Better to be a buy and hold investor or a private money lender?

Question

Hi, I just had a general question about whether you would generate bigger returns being a hard money lender or a buy and hold investor in real estate. I know both can be successful, I'm just wondering the pro's and con's to each. Just for the sake of the question say you had about a million dollars in cash in hand... Thanks!

Taylor Green · Answer

Thanks guys for all the input!

Jeff S Na great response... That response was exactly what I was looking for.

The high hourly rate of lending I'm sure is a huge bonus. Do many people use this strategy once they have collected enough cash and also enough properties to be able to write off their real estate property losses against income earned from lending? (If you qualify as a real estate professional)

Another question I had was, how long has the hard money lending business produced annual returns of 15+%, is there any reason to see this changing for the better/worse in the future?

Thanks again.

Taylor Green · Answer

Thanks again Jeff.

Do you have any knowledge about lending thru trusts? I know there is a lot of potential legal problems and hoops you have to jump thru though...

From my understanding, somebody sets up a trust and then finds deals and gets people to contribute to a fund for somebody who is borrowing the 'hard money'. Would the person who sets up the fund take a percent off the top? I'm wondering how the fund creator benefits...

For example, the fund creator gets investors to contribute 1,000,000 and finds somebody needing to borrow the money at 17%. The fund creator then pays the investors 15% and takes 2% for himself? I'm just curious if that's how it works...

Thanks

Jeff S. · Answer

My observation is that those who buy and hold always buy and hold, @Taylor Green.  They might occasionally loan with extra cash, but this is not their focus.  They have enough properties, managed with well-tuned systems humming along, and now the extra time, that they have no reason to change strategies.  On the other hand, if you ask the majority of rehabbers where they see themselves in years out, most will say they want to get into lending.  None that we’ve seen actually do.

As competition for inventory increases, we’ve seen some rehabbers leave the business, some are beginning to leverage their skills toward ground-up development, and some were able to put a few properties away to hold.  Many do a bit of each.  Of course, there are still those who developed deep contacts and resources and continue to flip.  The business is far from dead.

It seems that those who make money in real estate by buying the physical assets like to continue doing so, and vise versa.   I can’t say I know any flippers now exclusively into lending any more than I know any lenders who focus now on the physical assets.  The same is true for those who buy and hold.  I suppose it simply boils down to personal preference, what you’re used to, and where you’re comfortable.

Jeff S. · Answer

There are pros and cons to each and none better than the other.

In southern California, typical hard/private money terms will result in roughly a 17%-20% annual return, depending upon how fast you get paid back.  The problem of course is that this is always short term so you have to keep your pipeline full and continually market yourself. With skilled and active borrowers you can stay “loaned out” over 90% of the time.

The great benefit to lending is that from your first phone call to getting paid back, your time investment can be less than 6 to 8 hours per deal.  That is, aside from the terrific annual returns, your hourly rate is also high.  Risk too can also be very low if you limit your loans to 1st TD’s.

Major drawbacks are that all earnings are taxed as interest income, there is no depreciation, and you enjoy no appreciation of the assets you loan on.  Of course you can deduct appropriate business expenses, but these are also minimal.

Owning property will result in lower annual returns,  -- less than 10% or so in  CA for multi-family, but you also enjoy all the benefits of depreciation, property appreciation, and increases in equity as your tenants pay your loans off.

For me, the major drawback is the time it take to manage property as well as dealing with the toilets and tenants. Landlords will argue that this can be mitigated by using outside property management, and to some degree this is true, but you’ll always have to manage your manager (and pay them). Landlording can be a full time job, which to some, is an advantage.

You don’t have to fill a pipeline as you collect properties and these are almost always long-term investments and frequently tax free. Almost forgot that 1031 exchanges also apply making the sale tax free forever if done properly.

Lot's of money to be made all around.

Michael Seeker · Answer

Hard money lending is just like any other type of real estate investing.  You can be very successful and achieve healthy returns doing it, or you can lose your shirt.  Just like any other focus, you need to do your due diligence.  The big difference is you not only need to do this on the property, but the borrower as well.

I would think it would be much less hassle than flipping or renting once you get established, but it may be pretty difficult to get to that point.

Dawn Anastasi · Answer

@Taylor Green

if you are a hard money lender, you can get returns at hard money rates perhaps 10-15% + points.  If you are a buy-and-hold investor you can make greater returns (10% is the goal to shoot for, but it's possible to get more).  Another option is to be a flipper, where you buy, fix, and resell for a profit.