Solo private lending startup, seeking constructive feedback

[John B.]

Hello BP community,

Midwest here with a business plan and lots of questions. I’ll number them as I go since I know you all love that! First some background: I have never directly invested in real estate before outside of owning/renovating my own homes.

Over the last 6 months I’ve spent ~120 hours (and continuing always) educating myself on private lending, the different capital structures and deployment strategies. This self-education is built on top of almost 10 years cumulative experience operating two small service businesses (very small scale single-member LLCs), and what feels like a lifetime of rehabbing personal residences (3 homes, 2 of which were gut rehabs). I’m no longer involved with those businesses so have ample time for focusing on this lending idea.

I consider myself “semi-sophisticated” when it comes to investing, and also enjoy learning about legal processes and theory. I do not have any formal education or training in business or finance, just a general college education. I am slightly obsessed with real estate and know my local area well. I have a basic understanding of how closing works (have sat at the table twice), the local foreclosure process (non-judicial state here), and loan agreements.

     What I’ve decided so far: To operate as a PML for real estate investors and flippers/BRRRR'ers. Will use strict parameters like no out of state properties (at least until I'm experienced enough that I can confidently analyze remote markets, might be willing to travel for this once established), commercial use only loans with borrower signed affidavits, collateralized by the property and secured by deed of trust with first position liens only, made only to entities with EINs and no layered structures unless ownership is verified, with conservative underwriting such as 65-70% LTV, cash reserves to cover interest payments + 15% project cost etc…

     With all that said, I’m aware some aspects of private lending might only become clear through experience. Doing the thing. For example, I’m aware typical timelines in this business are relatively short (~1 week). I’m thinking about where to keep my capital so it’s not dying in a low interest business checking account but remains accessible. Where it sits now earning a relatively high yield with Edward Jones, transfers can take a couple days. Maybe it’s just a matter of organizing transfers so that they’re available/able to be verified before closing and a short period of idling has to be accepted, or maybe I’m overthinking this. “The money is the product” as I like to remind myself and I want to offer a reliable product.

Qs:

1. How do experienced private lenders manage cash so it’s available at closing without sacrificing too much yield?
   
   
2. Are there institutions or account types preferred for fast, reliable lending operations?

Addressing scale… this will be a small but serious venture, starting with my own capital of $225K (plus ~10% reserves). I plan to reinvest all net returns back into the business and once I’ve proven enough success I may gain access to further capital from family (but that’s another discussion). For the first 2-3 years it’ll be a one man show and I have no issues working actively (I don’t expect nor am I targeting “passive” income, I intend to make this a real business with strategic growth).

I anticipate funding either smaller loans in C/D neighborhoods where I won’t get the whole 225 out at once, but may be simpler to service, OR higher-end flips in upper C neighborhoods which may have more draws and complexity. Median sales price for my area is $290k and active inventory is still 40-50% of pre pandemic levels.

Qs:

     3. Are there other common deal types or borrower scenarios I should expect at this scale?

     4. Am I overlooking any major operational challenges tied to either of these approaches?

     5. Has anyone started this way and thrived?

How exactly do you handle having a small amount of capital? I foresee reputation issues if I’m having to turn down everyone 8-10 months out of the year (depending on term lengths and loan performance). In fact I’ve spent a lot of time considering branding in a “boutique” style to align with this limited approach.

As for insurance, I believe an E&O policy will cover my needs since I won't have a physical office or business property to insure under a general liability or BOP policy. I understand that separate policies like builder's risk should be in place for individual loans, naming my entity as loss payee.

Qs:

     6. How do small lenders manage reputational risk and marketing when capital is limited?

     7. Is branding as a boutique lender smart or short-sighted?

     8. Am I overlooking any insurance needs on the business operations side?

This all might be coming from risk aversion cultivated during my renovations of pre-1970s homes, or simply my nature of needing to feel completely prepared before taking on new challenges. I’m wondering if there are trustworthy and useful private lending consultants to help someone just starting out like this. Geraci is mentioned a lot for legal support and I’ve identified a couple local attorneys as well, but I’m thinking more about the broader context of business development.

