Private Lending for Real Estate
How many millionaires do you know who have become wealthy by investing in savings accounts? I rest my case.
– Robert G. Allen
The real estate industry has lucrative opportunities available to investors. Becoming a private lender for real estate investments is one such opportunity that doesn’t require much skill or experience in the field. A private lending investment strategy allows investors to earn passive income without the responsibility of day-to-day operations such as maintenance, leasing, and collecting lease payments. Lending also mitigates certain risks associated with a direct real estate investment.
Private real estate lenders lend capital directly to real estate investors using cash-on-hand or with retirement accounts such as a self-directed IRA or Solo 401(k). With private lending, real estate investors take on the larger risk as the “first line of defense” for unexpected costs and expenses while the private lender receives a regular income stream over a set period of time.
PASSIVE REAL ESTATE INVESTMENT
Lending in real estate is generally considered a passive investment. Private lenders, unlike direct real estate investors, don’t need special skills or extensive experience in real estate to be successful. Lenders don’t have to devote a large amount of time and labor to renovating, repairing, upgrading, or constructing. Lenders also avoid searching for properties to invest in, searching for tenants, collecting rent, conducting maintenance, turning over properties for new tenants, or all other work typically associated with owning and managing rental and other real estate investments.
Instead, as a private lender, tasks include, but are not limited to:
Finding and underwriting borrowers to finance
Underwriting properties subject to financing
Securing the loan with a note on one or more properties
Building relationships with borrowers for more lending opportunities
WHY BECOME A PRIVATE LENDER?
Lending is a fairly straightforward process. Once the borrower and lender agree to the loan terms, the lender then funds the deal, the property becomes collateral for the loan, and borrowers receive the title to the property. Unless otherwise agreed, the lender then receives regular monthly principal and interest payments until the loan is paid off.
REAL ESTATE AS COLLATERAL
When lending capital for real estate, the property itself secures the investment. This type of lending is considered more conservative than most other types of lending because the loan is secured by the subject property. If the borrower fails to make payments and defaults on the loan, the lender can foreclose, obtain title to the property, and recover some or all of the remaining loan principal in a subsequent sale. If the lender keeps title instead of selling after foreclosure, the property may become a direct real estate investment and, depending on the property, provide monthly rental income and has the potential for equity growth.
GENERALLY CONSISTENT RETURNS
Private real estate lenders prefer lending over investing directly in real property because of the nature of the investment and returns. Lenders can use a retirement account, such as Solo 410(K) or self-directed IRA, or cash-on-hand to invest in real estate and earn more consistent and stable returns on average than many other active and passive investments.
Private lenders frequently earn a higher rate of return than saving accounts, CDs, and other conservative investments. In 2020 and depending on the local market, lenders can expect to earn between 6% and 8% for long-term funding with qualified and reputable borrowers. Funding higher-risk borrowers such as “flippers” (people who purchase properties with the intent of fixing them up and then selling them for a profit) may increase the potential rate of return in exchange for the increased risk of default. Lenders with trusted and repeat borrowers find that this strategy can be an excellent way to grow a retirement account, increase passive cash flow, or provide retirement income.
Stock market investment relies on the hope that share prices will go up and dividends will be disbursed, but even conservative investments can be unreliable. Although some investors can grow a large portfolio of stocks, many investors take significant losses when the market takes an unpredictable turn. Even equity investments with a history of consistent dividends can’t be relied on from quarter to quarter to provide returns. It is illegal for a corporation to issue a dividend when doing so would result in a net loss. Thus, returns on equity investments are unpredictable. However, private real estate lenders stipulate in a contract how much they are to receive for their investment, generally on a monthly basis.
PREPARING TO BECOME A PRIVATE REAL ESTATE LENDER
While there is always a risk of non-payment, default by the borrower, or a dip in the real estate market, in many cases private real estate lenders receive a predictable monthly stream of income that comprises principal and interest over a specified period. If an unexpected change in the market, a sudden expense on the property, or a loss in rental income occurs, the borrower is in the first position to take the hit. A well-underwritten borrower will generally have the staying power and capital to endure and continue making payments despite negative conditions. Lending private money for real estate ventures offers exciting opportunities because it is designed to build wealth and because it provides borrowers a straightforward avenue to access funding.