Insider's guide to Private Lending
Subject: The Insider's Guide to Private Lending
The Insider's Guide to Private Lending: How to Earn Safe and Consistent Returns in Any Real Estate Market.
by Jeff Levin
Jeff, a former mortgage banker, decided to get involved in private lending when the crash came in 2008. He saw a unique opportunity to lend to qualified investors at a time when they couldn't get money from other sources. In the decade since he has perfected his system for private lending which is presented in this book. This book is designed for anyone looking to start their own private lending firm.
He starts by discussing the "five good reasons why" private lending would make a great addition to your portfolio. They are:
1. Returns - because private lenders can act more quickly than traditional banks, they can charge more. This can be up to double or triple what a bank would earn.
2. Convenience - there are lots of ways to invest in real estate, but many are time consuming. "Private lending allows individual investors to benefit from lucrative real estate projects without an investment of extensive time or construction expertise."
3. Diversification - while you can fund an entire project, you can also fund part of a project by joining with other investors. This allows you to spread your risk out across multiple projects.
4. Protection from Market Volatility - private lending spans a period of less than a year with high yields. While the stock market may jump up and down during a year, over the short term real estate is pretty stable. "By carefully selecting and vetting your borrowers, electing favorable terms that fit the needs of your portfolio, and lending for short windows, you can shield yourself for the volatility that is inherent in so many other investment vehicles."
5. Pacing - private lending allows you to invest at a gradual pace. You can start with a small loan and get comfortable before moving onto your next loan. Soon you will have predicable and stable income.
Private lenders can make money in three ways: origination fees, interest payments, and exit fees. The origination fee is a fee that the borrower pays in order to get the loan. The interest payments are the monthly interest paid while the funds are outstanding. "And finally, in some cases, you can charge an exit fee, which is a fee due from the borrower when the loan is paid off." This can earn the investor a total return of between 5 to 15 percent per year.
The typical customer for a private lender is a rehabber that fixes and flips properties. They find a deal and need someone to loan them money to close quickly on the property and finance the renovations. Hard Money Lenders or Private Lenders provide this service to these investors. Once they have completed the project, they will sell the property or convert the loan into a typical financing arrangement in order to reduce costs. Either way, the private lender receives their capital back plus interest at this time.
* How To Fine Opportunities *
According to Jeff, private lending is a boutique business and no two deals are the same. He suggests several methods for finding deals:
1. Online Lending Platforms - perfect for beginners, these platforms allow you to invest for as little as $5000. He suggests Fundrise, Realty Mogul, Realty Shares, or Prodigy Network. You can earn 5 to 20 percent this way, but many platforms are limited to accredited investors.
2. Experienced Private Lenders - man firms like Jeff's will accept money from private investors. They then take this money and invest it with their clients. This is a great way to diversify a portfolio.
3. Loans to Friends and Family - many people get started in private lending by funding a deal operated by a family member. You just have to be careful that the deal is sound and it won't interrupt the relationship.
4. Start a Self-Directed IRA - this permits individuals to use their retirement account to loan our money for real estate investments. "Using a self-directed IRA, you can buy, sell, or flip properties; redirect funds from one project to another; and lend to real estate flippers while deferring tax payments on gains."
5. A Private Lending LLC - basically start your own private lending firm. You will need industry knowledge and time in order to make this work. Jeff suggests going to a real estate convention he attends each year in Ocean City, Maryland or taking training from the National Private Lending Institute.
No matter which route you choose it is important to always be networking and maintain a good reputation. People want a trustworthy private lender.
* Who to Lend To *
Jeff has three main rules that he uses when choosing a borrower. He never lends on houses borrowers live in, only lends to LLCs, and always checks the four C's: credit, collateral, capacity, and character.
1. Credit - checking the borrowers credit report will tell you about how they borrow money. It will answer questions like how long they have been active and whether they pay their bills on time. Be aware of judgments or collections from other property lenders.
2. Collateral - this is the underlying property itself. Since you will have to take this back if the loan isn't repaid, it make sense to verify its worth.
