The Perks & Process of Becoming a Private Lender

In this article

For the busy non-real estate professional, I think traditional private lending is a very attractive asset class. It represents an area where you can get returns comparable to, or even superior to, the stock market that are secured by a tangible and valuable piece of property.

Once you have established your relationship with your operating partner or house flipper, it can be a relatively passive endeavor, requiring a few keystrokes and faxes to sign documents and transfer money at the initiation and closing of a project.  

Watch the video below or read on to learn step by step how you too can become a private lender. And find out even more about this asset class in my interview on episode 219 of the BiggerPockets Podcast.

How to Get Into Private Lending

1. Find a Reputable Partner

Without a doubt, the biggest hurdle most busy professionals will face is the upfront relationship building and due diligence required to find a solid operating partner. After all the books and podcasts I had consumed to get a good conceptual grasp on private lending, finally I had to take that next big step and actually attend my first ever REA meetings, shake hands, pass out cards, and network to start the process.

This led to the usual sequence of follow-up calls and subsequent meetings. After that, another first: attending a mastermind session, which ultimately resulted in finding my most reliable house flipping partner.

Besides having a good reputation, he had projects in my local area that I could inspect and a network of existing private lenders that I could talk to. Twenty or so projects later, our relationship has evolved to the point where if he proposes a deal, we often agree to proceed after a couple of phone conversations and detailed emails, documenting the scope of work and after repair value (ARV).

Related: Why You Should Consider Private Lending for Your Financing Needs

2. Limit Your Financial Exposure

At the beginning of our relationship, we had a very traditional financial arrangement where I, as the private lender, would contribute approximately 65 percent of the estimated ARV of the project. 

During the renovation and marketing phases, I received monthly interest payment until the house sold, after which I would receive back my original principal. I think that’s a good place to start for at least the first several projects when working with you’re operating partner.

Having them contribute about a third of the money required to complete the project gives them enough “skin in the game” to align your incentives and push for the project to be completed in a timely manner and on budget. In a worst-case scenario, this leaves you plenty of equity such that you should still be able to recover all of your initial capital and perhaps still make a profit in a foreclosure/sale scenario. 

 

After a few successful projects, the financial relationship can certainly evolve. There have been times, for instance, where my flip partner may be low on cash and a particularly good deal becomes available. In those instances, I have funded well above the traditional 65 percent threshold in exchange for a percentage of the profits when the house sells, as opposed to receiving a monthly payment.

As with nearly everything in investing, this approach is technically more risky, but it’s more rewarding, as well. I would only advise doing it with an established partner with a good track record for success.

3. Make Sure You Have Insurance

The home is your collateral for your capital and must be protected with proper insurance. Depending on the scope of work, you can have subcontractors and workers doing roofing, electrical, plumbing, et cetera. Accidents can and do happen, so liability coverage is a must.

Likewise, if the home were to burn to the ground or even just partially suffer fire damage, it could leave you with a structure worth much less than your loan amount. Therefore, fire coverage is also a requirement.

Related: My Investment Property Burned Down—What Now?!

Be sure that you, as the private lender, are named as an additional insured party on these policies.

The Bottom Line

In conclusion, private lending ticks a lot of boxes for me as an investment. It’s readily understandable, and it offers security for your capital and an attractive return profile. 

If the upfront work and due diligence are too much of a hurdle at the moment, I would encourage you to check out my article on real estate crowdfunding, “Crowdfunding Platforms I’d Recommend Based on 3 Years of Investing Across 35 Projects,” which removes this hurdle while introducing a unique set of risks and precautions. 

 

Note By BiggerPockets: These are opinions written by the author and do not necessarily represent the opinions of BiggerPockets.