I'm not too interested in JV'ing and mastermind/course offerings all seem to be geared towards the fund model or higher net worth individuals with greater starting capital. I have attended a local REIA meeting but it seemed like a platform for other local lenders to find borrowers and I'm not sure I'm ready to engage with either of those demographics (worried about being perceived as competition by the very small local industry of private lenders, and don't want to face exposure to borrowers before I'm even setup and ready).

Last Q:

     9. Are there trustworthy private lending consultants who can assist with early-stage business development on this scale? And is that even a worthwhile consideration here?

Thanks for reading through, I’m open to discussion and appreciate all replies!

[Jay Hinrichs]

Quote from @Patrick Roberts:

Quote from @John B.:

Quote from @Patrick Roberts:

Find a local experienced lender to partner with. Doesnt have to be some formal JV deal where you combine funds, but someone who will share risk with you in individual deals and help you with underwriting, credit analysis, and processing.

Lending is a skillset, and there's a lot that goes into underwriting a deal and preserving your capital. 

You wont need to do a ton of marketing with the amount of capital youre starting with. Your capital will be deployed with 1-3 loans, so unless you plan to have another outlet (like brokering to other lenders), that part can wait until later. 

You'll want to dig deeply into how you set up your banking. A lot of financial institutions do not allow lenders as customers and will close/freeze your accounts if youre lending out of accounts under the guise of a different business line. You should be able to order and send wires in under 24 hours with whatever institution you choose. 

There's way too much to cover to type it all out here. Youre best bet is to partner with someone local to you who is experienced and can guide you along the path with this. You'll definitely want to find a good attorney partner who can review title work and commitments/policies at the very minimum. Geraci will be able to draft your loan docs, but I dont know if they will review title - I've never tried that part with them. Jeff Watson is an attorney in Ohio who specializes in private lending, and some of his content would be a good resource for you. Hard Money Bankers has a great podcast for private lenders as well. 

Patrick, just circling back here as I learn more. To your point about issues with establishing bank accounts as a lender, does this have to do with NAICS coding for the lender’s entity?

522292 would be the NAICS code for a PML operating the way I plan (loans secured by real estate). Is this a key point to open with when approaching prospective banks? And are there any institutions with good reputation as the “lender’s bank”? 

 NAICS can be one of items that flags your bank to dig deeper. I know a lot of note investors and real estate private lenders use 531390 - Other Real Estate Services. Whether or not this is appropriate is another matter. 

I would say to just have an open conversation with any potential bank about exactly what your plan to do. If they have an issue with it, it's best to find out before you go through the trouble of building a relationship, setting up accounts, etc. Even if you use a different NAICS, eventually some analyst or auditor on the risk team is going to get an automated KYC/AML flag to review your activity. If they dont allow this kind of activity, they'll typically close or even freeze your accounts and then you'll have a massive headache to deal with. 

The "best" bank tends to be highly dependent on your size, volume, capital, preferences, etc. I tend to prefer small local banks where I have a relationship with one of the bankers and can call/text him on his cell when there is an issue.

its funny I have been lending PML and had a HML company since late 80s never heard of Naics . However I dont bank at big banks ONLY small commercial banks that I know the owners and my personal banker. Only Issue i have had is registering the LLC if you use a lending term sometimes you get blow back.. so just name your company your intials LLC nothing more and then open the account. Since your in a state that does not require a license to lend I dont know why there would be a banking issue.. but for sure stay away from the big box banks they are no help to a private lender.. 

Also at your capital your only going to do one maybe two loans like you said every 6 to 8 months .. so really very little activity. I Simply see this as a alternative to rentals or high yeild savings account.  Most of my clients have a fidelity account to move funds to and from.

For me based on my volume at my bank I get free wires both incoming and outgoing.. But you can ask.. Small banks are all about deposits.. 

On the making of the loan you got that handled.. just go inspect the asset make sure its not a turd and that your borrower can execute.. dont over think this its not that complicated. 

I will tall you though to make any real money and to me real money is well north of 250 to 500k a year you are going to need 3 to 5 mil in cash.. and then if you want to grow that you can collateralize that cash and double the amount or more to grow.