3. Capacity - this is the borrower's ability to repay the loan without the success of the project. A good sign is if they have another unrelated job with sufficient income to cover the costs. A bad sign is if this project is their only source of income.
4. Character - Jeff calls this "the linchpin of any transaction." He wants to know what makes the person tick and why they are in real estate. In addition to this, he runs a background check and makes sure he isn't lending to people with a criminal background.
It is important to only loan to investors (not individuals) which can be done by lending to LLCs only. If the person lies to you and moves into the house it can present issues in court if you have to take the property back. Protect yourself by having them sign a statement that they will not occupy the house, verify their residence, and loan funds only to an LLC.
* What Kind of Properties to Invest In *
You should invest in a property category that you are familiar with and in a good location nearby. The old real estate adage "location, location, location" applies to private lending as much as anything else. If you get stuck with this property you are going to have to get rid of it. That becomes a lot easier if you are in a good location. The basic point is to do your homework. Jeff suggests the following:
1. Vet the Property - check the property itself. Look at the neighborhood, schools, crime rates, etc. Drive around in the morning and at night to make sure this is a place you'd want your money tied up in. Don't forget to check the inside as well!
2. Vet the Appraisal - in other words order your own. Don't trust a third party provided appraisal because it could be filled with fraud.
3. Vet the Contractor - they will finish the project that you will have to sell if the loan doesn't perform. This is why it is important to make sure they are reliable.
The best method is to start with manageable renovation projects. Look for projects under $35,000 and work your way up as you gain more experience as a lender. Properties with less renovation also equal to less problems which are likely to popup in the loan repayment process.
* When to Make a Loan *
Private lenders will lend to bother Fix-and-Flip investors and Buy-and-Hold Investors. Both of these exit strategies will require different items in the review process.
For Fix and Flip deals you need to start with underwriting the borrower. You need to make sure they have good credit and the experience to handle the project. Ask the following important questions:
1) How many project has your borrower done and were they successful?
2) Where are those projects located?
3) Has he of she ever borrowed privately for from a bank?
4) Does your borrower expect you to fund the entire project, or is he or she planning to invest his or her own resources?
Next you will need to underwrite the property. This will require a pre and post rehab value of the property, zoning checks, verifying the accuracy of the estimate, checking the timeline, and finding out how long it would likely take to sell. The bigger the loan the more important it is to big into these items.
For Buy and Hold deals you need to obtain the credit score for the investor. This is important because it is what a traditional lender will look for in extending the loan (that will get your money back). A score of 680 or better is required. Next, you need to look at tax returns. Does the reported income match what will be required to qualify for the loan? It is best to work with a traditional lender to make sure the investor will qualify at the end of the process.
* How to Protect Yourself and Your Investments *
What Jeff calls "papering the deal" is when you are ready to make the loan. This means that the borrowers has accepted the terms and you are confident in all your due diligence and ready to fund the loan. Once you have reached this point it is time to document the loan properly. He advices against moving to quickly that you skip something important. The best thing to do is get your entire team to sign off first. This should include the appraiser, realtor, mortgage lender, insurance agent, title company, title insurance company, and real estate lawyer. He goes over a number of pitfalls that are worth reviewing in the book before you complete your first loan.
* How to Get Paid *
Getting paid is a function of three things: loan servicing, loan monitoring, and loan payoff. You need to ensure that you have streamlined the processes and procedures for each loan so that borrowers understand what is expected of them. You must also continue to monitor the borrower's finances in order to ensure that you are on track for the payoff. This can be done through property inspections, financial statements, credit reports, and tax returns. All of this leads to the loan payoff which is when the transaction wraps up. Keep your exit strategy in mind and make sure that the process you employ facilitates the end goal of reaching this strategy.
Websites from the book:
http://www.nplinstitute.com - The National Private Lending Institute offers understandable education for both new and experienced private lenders.
http://www.JeffLevinLends.com - Jeff Levin is a speaker, author, and private lending expert who has completed over $1 billion in originations. He has trained thousands of people on how to earn safe and consistent returns through private lending.
The summary of this book was prepared by Casey Ryan Richards (http://www.CaseyRyanRichards.name)
Casey is a private real estate investor in Rutland, Vermont.