Following the housing crisis of 2008, bank mortgage lenders were buttoned up tight as a drum, leaving many real estate investors out in the cold. A significant component of the economic crash was reckless real estate speculation. After the crisis, banks were reeling from their past mistakes and generally shied away from investment real estate transactions, or at least made them very difficult to close. Enter private lenders.
Private money lenders soon stepped in to fill the gaps the banks left after essentially abandoning in the industry. Those with a high net-worth began funding developers and real estate investors through hard-money loans. There were two types of investors into this growing new market – pooled investors, or those who invested in a hard money fund, and direct investors, or those who preferred to directly fund hard money transactions.
The private money industry is booming because those with idle capital who are willing to become the “bank” can make extraordinary profits while building a network of financial professionals. However, if the business is not set up correctly, a private lender risks missed payments, defaulting borrowers, foreclosure, and possible loss of capital.
If you are thinking about becoming a private lender, consider the following issues before you commit funds.
Learn About the Market
The majority of hard money loans are for real estate investors, or “house flippers.” Before you commit money to real estate investors, take the time to educate yourself on the “flipping” industry, along with the many benefits, and, of course, the pitfalls that accompany lending in this space. The first step is being able to evaluate and understand every deal that crosses your desk. You will need to know how to assess the neighborhood you are investing in, realize the potential of the property that you are financing, understand zoning and permit issues that may become obstacles to the investor, and familiarize yourself with construction costs and time frames.
Most successful private money lenders invest locally. A local perspective provides them with insight into the housing market and zoning, as well as the ability to visit the property location and better evaluate its potential.
Take Only Calculated Risks
Private lending can be extremely lucrative, with monthly interest payments regularly flowing into your bank account. However, what happens if the payments stop coming? Some investments may require a deferred interest payment – where your money is tied up in the rehab – and you won’t get paid until the project is complete and the property sold. Can you stomach the wait? What about defaults? Do you have the resources to go after a defaulting borrower? If you don’t think you can stomach the ugly side, then private lending may not be right for you. If you are unsure about a transaction you are considering, consult an expert. Call someone you know who is in the business and don’t be shy about running the agreement by them before you make that all-important decision of whether to fund the deal.
Build an All-Star Team
You can’t do everything on your own, and so you should work on building a stellar team of educated professionals to help you build a successful private lending business. If you are considering direct lending, then it is a good idea to have industry consultants look over deals to make sure you are being adequately compensated. Enroll the help of a good accountant and legal team to ensure your contracts are water-tight, and that you are correctly calculating the tax liability into your cost of doing business.
Probably the most important thing to consider when entering this business is having the intestinal fortitude to keep pushing forward. There will be times when you will second guess a decision you may have made on a deal that went south. However, if you have confidence in yourself and your team, you will quickly overcome those little bumps in the road and be on your way to building a thriving private lending business.
