550FAST has been working with a handful of private money lenders in which we have established and built strong relationships with over the last 10 years. Please contact our offices if you would like to discuss the real estate investment opportunities we offer our partners. We would love to speak with you about fast and easy opportunities to grow your wealth through real estate investing.
Private Investors seeking alternatives to the stock and bond markets can find more opportunities in private lending (aka hard money lending). If you understand the basics and perform the adequate due diligence for each deal. You can earn solid returns while minimizing your risk as a private money lender. The returns can be sweeter in private money loans (compared to pushing a button to buy or sell a stick) because it requires a little more patience. And if you are willing to focus and put in the time to learn how it works, you can hit home runs most every time you bat! So let’s do exactly that – learn the game of lending.
At its heart, investing in Private Money Loans is a lot like investing in a bond, which returns a fixed yield and pays off at maturity. With real estate investment opportunities, maturity is often much sooner.
Example: If you make a loan to a borrower for $100,000 at 8.00% – 12.00% interest, and require interest-only payments, you will earn an income of $8,000-$12,000 every year. Though typical turn around times are often shorter than 6 months. And if the borrower does not default, the loan will pay off at or before the maturity date, and the original invested principal will be returned.
Tip: If you make a loan to a real estate investor who is in the business of flipping property, you should offer to lend the total project cost (acquisition of property plus renovation cost) only if the investor comes to the table with 10% down. To fully capitalize on your real estate investment opportunities you should only lend entire cost if the investor has a proven track record with projects and investments. Having experience working with many private money lenders and fellow investors, you will also want to make sure the real estate investor provides you with the appropriate due diligence -proving why the flip project has the highest chance to succeed. These should consist of supporting comparable properties supporting claimed ARV (After-Repaired-Value) and estimated project costs.
When researching how to lend capital to others for a yearly return, you’ll discover a few important factors that make the private loan investment considerably more involved than a bond investment. If you can master these, then you can find success in all the real estate investment opportunities you get involved in.
- Liquidity. If you think you’ll need the money that you expect to invest before the maturity date of the loan, absolutely do not consider becoming a private lender. Even though most loans payoff, there is a chance that it may not pay off as expected. In the event that you do need your invested capital returned prior to the maturity date, you can try to sell your loan using an online loan exchange such as LoanMLS, or offer it to another private investor for sale through a hard money loan broker. However, keep this in mind: performing and non-performing private money loans are typically sold at a discount, so be prepared to take a haircut on the amount of capital returned to you.
- Collateral Valuation. This is where you mitigate risk! The underlying collateral for a hard money loan is very important to your overall security and participation in the transaction. To make the most educated and informed decision on your real estate investment opportunity, be sure to carefully evaluate the value of the collateral and use several sources to make your valuation. A common mantra among private money lenders is to “drive the comps yourself.” That means do not just look at photos of the comparable properties and make your consideration. Make sure the the comparable properties are within .25-.5 miles (in most cases) or more preferably that they are in the same “sub-area” as the subject property. You will also want to make sure that the comparable properties are within 10% of the same square foot or that appropriate adjustments have been considered in the evaluation to support the estimated ARV. Another item that should be considered during evaluation is adverse conditions in comparison to the supporting comparable properties, such as maybe an apartment complex or retail space adjoining the property amongst others. In addition to an appraisal and driving the neighborhood and comparables, consider using an Automated Valuation Model in which you utilize google street view to virtually drive the neighborhoods.
- Advances. Some loans regarding the specific real estate investment opportunity may require that lenders advance additional funds for a variety of reasons. Advances may be required to cure delinquent property taxes, cure a senior lien position, hire an attorney, pay to defend bankruptcy claims, or even renovate and re-model a property if a foreclosure occurs. The lesson here is do not invest in hard money loans without leaving yourself a cash cushion. Take a conservative approach and leave plenty of liquidity in your personal finances to handle unexpected circumstances.
- Private Lender Insurance. In order to protect your real estate investment and to see the most ROI from the opportunity at hand, make sure the property owner has the appropriate fire and liability insurance in the amounts to cover the entire amount of the principle of the loan. The insurance company must also be notified to include you as an additional insured on the policy. So making sure that the investor secures an insurance policy prior to closing and names you the private money lender as an additional insured, is very important.
- Documentation. The single most important item next to being properly insured, is making sure that the loan is secured against the property which is done with a Mortgage or a Deed of Trust depending on the state that you are lending in. These can often be created through the Title Company on the state approved forms. It is important that these contain the specific terms of the loan that is being made, and that the lien position is clearly defined in the documents.
Servicing Your Loan
There are generally 2 ways that interest is paid on Hard Money or Private Loans. 1) Monthly as interest only payments or 2) Accrued at the time of the sale or payoff of the loan. If you do not desire the monthly cash-flow, it is often more convenient to allow the interest to be accrued and paid all at once.
What Happens If A Borrower Doesn’t Pay?
If a borrower does not pay on your real estate investment opportunity, investors must be prepared to go through a foreclose process to claim the collateral. This will be an involved process and one that an attorney will most likely need to be involved in. If you are working with an experienced investor with a track record this is of minimal concern.
Befriend Another Lender
Private lending can provide returns substantially greater than those generally found anywhere else (i.e. stocks, bonds, mutual funds, etc). And now that you have discovered the business of private money lending, take your time to fully understand the nuances, ins and outs of the business, and most importantly, your investing personality. Only then take the next step of identifying and capitalizing on opportunities.
A great way to get started and to learn more is to seek the help of other private money lenders who are already in the business of providing loans to investors or investors that are already working with Lenders. In the past, these individuals were referred to as hard money lenders, loan brokers, or also mortgage loan originators. The term “private money lender” describes a highly sophisticated business person originating private money loans.
