an economic downturn.
- Higher Fees: Management fees are higher than low-cost index funds or traditional real estate investment trusts.
- Poor Liquidity: REITs have quarterly redemption options, while private offerings have longer terms.