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Private Lending: Pros and Cons

by Ken Corsini on October 3, 2012 · 5 comments

  
private lending

One of my investors called me up today and told me he had decided he was ready to get into the lending business.  He had already purchased a number of properties over the last year or so and was ready to diversify his real estate investing strategy. Part of his decision making process had to do with the tedious financing process he had experienced when buying a property a few months prior, but I think most of the decision had to do with a desire to branch out into an area of real estate that has great earning potential with very little effort.

While private lending is not for everybody, I’ve found that real estate investors who are cash heavy tend to lean towards this type of opportunity.  This type of investor usually falls into one of two camps: An investor who simply doesn’t want the hassle of owning properties and dealing with tenants, or the investor who has already acquired a healthy number of properties and simply wants to diversify.

While there is not a right or wrong answer as to which investing strategy is better, it is worth analyzing owning versus private lending.

Here are some Pros and Cons of Private Lending:

PROS

  • Private Investors can typically earn over a 15% annualized return on their invested money.
  • Private lending is typically very secure in 1st lien position on a physical asset such as a property.
  • If the loan defaults, the lender has the ability to seize the collateral (property) through foreclosure.
  • Private lending allows an investor to invest funds in real estate without the risks and headaches associated with flipping and renting.
  • Private lending is typically short term so investor has the ability to move the money in and out if desired.

CONS

  • Private lending does not have the same favorable tax advantages that owning does (i.e. mortgage interest deduction, 1031 tax free exchange, etc.)
  • While private lending does produce tremendous yield (actually better than most cash flowing rental properties), it does not appreciate the way an owned asset does.
  • Longer term lending can be at risk of inflationary loss.

While this is a relatively high-level analysis, it is important to understand the benefits of one investing method versus the other. In my dealings with investors, it seems like a blended approach works well. I think it is important to own property and get the tax and appreciation benefits that come with it. However, I also like the secure high yield returns that can be obtained from private lending as well. Finding some balance between the two really depends on the goals and risk tolerance of the investor.

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{ 5 comments… read them below or add one }

Dale Osborn October 3, 2012 at 1:30 pm

Ken: I have been considering looking deeper into this as we have had rental property since 1982 and have self-managed the properties. We are now looking to step out of the properties and look at the private lending sector. Will probably be a few more years before we do this, but will keep checking as to any special requirements. Nice summary of the pros and cons of getting into private lending.

Dale

Reply

Brad Friesen October 4, 2012 at 9:57 am

Great post Ken! Thanks for sharing.

Reply

Joshua October 4, 2012 at 11:33 am

@Dale:

Hi Dale, I’m a young RE investor and my problems is coming up with cash to acquire more high quality properties faster. I’d love to find someone like you who’d rather just lend the funds and let me handle the property acquisition and management portion of the business so I can grow faster and provide you with as safe an investment as possible.

Perhaps you and I can network and speak more about this over email if you’re interested?

Reply

Tracey October 7, 2012 at 9:36 pm

Ken,
Great information on private leading.
Thanks for sharing
Tracey

Reply

Eric Howard October 8, 2012 at 7:54 am

great post I’m a fairly new investor in the real-Estate world I’m currently looking for more investors to work with.good plan

Reply

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