If you’re searching for the next opportunity, why not look into real estate investments? For more information on the benefits reach out to a hard money lender. The services of a private money lender are invaluable and they will help walk you through the transaction. Most investors who are real estate professionals maintain life-long relationships with their private money lenders just as business executives would maintain a relationship with their financial advisors. When you work with investors as a private money lenders, you should be aware of the various methods you can invest in loans and the pros and cons associated with each method.
- New Loans. The new loan can be for either the purchase or construction of a new property or for the renovation/rehab or refinance of existing debt on a property.
Pro: In this scenario you are lending specifically to one party and have control over origination, documentation requirements, terms, servicing, etc. You will not have potential liability for a previous originator or servicer’s mistakes. If this is a new loan made to a previous client you have the previous performance history readily available.
Con: If this is a new client, there will be little to no prior payment history on which to base a lending decision. You will have to rely upon the past performance representations provided by the investor or on the accuracy of conversations or reports from previous lenders. Remember these are asset based loans which are generally based on the equity position of the property and rate of return on the investment.
- Buy Notes. For most real estate investment opportunities, private money lenders can also purchase loans that have already been originated. When you buy loans from private money lenders (either performing or non-performing), they can be purchased at face value, at a discount, or if it’s a great loan (high yield, low LTV, great borrower), at a premium.
Pro: There is a performance history that can be analyzed and evaluated. For non-performing loans, a combination of solid valuations for collateral and deep discounts at purchase can provide excellent yields for an investor who is willing to go through the foreclosure process. Some notes, while currently non-performing, may either payoff to avoid foreclosure or be “rehabbed” and restructured to become a performing note in the future.
Con: You can potentially buy an existing liability if the note was not originated or serviced properly. Non-performing loans may force you to foreclose to recoup your investment, this can be a lengthy and costly process. In addition, your due diligence process will always be at the mercy of the records available from the current lender.
- Pools of Loans. The process of buying a group of loans in one transaction.
Pro: You will get a much better discount for buying loans in bulk for any real estate investment opportunity you come across. And for performing loans, there are established performance histories to evaluate.
Con: Files may not be readily available to conduct due diligence. Buyers are often rushed to make a bid when evaluating numerous loans across different cities and states. This only means one thing: it’s easier and more likely for mistakes to be made in the analysis. For the privilege of buying in bulk, you’ll get some good loans at a good price, but you’ll also likely get some duds.
- Syndicated Capital. There are companies that offer opportunities to pool together funds from many private money lenders and create a single entity to loan money.
Pro: You don’t have to make individual loan decisions as these are handled by a pool manager and your investment is diversified across a wide variety of loans.
Con: You can’t foreclose and liquidate just one loan and may be subject to the entire pool closing before you can get your funds liquid. For this specific opportunity regarding real estate investing, It’s important to know that your success is directly tied to the success of the pool. If the pool manager makes poor decisions, it will jeopardize the stability and return of the entire fund.
It can be difficult to sell your position once you invest. The pool manager will only be able to accommodate your request if another party is interested in investing.
- Fractionalized Loans. Similar to a pool, but in the case of a factionalized loan, private investor funds are gathered and vested on the security instrument. For example, if a borrower required a $1 million loan for a shopping center, the note may be fractionalized across 10 different investors, each investing $100,000. All 10 investors would be vested on the recorded security document.
Investing in a factionalized note is different from investing in a mortgage pool. In the factionalized note, all investors have an interest in a singular note. When the note liquidates, the investment liquidates. In a pool, members have an interest in the overall pool and not a particular note.
It is common for fractionalized transactions to be structured in an entity such as a limited liability company (LLC). This way, the 10 members from the example above would be members of the LLC and the manager (typically the note originator) is responsible for decisions about the note. It is commonplace to see transactions which are structured in this manner because it can avoid a conflict when decisions about advances or foreclosure have to be made on the real estate opportunity. If all private money lenders have equal interest in a note, all members must agree on every course of action and with the LLC in place, the manager can make decisions in the best interest of the group as a whole.
Pro: Investors can diversify by investing in multiple fractional transactions instead of all funds in one bucket.
Con: Everyone in the fractionalized group must agree on foreclosure and advances, unless the transaction is set up as an LLC with a specific individual named as the manager. If any one member does not agree, or cannot advance needed funds, it could create problems detrimental to the real estate investment opportunity.
- Junior (2nd Position) Liens. You can earn higher returns by buying seconds or other junior liens, but the risks and complications of servicing escalate substantially. Junior lien investments are not for the faint of heart. You may be called upon to reinstate the 1st, payoff the 1st, or, if the market drops or a bankruptcy is filed, your likelihood of being wiped out entirely is much greater than a 1st lien position.
Pro: Higher rate of return and less initial cash outlay.
Con: Significantly higher risk. If a borrower defaults on the first mortgage, you may have no choice but to bring the 1st mortgage current or pay it off to protect your investment. A declining market could turn the property upside down unless you are able to “ride it out” until the market swings back. A bankruptcy filing by the borrower could also easily wipe out your real estate investment opportunity completely as first liens will take priority over you in the proceedings.
Overall, there is no “right” way to invest in loans. The only thing you can control is a relationship with private money lenders you have researched and or established a relationship with, feel comfortable with, and trust with your investment. Remember, there is no substitute for your personal due diligence, whether it’s on the borrower or on the property. Rely on proven professionals for advice, but make the private lending underwriting decisions yourself after careful due diligence.
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550FAST has been working with only a handful of private money lenders in which we have established and built strong relationships with over the last 10 years. Please contact our offices if you would like to ever discuss in person how we work with our current and longstanding lending partners.