One of my investors called me up today and told me he had decided he was ready to get into the lending business. He had already purchased a number of properties over the last year or so and was ready to diversify his real estate investing strategy. Part of his decision making process had to do with the tedious financing process he had experienced when buying a property a few months prior, but I think most of the decision had to do with a desire to branch out into an area of real estate that has great earning potential with very little effort.
While private lending is not for everybody, I’ve found that real estate investors who are cash heavy tend to lean towards this type of opportunity. This type of investor usually falls into one of two camps: An investor who simply doesn’t want the hassle of owning properties and dealing with tenants, or the investor who has already acquired a healthy number of properties and simply wants to diversify.
While there is not a right or wrong answer as to which investing strategy is better, it is worth analyzing owning versus private lending.
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Here are some Pros and Cons of Private Lending:
- Private Investors can typically earn over a 15% annualized return on their invested money.
- Private lending is typically very secure in 1st lien position on a physical asset such as a property.
- If the loan defaults, the lender has the ability to seize the collateral (property) through foreclosure.
- Private lending allows an investor to invest funds in real estate without the risks and headaches associated with flipping and renting.
- Private lending is typically short term so investor has the ability to move the money in and out if desired.
- Private lending does not have the same favorable tax advantages that owning does (i.e. mortgage interest deduction, 1031 tax free exchange, etc.)
- While private lending does produce tremendous yield (actually better than most cash flowing rental properties), it does not appreciate the way an owned asset does.
- Longer term lending can be at risk of inflationary loss.
While this is a relatively high-level analysis, it is important to understand the benefits of one investing method versus the other. In my dealings with investors, it seems like a blended approach works well. I think it is important to own property and get the tax and appreciation benefits that come with it. However, I also like the secure high yield returns that can be obtained from private lending as well. Finding some balance between the two really depends on the goals and risk tolerance of the investor.