When we talk about investing, there are two important components. First you want return of your money, then you want a return on your money. The return of your money bit is all about safety. Oddly enough, some of the investments that people accept as safe are the exact opposite of safe.
Let me start off with a guaranteed money loser. What makes this money loser so appalling is that most people view it as a safe bet. A bank savings account is a sure loser. I am 100% sure of this. While your money is in the bank making some pathetic return, the inflation rate is outpacing your rate of return, absolutely, 100%, guaranteeing you a loss in purchasing power. Stated differently, you have been sucked into a trap where your money loses value faster than the false return that the bank pays you. In the immortal words of P.T. Barnum “there is a sucker born every minute”. You are making a private loan to the bank. The bank is lending your money out and paying you a pathetic return in exchange for keeping your capital in this pit of doom. Your money loses value while the bank makes a profit on your money, yay. A Certificate of Deposit or CD is just a fancy word for a savings account with a slightly less pathetic rate of return. You will still lose value, and you have limited access to your money, but you do get the privilege of saying that you have money in a CD to go along with ¼% interest.
Stocks and bonds are gamble. You might make money, you might lose money. I don’t like that sort of risk at all. In the bond market you are placing your bet that the large corporation or government entity will not go bankrupt before your bond comes due. The federal government is literally trillions of dollars in debt, and they are a shining star compared to most municipal governments. Do you really want to bet your money on those people? Corporate bonds are even riskier, anyone remember when Ford Motor Company defaulted on ALL of their bonds?
Stocks aren’t much safer than bonds. A stock is a tiny, tiny, tiny little portion of an ownership stake in a big company. The gamble here is that you are betting on the continued success of a company, yay. You don’t control that company. You don’t control their competition. You don’t control government regulations that might affect that business. You also have no ability to verify that the numbers on the stock reports are even accurate. Anyone remember Enron? At the core of the stock problem is that the stock itself has no intrinsic value. If the market crashes or the company goes under, you own a worthless piece of paper. Some people attempt to mitigate this risk but buying a basket of stocks called a mutual fund. This mirage actually removes you from even knowing what stocks you own, and adds another layer of risk. You are now betting on the success of a fund manager who is competing with every other fund manager on the planet.
This brings me to real estate. Real estate has value. No matter what happens to the economy, people will always need a place to live, and they will always pay for a place to live. Real estate value is never zero. Compare that to the bank account where you actually lose money, or the stock and bond market where you can go to zero without any control over your own investment.
Investing in real estate does take time. You don’t just walk up to an office and hand over a pile of money. You need to seek out individual investment, evaluate them, and the verify all of the information that you are basing your investment upon. Real estate investing is not a lazy man’s game.
To my lazy friends who seek safety, I say to you, do not lose hope. There is a way to invest in real estate, without all of the effort of constructing and overseeing real estate deals, while still getting safer and higher returns that the bank or stock markets. What I am describing is the world of private lending.
Private lending can be the greatest thing since sliced bread for anyone who is interested in passive investing. You do need to put forth some effort and no investment is without risk, but if you do your due diligence on the front end, you can make a very good return on almost any amount of money.
The risk factors are where you need to focus before you get involved as a private lender. The first thing you need to investigate is the investor who you are are placing your trust and your hard earned cash with. You need to ask two very important questions. Can you trust this person? Do they know what they are doing? Assuming that you are speaking with an experienced investor and they have a good reputation (check to see if they have a criminal record). Then you need to look at the deal they are proposing. Even the best investors have a limited amount of their own capital to invest. Successful investors are always looking for private money loans, and they will welcome you to the business.
The deal is where you build in your safety catches. First off, you need your money to be secured by a note against real property. No IOU’s attached to nothing. You need a legally enforceable note, and you need to have it registered with the local municipality. That will allow you take the property back if the investor screws up.
You also need to see the numbers on the deal itself and those numbers need to make sense. The numbers need to indicate that this a profitable deal. If you are funding a purchase and the purchase price is market price, then it is going to be impossible to resell the house at a profit.
As a rule of thumb, you need the purchase price and repairs to be less than 70% of the after repaired value. That is the absolute maximum that you can be into this deal with a relative amount of safety.
What I have described above is the traditional private money loan but not the only type of private money loan that you can get into.
In the commercial end of real estate, you can participate in syndications, joint ventures, and limited partnerships where you place your money into an investment and get an equity share of the deal. This sort of investment is generally but not exclusively limited to investors with $100,000 or more to invest. I have actually seen deals where you can get into equity investing as low as $25,000. A recent example that I helped put together gave a group of investors who raised $4,000,000, 55% control over a $20,000,000 hotel deal. This sort of disproportionate ownership of a large deal happens all the time in the commercial real estate world. This is just another way to be a private lender.
You can also become a private lender in cash flowing single family houses by doing a join venture ( a sort of one time partnership), where you put up the money and the other person locates, negotiates, and secures the property, then you share an agreed upon percentage of the deal. I can actually spend a lot of time describing ways to do private lender type deals, but I am pretty sure that I have made my point. Anyone can be a private lender.
One of the sexiest things about private lending is that you can use IRA money to do it. You are not limited to your cash on hand. You can easily convert your IRA accounts into a self-directed IRA and use those funds to invest passively in real estate as a private lender.
I would like to keep writing but I just got myself so fired up that I need to go out and find some more deals.
@Josh Caldwell Great post!
@Josh Caldwell thanks! I like your post.