Some of you more perceptive (and interested) readers have picked up on this and sent me notes.
Here’s an example of one I received recently:
From reading your money blog I see that one of your income streams comes from lending money to a builder friend to construct rental homes. I would assume this would be in the area of private or hard money lending.
I realize it isn’t a full time gig for you but curious as to how you put it in motion. Is it just an informal loan or did you tap resources such as an attorney to set up application forms and schedules for lending money?
I am looking to get into the hard money lending business using my own assets and feeling around to see how best to get started. There is plenty of info online regarding how this type of lending works but I don’t see much regarding starting this type of business.
I responded to him as follows:
I should probably write a post about this.
I got into it when someone I knew well started buying places and needing some extra financial support. I know and trust him, plus he’s a good business person.
So basically, I fell into a great situation.
I have no idea how to go out there and find a person, vet them, and then invest.
With that as background, I’m writing this post on private lending for real estate.
I’ll detail what it is, share my story, and offer experiences and advice from some other real estate investors.
And perhaps some of you will comment with your experiences as well — I’m sure we can learn from each other.
Let’s get started…
Private Lending Versus Hard Money Lending
The idea we’ll be discussing today is giving money to another person so that person can build or buy real estate. This could be their sole means of borrowing or be in addition to other loans.
In exchange that person pays you back an agreed upon rate of interest for a specific time period. After that, they return your principal and the deal is over.
I’ve heard this arrangement called both “private lending” and “hard money lending”, so let’s start there and define each of those.
Here’s how BiggerPockets explains the difference:
A hard money loan is a loan collateralized by a hard asset (often real estate). Therefore, a hard money lender is a lender who uses the value of the underlying real estate to determine the loan amount and rate. There are very few true hard money lenders left. Most of them ask for FICO scores, tax returns, or other indicators traditionally used by conventional lenders.
Private money is what it sounds like. It’s money lent by a private person or organization. As such, terms vary widely. A private lender can use whatever criteria he or she is comfortable with when “qualifying” the person or entity to which they lend. It can be as basic as, “I’ve known you since you were in diapers, so I trust you.”
There is no hard and fast definition of a private lender versus a hard money lender. In fact, any non-institutional lender can call themselves a “private lender” — that is if they choose to be defined as “non-institutional.”
But in today’s common usage, a hard money lender advertises his services, has a process for qualifying loan applicants, and is available to any borrower meeting the established criteria.
A private lender is someone you know, who doesn’t lend to the general public, and may charge less than the local going rate.
Evaluate each lender based on your needs, their reputation, and their ability to deliver what they say.
Ok, that clears things up. LOL!
Basically it appears that a hard money lender is more like a business, dealing with those he doesn’t know, and acting more like a bank in creating partnerships. he may also require a higher level of guarantee/security in exchange for a loan.
A private loan appears to be more of an “I know a guy” arrangement with the lender and receiver working out whatever sort of deal they both feel comfortable with.
That puts my deal squarely in the “private lending” camp and thus I’ll refer to it as such. That said, the web appears to use the terms interchangeably a lot, so if you see tips for one of these it probably applies to the other as well.
BTW, you can basically do the same thing with real estate crowdfunding, but what we’ll be covering is a one-on-one agreement/arrangement versus doing a group-buy thing through an investing platform. Each have their pros and cons and you might want to consider both to determine which is best for you.
Now let’s get into some real life examples of how people set up private lending arrangements.
I’ll begin with my story, which is pretty basic, and then I’ll share thoughts from two guys who are way more advanced in this than I am.
My experience started years ago when I retired.
As you might imagine, many people were curious how someone could afford to retire at 52 and have enough to live on.
I could have explained how I stockpiled a large amount of assets and then planned to use the 4% rule to live, but that seemed to be a long, tedious explanation that neither of us wanted to get into. Besides, I wasn’t planning on withdrawing any assets — I had enough income to live off of.
So I told people I had bought rental apartments in Michigan and that I had more than enough income. All this is true, of course.
One guy asked to meet with me to learn more. He was I guy I worked with once who was smart, trustworthy, and about 20 years younger than me. He wanted to know the details of how I bought/managed my real estate and I shared them with him. It was a great conversation, I advised him to check into real estate investing a bit more, and that was that.
A couple years later (it could have been only a year later, you know what a time warp retirement is), he contacted me again. He said he had studied what I said and was planning on doing some real estate investing himself.
He had a partner and they had purchased a few places themselves in a market across the country they were familiar with. But they wanted to buy more and as such started financing these deals with a combination of both bank and private money.
I told him I had $50k to invest (I had almost $500k in cash at that point earning 2% and had been looking for great ways to deploy it.) He agreed to send me some specifics when they got to that point.
Since then I have invested in four different deals with him. Here’s how it works:
- He and his partner find a place they are interested in. They loop me in early, sharing what they know. I then give them preliminary feedback on if I want in, at what amount, etc.
- They make an offer and get it accepted. They send me updated financials on how they’ll make money. I then agree or not, and if so, we’re off to the races.
- They get a bank loan for the majority of the purchase. I lend them the rest at 10%. It’s a bit higher because it’s riskier. We sign a contract detailing what I’m giving them, how much I get paid, that I have a claim on the property if they default (second to the bank’s), etc.
- I send them the money, they buy the place, and they begin fixing it up, raising rents, etc. And they start to pay me, of course.
The four deals I’ve done with them have been three at $20k each and one at $65k — to spread out the risk of any one piece of real estate going bad.
