Profiting as a Real Estate Private Lender

Real estate investing does have its risks, but with a properly structured deal, the risks can be kept to a minimum, making the return on investment reach maximum potential.  A private lender should never allow their investment to be the down payment on a property.  Instead having a seller held second if a down payment is still needed is a better option, but it should not be lender money.  A second position is riskier than a first position but a down payment position, the money is not secured by the asset and possibly not collateralized.

There can also be a primary position coupled with being an equity partner.  As an equity partner, a private lender will contribute to the down payment in return for a percentage of equity in the property.  This strategy tends to lessen any down payment issues since it’s shared, while reducing risk of the down payment money by having an equity partnership in the property.

Syndication is also a possibility if you have a group of people wanting to invest and everyone in the group is contributing varying amounts of capital.  If an equity position is also in play, then the syndicate would be the equity partner, not just a few of the members.

The other consideration for impact on your return of investment would be fees.  Fees accompany many investments such as CD’s, Stocks, bonds, etc.  Those fees can cut into your final profit.  With private lending, secured by realty, there is a tendency to not have maintenance, origination, or any other type of fees involved.

In conclusion, as a private lender, after being presented with a deal, then checking the numbers for yourself, remember to keep in mind:

• The cost of money
• The impact the cost of money will have on your profit
• Level of risk
• Covering the downside if the loan should go bad
• The profit/ return of investment

These are just a few tips for being a private lender in real estate with minimal effort.  Keeping these tips in mind may aid in the reaping of the rewards on your investment. 

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Private Lending Tips: Sunday Morning Thoughts 15 May 2011

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So you have decided to become a private lender.  You have considered many options on the types of deals you will choose to provide lending.  You understand that private lending is not a REIT, but is more like being the bank.  There are things you should keep in mind when private lending.  This is a short list given in a series of posts.  As you become more familiar with lending you will without a doubt make a few additions to the list for yourself.

Cost of Money

Level of Risk

What to do when a loan goes bad

Profit/ Return on your investment

Cost of Money:  How much is money costing you as a borrower?

You should not use your life savings.  This should not even be considered as a viable option.  Keeping a reserve is even a strategy Warren Buffett utilizes.  Answer a basic question-how much can you afford to lend and at what cost?

Borrowing to lend is a viable strategy; many people use the leverage of other people’s money to make money.  An example, a homeowner buys a house then takes out a second mortgage to pay off credit cards, cars, and to free up currency.  They are making payments on the second mortgage but are saving money in interest and possibly receiving tax advantages.

You can use a line of credit if you own something which can be used as collateral, such as a house, property, etc.

Using your IRA is also an option.  When using your IRA the profit goes back to the IRA aiding in the building of your future savings.  With an IRA you are using the money in the IRA versus borrowing against the IRA.   For more on IRA account usage please read our past post.

What is important to remember, how much interest you are paying on the money you are borrowing, and then subtract that from the interest you will gain from the lending.

For example you are the private lender, and are looking to earn passive money.  You do not wish to own the property but would like an investment with a decent return, something better than a CD.  You find an Investor who has a deal which needs funding.  The investor offers you 8% interest on terms for the use of your money to quickly close a profitable deal.

For arguments sake, let’s say you as the private lender decide to use a line of credit from your property to fund the deal.  Always remember you will be responsible for the repayment of the line of credit.  The investor as a borrower from you is responsible to repay the loan you are extending to fund the deal. If the bank gives you a line of credit with 4% interest and you loan the money to the investor at 8% interest you will have made a 4% earning on the difference in loans.

In short borrow for less interest than you loan.

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Neutral Arbitrage and the Effect on ROR: Sunday Morning Thoughts 19 December 2010

Quick recap, positive arbitrage is when your investment return increases with financing.  Negative arbitrage, your investment return decreases with financing.  Neutral arbitrage, your return on investment does not change with financing.

So how can an investor have positive or neutral arbitrage, picking the right loan is key to having a better rate of return.  When considering commercial property, such as multi-unit apartments, a low to no interest loan is best.

Interest only loans were only meant to have a life of no more than five years, after five years the loan could become upside down.  In today’s credit climate having a no interest loan would be difficult.  Lenders were admonished by the government for offering what is known as an investor’s loan to the average American.  This offering to the average person caused many to be in over their head at the time of the loan reset, contributing to our current foreclosure crisis.

All three arbitrage can be present when private lending, of course not at the same time; it just depends on the deal.

Related Articles:

http://backedbyrealestate.com/2010/11/14/arbitrage-and-real-estate-sunday-morning-thoughts-14-november-2010/

Negative Arbitrage and the Effect on ROR:  Sunday Morning Thoughts 12 December 2010

Arbitrage and Real Estate: Sunday Morning Thoughts 14 November 2010

Arbitrage by definition: The practice of taking advantage of a price difference between two or more markets striking a combination of matching deals that capitalize upon the imbalance, the profit being the difference between the market prices.

And there you have it, a way of making money in real estate in a nutshell, now let’s crack it open and see what’s inside.

An example of simple arbitrage and real estate, making money on the difference as a private lender, would be if you did not have the funds but you have a wealthy Uncle with the funds.  The Uncle loans you the money at 2% simple interest then you loan the money to an investor with the collateral being real estate at 8% simple interest.  Not a bad investment.  Your Uncle loaned you the money as a personal loan then you in turn loan the money on a collateralized investment.  The difference of 6% simple interest is your profit.  This is how easy arbitrage works.

Now let’s look at arbitrage with your own credit abilities if the rich Uncle does not pan out.

There are many types of credit you can utilize to perform arbitrage.

Line of Credit from a property you currently own. You use the line of credit which has a low-interest rate then invest in a property as a private lender gaining a profit from the difference in interest.  You can pay a line of credit with the line of credit (read the fine print from your lender to make sure).  You may also have tax benefits, consult an accountant for the specific in’s and out’s.

Credit Offers in the mail, the best ones are the interest free for 12 months or longer.  But be careful to read the fine print, make sure the creditor is not charging a fee for using the credit.  Also make sure the investment you are lending on can be liquidated before the interest begins from the credit offer.  With the use of this type of credit, payments would have to be made, so make sure you can cover the monthly payments with either payments from the loan or from your own source of funds.

Credit Cards you currently have.  Credit card companies send convenience checks to some of their customers from time to time.  Occasionally the use of the check may or may not be interest free for a period of time.  But beware some of the check offers charge a fee, which may be a percentage of the value of the check.

Obtaining a regular personal loan, this may not give you the best arbitrage but as long as there is a difference in interest in your favor then you still have arbitrage.  A personal loan normally will have a specific limit with a payment schedule, so monthly payments are something to be considered.

Which ever way fits your situation arbitrage is a way a private lender can make money in real estate with minimal use of your own liquid funds.  You can make a profit on lending the funds and make a profit on the use of the funds.  So even if you are just thinking about becoming a private lender.