Undoubtedly, active real estate investors have heard about raising private money for real estate projects. Blogs, podcasts, books, and other media share tactics to successfully find this capital and have it fund your real estate investments using other people’s money (OPM).
This magical pool of private capital is much like a secret society with no storefronts, no advertising, and no easy way to search for these lucrative sources of OPM to help you fund your next project. However, what isn’t discussed as often is how to “be the bank” as a private money lender, an often-overlooked source of passive income in real estate. You might be surprised by how easily private money lending can fit into your investing goals and lifestyle.
Most assume private money lending is a niche market reserved for retirement plans and older retired people with millions in loose change. However, private money lending—the act of being the “other” person in other people’s money—is actually a diversification strategy employed by experienced and novice real estate investors alike. There are a few scenarios we commonly see for active investors who are also private lenders, all of which fit nicely into an existing real estate portfolio.
Lend Private Money Instead of Flipping Yourself
The first scenario we will cover is flipping. This flashy HGTV style of investing often involves a lot of time and capital to acquire and renovate a property. As the market changes or possible life events require an active flipper to pause for a period of time, flippers often utilize private money lending to earn some interest income while they take a break between projects.
This capital, which otherwise might sit in a low-interest savings account, is instead used to help fund another investor’s flip project. Flipping will always be an active income source, but why not take a break and earn some passive cash flow by becoming a lender on a project instead? Similarly, an active investor may use a retirement account to fund other investor projects since they cannot lend the money to themselves. Borrowers pay interest to your future self in that case!
As an active flipper grows, they may choose to “graduate” from such a time-consuming activity as flipping altogether and pursue more passive income routes. Private money lending can be one of those strategies! The lack of strict time commitments attracts these maturing active flippers as they search for more relaxed cashflow approaches. As an active flipper, you might be under very tight deadlines, dealing with contractors at the job site, difficulty getting materials, or even finding more problems with the project than initially thought.
A phone call can come in anytime with a potential (and sometimes literal) fire to be put out. In private money lending, rarely is there an emergency moment that must be addressed immediately. This allows an active investor to regain the one asset no one can buy more of: time. When active investors start transitioning to private lending, they still underwrite the project the way they would if they were to purchase the flip themselves. The bonus this time is that they get to sit back and watch the interest income stream in monthly without the hassle of dealing with project budgets, sub-contractors, and supply chain issues.
Lending Money Instead of Managing Rental Properties
Investors who typically use the BRRRR method to acquire and stabilize buy and hold investments are increasingly concerned about how rising interest rates might affect their ability to refinance and maintain cash flow, much less get most or all of their capital back out of the deal. Instead of rolling the dice in a fluctuating market, rental property owners may choose to lend out their capital to other active investors while they wait and see what interest rates will do in the long term. Rising interest rates are good for lenders, and private money lenders are no different!
Don’t think the benefits are just for the active and scaling investor. Landlords who aren’t interested in growing their portfolios can choose to unlock the equity in their investment properties. You can do this through cash-out refinances or a home equity line of credit (HELOC), arbitraging the funds into private money loans and earning a spread on the interest. In other words, if a HELOC is worth $100,000 at a variable interest rate of around 5%, and then you lend those funds out to an investor at 10%, you will earn the difference between these two rates. In this case, 5%.
Landlords approaching retirement age and making plans for their families may also turn to private lending to continue cash flow from real estate without having heirs take on the burden of rental units. If market conditions make selling these rentals attractive, landlords may choose to transition that capital into private money lending to keep the income stream they acquired through rental units. Some landlords may own properties in multiple states and want to downsize to make managing the portfolio easier with fewer vendors needed and less complication with income taxes. These opportunities to pivot make a great segway into private money lending!
Private Lending Can Be a Strong Starting Alternative to Wholesaling
While this is a more sophisticated approach to private money lending using “borrowed” capital, private lending isn’t just for experienced investors. In fact, private lending can be a preferred entry point into real estate for many investors gun shy on the idea of wholesaling. All too often, wholesaling is touted as the best and fastest way to get into real estate with little to no money.
While that may be true for some of the brave souls out there willing to undertake all the actions needed in this multi-disciplined sector of real estate, the fact is that many newbies are often discouraged by how many skills and competencies they must learn to truly be successful in wholesaling. In addition, similar to active flipping, wholesaling requires a near-constant connection with your cell phone as motivated sellers don’t generally make appointments ahead of time to discuss a deal.
Cold calling, door knocking, and negotiating with reluctant sellers can be overwhelming and lead some new investors to seek other entry points into real estate investing. Armed with a “small” amount of cash—perhaps not enough to truly start a flip on their own—investors act as the bank for other investors so they can earn interest income and learn how to underwrite deals along the way.
The Benefits of Learning About Private Lending
Having covered who may consider private lending, there are also numerous benefits to learning more about private lending and incorporating this passive income opportunity into your real estate investment strategy. First, the lender gets to set the rules. The lender can choose how much to charge in interest rates (within state and federal regulations) and the terms and conditions of the loan. Private lenders can walk into any deal knowing ahead of time what they will be making, which likely isn’t possible with other methods of investing in real estate. Many private lenders choose short-term loans offering CD-like liquidity without the ultra-low interest rates currently offered on those types of depository investments. Each time the capital is turned over, it is another opportunity to earn origination points and any associated fees with the loan.
Additionally, the underwriting associated with being the creditor, or lender, on an investment project is similar to the due diligence of the active investor. For novice real estate investors, this is a relatively safe way to learn the ropes while a lot of the heavy lifting is done by your more experienced borrower. Experienced investors looking to get into more passive investing strategies are already familiar with underwriting projects, so the transition from flipper or landlord to lender is smooth.
Private money lending is also a team sport. Active investors may be used to “going it alone,” often shouldering the responsibility entirely for the progression of the project. On the other hand, the lender has multiple professionals to help advise and protect the capital in the loan.
Private money lenders have legal help in drawing up documents for the loan, a title representative to do a title search and assure clear title, a hazard insurance broker to help review insurance quotes from the borrower, and even other private lenders in their network to help balance out their risks and rewards in the loan. If a private lender builds a solid virtual team, many simply become the reviewer of information instead of the collector, which is even better.
Perhaps one of the best benefits of private money lending is that it can be done anywhere at any time. A business in a backpack, if you will.
This isn’t just financial freedom but more of a lifestyle choice. Those seeking more time back in their busy lives but want to make their money work for them in real estate-backed private money lending while living their best life. Most people pursue real estate investing for financial freedom, but most of the time, what they are really seeking is time freedom or even geographical freedom. Their “why” often revolves around wanting to do what they want, where they want, not necessarily having $10,000 per month coming in as income. For those who value time freedom over anything else, building a private lending practice from anywhere in the world is easy!
Even if you don’t feel private money lending is a path you want to explore, learning more about how it’s done safely and securely, from the lender’s point of view, can help you raise private capital. Private lenders will want to work with borrowers concerned with and know how to mitigate the risks associated with being the creditor on the loan. The more acumen you can display to potential private debt partners and share how you can protect their investment through safe and secure lending practices, the more confident the lender will be in working with you.
Armed with the knowledge of how to do private lending, you can share your real estate knowledge with others in your network, potentially making some your own private lender!
All the cash flow, none of the hassle
Learn how to create financial freedom and passive income in real estate as a private money lender. Lend to Live makes passive income through private lending achievable for anyone.
Note By BiggerPockets: These are opinions written by the author and do not necessarily represent the opinions of BiggerPockets.