Summary
One of the benefits of real estate investing is the wide range of strategies that you can take advantage of to balance your risk and reward. Based on your goals and personal risk tolerance it’s very possible to have a balanced portfolio from a risk perspective in just real estate given how diverse this field is.
In this article we’ll talk about the least risky strategy in this field which is private money lending through funds (also called hard money lending).
Private Money Lending
Private money lending refers to you being the bank. Similar to how you purchase a home and will take out a mortgage, you can use your cash to fund real estate purchases.
In exchange for your cash, the borrower pays a monthly interest and instead of making that check out to a bank, that check goes to you as the investor.
These loans can have a wide range of timelines, from 6 months all the way to 30 years. These types of loans are popular to fund flips or for borrowers who may not fit a strict bank loan criteria, like someone who is self-employed with no stable W2 earnings.
At the end of the loan period, the borrower pays back any remaining balance of the loan and the interest payments made along the way are your profits.
Why Is It So Low Risk
Private money lending is considered to be one of, if not the, lowest risk form of investing in real estate. This is for a few reasons:
1 - Returns are fixed as interest, not variable depending on the performance of the property: In other versions of real estate investing your payout is tied to equity. Meaning if the property overperforms expectations, your payout is higher, but if the property underperforms your payout is lower.
2 - Your cash is a loan: Because your investment is in a loan you are higher on what’s called the ‘capital stack’. The higher on the capital stack, the sooner you get paid. Meaning in the private money structure your investment should be the first thing paid back before any other profits are distributed. Similar to how if you sell your home, you first have to pay off your remaining mortgage before taking any profits for yourself. Meaning even in an underperforming deal, you’re still owed your investment back before anybody else sees returns.
3 - Secured by the property: Because your cash is a loan, in the event the borrower cannot pay the loan back you should take over ownership of the property, similar to a bank foreclosing on a mortgage, so there is a very high motivation for borrowers to pay on time.
Decreasing Risk Through A Fund
For those seeking the lowest form of risk, deploying capital in a fund structure is going to be your best bet.
A fund means you are deploying your cash one time and that fund is deploying that cash to multiple properties, so your return isn’t tied to just one or a handful of properties.
Example: If you invest $100,000 into one property as a private money lender and that property defaults, you’d be responsible for taking over that property and either selling it off for what you can, or fixing it up to increase your returns.
In a private money fund, you can invest that same $100,000 and the fund will take that cash and deploy it across dozens of properties. A strong fund will have a low default rate, but as properties default, the fund is responsible for taking over the property, not you as the investor. The low rate of defaults also means lower risk and it’s unlikely you’ll notice a handful of defaults in your returns.
Expected Returns & Distributions
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Private money lending through funds typically see returns between the 7 - 11% range with distributions paid out monthly. Generally, returns start in month 1 after you make your investment.
Example: If you invested $100,000 into a private money fund, I’d expect in today’s market to see a minimum 7% return projection.
Which means you’d receive $7,000 in cash flow paid out monthly, or $583 per month.
Other Considerations
A key consideration in private money lending is taxes.
***This is not tax advice, please consult your personal tax advisors or seek your own tax counsel before making any investment decisions***
Private money lending is considered investing in debt, secured by real estate. Not an investment in real estate itself. Because of this, it will typically change your taxable position in regards to how the income from interest payments is taxed, and generally does not give you access to depreciation.
Conclusion
Private money lending specifically through a fund is likely the lowest risk strategy available in today's market. Not only is this a great option for investors looking to take on a lower risk strategy, but it’s also a great cash flow strategy that should see returns come in quickly.
If you’re interested in learning more about private money funds, fill out this form and lets get in touch: Learn More About Private Money Funds
