Private lenders might just be holding the key to your next big real estate investment deal, especially if you’re dreaming of moving from single family investments to apartments.
Let’s cover some key definitions and principles of investing, then turn to a few examples of private lending deals and some of the benefits you’ll see when you turn to private lending to fund your next deal.
Active vs. Passive Investing
There are two types of investing opportunities: active and passive. Both are key to a highly profitable investing strategy, and you can’t have one without the other.
Active investing is the work of actually buying a property (often using borrowed funds). This includes wholesaling, flipping, and rental investments.
Passive investing is participating in real estate by providing the funds needed for the active investor to do those deals.
As you profit from active investing you should begin to invest passively as well. This helps you diversify your investment, spread out the risk, and increase your dividends.
The Four S's of Investing
Both active and passive investors should evaluate every possible investment using the Four S's of Investing.
You should be able to explain the investment in under a minute. If you’re an active investor, this is your elevator speech. It should be concise and should clearly explain what you do and how passive investors will specifically benefit.
You shouldn’t be overleveraging your resources. All your numbers should be conservative. All deals involve risk, but you should be confident in the success of the deal. Passive investors should be sure their investment is protected, and active investors should be sure they have a buffer for holding costs if the property doesn’t sell immediately.
The investment should give you a worthwhile return. If you’re investing passively you should be looking for a double-digit return. And as an active investor, you should be sure that the property is going to bring in the profit you’re expecting, which it should if it’s meeting your safe standard as well.
Everything should be backed by the asset itself. There should be a mortgage against the real estate and a promissory note. In other words, you should feel confident in what will happen if something about the deal goes sideways—you want to be protected.
Private Funding and Lending Structures
There’s nothing wrong with building your own team of private lenders. It’s a great strategy, but it can also be stressful and time-consuming. Another option is to find a full-service private lending company.
These companies do the heavy lifting of finding investors for you. They rely on a network of wall street investors, high net worth individuals, and retirement funds, among others. And they can fund any type of real estate investment—apartments, commercial investments, single-family fix and flips, you name it.
Working with a private lending company can also provide you with the funds you need to reposition a larger investment such as an apartment building. A bank might not be willing to provide funding for a property that needs significant repair or isn’t fully occupied. You can work with a private lending company to reposition the property—they will often cover the full cost of the repairs.
Let’s consider a private lending example: Apartments.
- Step 1: Purchase Apartment
- 80% bank financing at 5–6% and personal guarantee
- 20% private money for down payments
- Private lenders get equity ownership and promissory note at 10% fixed simple interest
- Step 2: Property repositioned and stabled with value add improvements and increased rents
- Step 3 (after 12–24 months): Refinance the loan
- Pay off the bank loan and equity investment
- Private investors get all their principal back, plus a percentage of the refinancing “cash out” proceeds
- Private investors keep a percentage of the building cash flow and equity with zero cash left in the deal
Keep in mind that apartments are larger investments. There’s more risk, but there’s also more potential return. It’s also going to take longer to reposition the property—12 to 24 months, typically.
Your profit in this scenario comes from three different sources: refinancing proceeds, cash flow, and equity in the property.
Let’s take a look at some numbers.
Property details: Apartment complex with 5 buildings, 730 units
Purchase Price $9.6M
Improvement Costs $10.4M
Soft Costs $4.1M
All In $24.1M
Stabilized NOI $2.8M
Stabilized Cap 11.7%
Stabilized Value $40.3M
Equity Created $16.2M
Cash Flow $874K
Equity in Property $10M
Single Family Investing
Investing in single-family fix and flips is much more straightforward. Often the investor buys and owns the entire loan, rather than dividing the loan out. It’s easier to forecast success for these investments, although the potential profits are smaller.
If a passive investor chooses to invest in a single-family property with note investing, the investor owns the note and mortgage. He can get in and out of the deal in 6–8 months, but it is a higher risk than investing with a private lending company in a general investment fund where the money is used in a few different projects. However, the private lending company can still service and back the loan.
The Bottom Line
No matter how you’re investing—as an active investor, passive investor, or a combination of the two—you should be doing everything you can to maximize your profit. Let’s consider a few final points designed to boost your profits.
- Start your rehab right away. You should be working on the property the day after you close. The longer you wait, the more carrying costs (monthly expenses) you incur, from utilities and property taxes to maintenance. Stick to your timeline.
- Estimate your costs and rehab timeline well. The things that set you back should not be things you can anticipate. Get that property on the market within 120 days (if you’re doing a fix and flip) and get it done under budget.
- Don’t overprice the property after you flip it. If you do you’re going to be costing yourself money. Ideally, put it on the market slightly under price to get a few bidders.
- Pick the right contractor (not the cheap one). Look at his vehicle. It should be used but well cared for. Get a few quotes from a few contractors and understand what costs are involved with the project. Ultimately, go with your gut.
- State your expectations clearly and establish rapport with your contractor. Expect work to be done well and on time. And keep your end of the deal—pay your contractor on time. A great relationship with your contractor will pay off in the long run.