Private lending for real estate occurs when an investor uses their own capital in order to lend money to individual investors while securing the main property with a mortgage. This capital can also be placed into a managed real estate fund. Private lending is considered to be a viable alternative to large banks and similar financial institutions. In many cases, private lending for real estate is a relatively safe investment since the investment is backed by a mortgage.
If you don’t want to be a landlord or go through the lengthy and time-consuming process of flipping properties yourself, private lending is a great way to invest in real estate. The payments that you receive from the borrower will include interest that can help you obtain consistent returns on your initial investment. If you lend money to a flipper as opposed to flipping a property yourself, you’ll typically have much less work to do, which means that there will be less stress and risk involved during the process.
If you purchase the property yourself, you would have to flip the home on your own. While doing so could net you a high return, it’s a risky process if you’re not completely confident about what you’re doing. If you’re searching for ways to invest in real estate without being required to manage the property, you should consider private lending. This article goes over things you need to know about private lenders for real estate as well as the types of borrowers you could lend money to.
How to Become a Private Lender for Real Estate
If you want to become a private lender for real estate, the process is relatively straightforward. First, it’s recommended that you start making these investments locally so that you can meet with borrowers face-to-face while also visiting the property in person. This will give you much-needed experience in identifying the right properties and investing in borrowers you can trust. If you start investing on a larger scale where you are unable to meet face-to-face with borrowers or won’t have the opportunity to visit the property that the borrower is purchasing, it’s possible that you could make mistakes during the process that could lead to you losing a significant sum of money before you’ve had a chance to learn the ins and outs of private lending.
Because of how important it is to choose the right borrower and the right property, it’s highly recommended that you perform an extensive amount of research into these aspects. Even before you conduct a face-to-face meeting or visit the home, you should research these components to better identify ones that would make wise investments. Doing research is also going to be essential once you start lending to borrowers in other states, which is why you should get started as soon as you’ve confirmed your interest in private lending. The different types of private lenders that partake in these investments include:
- Investors with surplus capital
- Investors who are looking to diversify their portfolios
- Investors who have a large retirement savings account
- Retirees who want to make passive investments in real estate
Questions Private Lenders for Real Estate Should Consider
Before you engage in private lending, there are some questions that you should consider. First of all, it’s important that you do your due diligence. Before you provide money to a borrower, you should check with a lawyer to make sure that all of the documentation is legitimate and without error. You should do research to find out if the borrower has had success in the past with other investments. If you’re thinking about providing a loan to someone who flips houses, you likely don’t want to lend to an individual who has been relatively unsuccessful in flipping homes. You may be able to check the credibility of the buyer through your own network.
It’s also important that you understand exactly what the borrower is going to be doing with the money. If you make a loan without being certain about what the borrower is going to do once they purchase the property, you may find that a relatively safe investment has quickly become much riskier. Without asking for this information before providing the investment, you might believe that the borrower is intending to rent out the property when instead they are going to be flipping the home, the latter of which is typically riskier. Once you identify what the borrower is going to be doing with your loan, make sure that they have experience with that kind of investment.
Private Lenders for Real Estate Should be Cautious
You should also ask yourself if the numbers are realistic. If the borrower is asking for a certain amount of money, make sure that this amount will be used for the intended purpose of the investment. All applicants for private loans will be required to provide their own research on the property that they are looking to flip. This research will include the value of the home as well as the budget for the renovations, which can help you determine if providing them with a loan is the right decision.
However, it’s important to understand that nearly every applicant will overestimate the value of the home while underestimating the budget for renovations at the same time, which can make your loan seem much less risky. As such, you should check out the value of the home on your own to make sure that it matches the estimate provided by the borrower.
One of the last things to do is to look at the interest payments that the borrower is offering when asking for the loan. Borrowers want the lowest interest rates imaginable. If they happen to offer 20 percent interest payments, there’s a good chance that there’s something wrong with the deal that you might have overlooked. If the loan terms appear to be much more beneficial to you than they are to the borrower, you may want to avoid making this deal. It’s possible that there’s a much higher risk of making such an investment than you initially realized.
Types of Borrowers
There are several different types of borrowers that you can provide a private loan to, which include rehab/sell borrowers, rehab/rent borrowers, and commercial investors.
Rehab/Sell: This type of borrower usually purchases residential properties with the intent of completing renovations and improving the value of the property. Once the renovations have been made, they will quickly resell the property. The main reason that private lenders are considered to be more willing to lend money to individuals who want to flip homes is that banks are wary of lending money when it involves properties that are currently in poor condition.
Rehab/Rent: This borrower will typically buy residential properties in order to make necessary renovations that will improve the quality and value of the property in question. When the renovations have been completed, the property will be rented out in order to obtain a consistent cash flow.
Commercial Investors: These are investors who are seeking private money for what’s known as a bridge loan. This type of loan is used to purchase a commercial property when a standard bank will not lend on an unstable asset. Keep in mind that a bridge loan is usually a short-term loan that can last for anywhere from two months to three years. As such, this specific type of loan can come with some risk.
Private Lenders and Commercial Real Estate
Are you looking for ways to diversify your portfolio while minimizing risk? If so, becoming a private lender for commercial real estate is a great way to minimize the amount of risk that comes with investing in a property. Since you won’t be flipping the home yourself or renting out the property to tenants, you will be able to receive consistent returns without the time that comes with managing the property. Before you get started with investing in commercial real estate, it’s important that you understand what these investments entail. While you won’t be required to manage a property, you will be tasked with completing comprehensive research to make sure that the borrower is legitimate and that the property is a good investment.
*Disclaimer: The statements and opinions expressed in this article are solely those of AB Capital. AB Capital makes no representations, warranties or guaranties as to the accuracy or completeness of any information contained in this article. AB Capital is licensed by the Financial Division of the California Department of Business Oversight as a California finance lender and broker (DBO Lic. No. 60DBO-69427). AB Capital makes money from providing bridge loans. Nothing stated in this article should be interpreted, construed or used as legal, financial, investment or tax planning advice, or a substitute for thorough due diligence and the exercise of sound independent judgment. If you are considering obtaining a bridge loan, it is recommended that you consult with persons that you trust including but not limited to real estate brokers, attorneys, accountants or financial advisors.