The key to this arrangement is my friend. If I didn’t think he was smart, a good business person, and trustworthy, there’s no way I would invest with them. But I do think he’s got what it takes to be successful, so I’m in.
I’ll probably invest more too. I’m willing to go to $200k with this arrangement.
Eventually he’ll pay me back (the notes have five year terms but he can pay early) and then I’ll be looking for another way to deploy cash.
In the meantime, I’m earning 10% off money that was making 2% at best. In fact, I’m making more off my $125k with him than I am off the $450k in “high-yield” savings accounts.
Coach Carson’s Perspective
I wanted to include some thoughts from other, more experienced private lenders so I reached out to a couple blogging friends.
The first was Coach Carson who wrote Seven Ways to Invest in Real Estate to Get Across the Retirement Finish Line. I started by asking him what experience he had with lending private money. His response:
I have been doing a little more private lending lately to other investors.
Here are summary of two deals:
I provided the money for a builder who needed to build a house for a client. The builder owned a lot and had an interested buyer who was qualified for a first time home buyer loan at a price where he could make a good profit. But the builder didn’t want to stretch himself too thin using his own cash. So, I loaned him the construction money at 12% for what ended up being about 4 months. My loan was less than 65% of the full value, so I felt secure in making the loan. I was also willing to take the property back and keep it as a rental, if needed. It seemed to be a win-win-win.
I’m also doing another deal where instead of a loan, I bought a house for an investor and then I’ll sell it to him a short period of time later. This investor wanted to buy the house, but he needed to sell another property first. He planned to execute what’s called a 1031 tax free exchange, which allows him to pay no tax on the sale of his property.
So, I bought the house he wanted, and then the investor and I signed a lease option agreement so that he can control the property. He pays me a monthly lease payment, and he subleases the property to a tenant. The investor is also responsible for all maintenance, expenses, and tenant issues. In the end, the price he’ll pay me is $10,000 higher than my purchase price. So, I’ll also get a nice “bump” at the end. And if all goes well, I’ll never visit the property or have to deal with any landlord issues.
I followed up with what appears to be the million dollar question: “How do you find people you can trust to lend to?”
Networking. Talking to other investors. Getting to know them FIRST before doing business.
In fact, I don’t usually let people know upfront that I might lend them money. I just learn more about them, and if I like their character and competence, then I’ll bring it up as a possibility.
I then asked: “Where do you meet them? In person (if so where)? Or online?”
I met the builder in my small town by volunteering on local boards and community improvement committees. We were both active in the town, so we got to know each other better. I’ve also just reached out directly to builders, investors, and property managers and asked them to go to coffee or lunch.
I met the second investor through my local REIA (Real Estate Investor Association). There are many local real estate meetups or classes where you can chat with other local investors. Look on meetup.com, BiggerPockets.com, and NationalREIA.org.
I also recommend people network at local Chamber of Commerce events, civic clubs (like Rotary), builder associations, Realtor Associations, and any entrepreneurial-focused group where other investors and builders might hang out.
Lots of good advice from a real estate expert!
Mr. 1500’s Perspective
Here’s what he sent me:
If I could guarantee an 8% return on my portfolio for the rest of my life, I’d sign up in an instant. And this is what’s so appealing about private lending. The least amount of interest I charge is 8%, but most of my loans have been at 10% and this is low compared to what most ask for.
Here are some of my general guidelines:
- Loan to value ratio: I like to see a loan to value ratio of 65% or lower. This means that if the home is worth $100,000, I won’t loan more than $65,000. If the borrower defaults, I’ll easily recoup my money.
- First position on the lien: Being in the first position on the lien means that in the event of a default, I’ll get paid first.
- The home: I have never lent money to purchase a home in my home state. I’ve never even seen any of the homes in person that I’ve lent money to buy. Luckily, there are a lot of great online resources like Zillow that can help me get a feel for the property. I also ask the borrower for pictures and inspection reports.
- The borrower: I’ll only lend money to someone I know or someone recommended by a trusted source. I want to see real estate investment experience. I also want to hear that the borrower has a solid plan.
My motto in life is this: Hope for the best, but be prepared for the worst. I’ve had nothing but success and on-time payments with every loan that I’ve held. However, I’ve set myself up to win even if the borrower defaults.
Again, lots of great advice here!
How to Get into Private Lending
For those of you who want to get started in private lending (or even simply consider it), the key seems to be finding the right person to invest with.
If I was starting from ground zero, I’d begin to network with real estate professionals (I know some from church, from the gym, and from pickleball) and see if I could identify some possibilities.
I’d probably also attend some meetings for local business and real estate clubs, if any existed in my area (I’d have to do some digging to find out, but it’s not that hard the way everything is online these days.)
I would probably ask friends who I know (or at least think) are doing well financially if they had any leads.
Finally, I’d get involved in the BiggerPockets forums since they probably have both lenders and those looking for loans there.
After a while of beating the bushes, I’m sure something would turn up. Then it would be a matter of getting to know them and feeling comfortable with giving them money.
I’m not sure I’d ever reach that point with a complete stranger. I’m interested in what you think on the subject.
To wrap up, I want to share several useful resources I found while doing some research for this piece.
If you want to become a private money lender (the subject of this post), here’s a video for you:
- Confessions of a Private Lender
- The Ultimate Guide to Hard Money Loans
- How to Structure Your Private Loans: An Interview with 4 Real Estate Investors
Those are my thoughts. Anyone out there ever done private lending for real estate (or received loans through a private lending agreement)? If so, what tips would you have for the rest of us?