Lately, I’ve experienced a fair amount of interest (no pun intended) in private note investing, where you lend out your money to a real estate investor to passively earn interest income. It seems like many investors are sitting on a pile of cash from a recent flip or a work bonus, and are curious about diversifying their portfolio beyond stocks and other traditional investment strategies. I thought I would provide a little more information for those interested and contemplating whether investing in real estate-backed loans is right for you.
There are a ton of us hard money and private money lenders out there willing to take your money and provide you with solid rates of return in exchange. Most importantly, you should meet with potential lenders in person, if possible, about placing your money with them.
There are some key considerations you’ll need to ponder beforehand. Hopefully, this can be just a starting point to answer some questions some of you might have.
Please note that I am not providing legal or financial advice. I am merely putting some questions out there you should ask yourself in order to decide if real estate-backed loans are the right investment option for you. As a side note, I’m leaving out syndication and other “passive” real estate investment opportunities outside note investing, that’s a totally different subject.
How much money do you have/want to invest?
Many hard money lenders (HMLs) who lend through pooled mortgage funds have minimum thresholds for investing. If you have *only* $50,000 (which is still a lot of money in my book), your options may be limited. Figure out how much you’d like to invest and right-size the lender. If you have a relatively smaller amount to invest, a private money lender (PML) who places whole notes (or trust deed investments) may be a better option, or your only option, when accredited investor qualifications or minimum capital amounts can’t be met.
How much time do you want to invest your money?
Some HMLs and PMLs, especially those who do mortgage funds, or pooled funds, have minimum timeframes to invest your money. If you are looking for a safe place to invest your money for less than a year and would like to keep your funds fairly liquid for a future project or flip, then you need to ask lenders about how long your money will be tied up and what options you have for getting your money back early, should you need it, and if they’ll even let you.
How much control and autonomy do you want over your investment?
There are a couple of different ways to invest in hard or private money loans: pooled funds, fractionalized notes and whole notes (also known as trust deeds). For the sake of simplicity, I will steer clear of fractionalized – this is where you go into a loan with multiple people or entities named with equal or varying % of ownership. I would avoid these unless you absolutely know with complete certainty about the partnership (e.g. you and your mom) and can agree on how to proceed if things go sideways. Think of this as “too many cooks in the kitchen” in many scenarios.
Pooled funds are a good option for those looking for a more passive way to invest without having to do a whole lot. You pool your funds (with many other investors) for a set period and they send you varying rates of returns on a specified cadence (monthly, quarterly, etc.)
>>Upside – you get interest returns regularly without having to do anything to vet the deal.
>>Downside – you don’t get to vet the deals so if you don’t like 85% loan-to-value loans or 80% LTC loans, and your lender does them, you don’t have a say.
Some people like more involvement in note investing, also known as trust deed investments – this is where whole notes comes into play, where the investor is individually named on the loan docs. Here you can call the shots on the borrower profile, the loan-to-value, and the subject property being put up for collateral, etc.
>> Upside – you get to determine the rate(s) of return on each deal which can often yield higher returns than pooled funds. You also get to stipulate the terms – if you only want your money out for a short period, this may be a better option.
>> Downside – you may have to wait to place your money, depending on deal availability and your own risk preferences.
How risk adverse are you and how real estate investment savvy are you?
If you don’t know much about real estate, then being more passive through a pooled fund might make more sense, since you won’t have to do anything to vet the loans coming through. If you are extremely conservative and risk adverse you might prefer to do whole note investing where you can determine your own deal criteria and make your own investment selection.
Do you care if it’s local, regional or national?
This sort of goes back to control over your investments. Maybe you prefer to be able to drive by your subject properties (whole notes) or maybe you don’t like the idea of funding deals in other parts of the country that you feel may not have as strong of a real estate market. Maybe you prefer spreading out your risk over multiple loans so crowdfunding or pooled funds is a better idea than whole notes. Figure out how much you care if the company, the deals they fund, etc. are local to you or not.
This is just a starting point to figuring out whether note investing is for you or not and is one person’s perspective so take it all with a grain of salt.
Published on Bigger Pockets – 5 Questions to Ask Yourself Before Becoming a Private Lender (biggerpockets.com)