Is Private lending the only true passive investment?
Many gurus and online ads talk about passive income. Unlike flipping or owning real estate, private lending is one of the most truly passive investment options. When you become a private lender, you leave all the active portions to the owner of the property and, in theory, you just sit back and reap a healthy return on your money. Some private lenders can easily make double digit returns but as your return rate goes up, so does your risk!
What is private lending in real estate?
Private lending lets you become the bank. For those wanting to borrow the money, it can be a way to fund their investing when banks don’t want to lend on a certain property or project. As a lender, you have to ask yourself, why doesn’t the bank want to make this loan? There are many reasons. Banks tend to be very conservative and are highly regulated. They also have extremely high operating costs so most will not make loans under $50k on real property. They also will usually not lend on assets such as distressed properties, manufactured homes and other niche properties. For borrowers, if you can get a bank loan, that is usually the best rates but sometimes the biggest returns are on highly distressed properties or unusual properties.
For borrowers, if you can get a bank loan, that is usually the best rates but sometimes the biggest returns are on highly distressed properties or unusual properties. And private lenders can usually move fast; like 2-3 days instead of 45-60 or more days for a traditional bank loan. This gives these borrowers a distinct advantage over other buyers. If you’re trying to stop a foreclosure, speed is of the essence. Yes, private money can be expensive but if you buy right and factor the costs into your investing, it can actually be cheaper than banks.
A private lender can use their own personal funds or a Self-Directed IRA (SDIRA) to lend to an investor. Just like a bank, they set the terms including interest rate, payment schedule, length of the loan, points, fees and any other terms necessary to make them feel comfortable giving the loan. In real estate lending, the lender is then given a lien against the property to secure their loan. They have the same rights as any other lender to foreclose or take back a property if the borrower defaults. Here, the asset is key as many private lenders will only loan up to a certain amount of the asset value; i.e. if the property is valued at $100k, the lender may only want to give up to 70% of the value of the property.
But what is the risk for lenders?
As I mentioned, these can be risky loans for several reasons. The borrower may not be able to obtain a bank loan because of their credit. The property may be highly distressed, etc. The biggest risk is that they would end up with the property if the borrower defaults. That is why private lenders need to decide on their risk factor and what would they do if they had to foreclose.
How passive is it?
Private lending can be extremely passive! You get the request from an investor, you agree on the terms, you have your documents drawn up by an attorney then send your money to the Title company or closing attorney. All from your living room! or anywhere in the world. I’ve done this all by email and online signing services before. However, many private lenders are much more active in their lending. I know several who insist on inspecting the property, meeting with the borrower, getting appraisals, inspections, full loan packages, etc. They then keep a close eye on the progress of the rehab and sometimes will only lend in stages or draws. These are extreme cases and usually only on highly distressed properties that need a great deal of repairs. But, as I said, these riskier loans can offer the highest returns.
Contact me if you want more info on passive income opportunities in real estate.