Private Money: The Most Overlooked Source of Passive Income
Private money is when an individual “becomes the bank”. They lend their capital to individual real estate projects or to a pool of funds. This is how many developers fund their projects and it creates a win-win for everyone. Being a private money lender is one of the most secure ways to see double digit returns on your money. It’s an often-overlooked and lucrative source of passive income in real estate.
Most assume private money lending is a niche market reserved for people with millions in loose change. However, private money lending is actually a diversification strategy employed by experienced and novice real estate investors alike. Private money lenders often earn an 8-12% return on a short term loan backed by a Deed of Trust, or ownership in the project. You might be surprised by how easily private money lending can fit into your investing goals.
Lend Private Money Instead of Flipping Yourself
This capital, which otherwise might sit in a low-interest savings account or in the volatile stock market, is instead used to help fund an investor’s flip project, buy an apartment building or develop raw land. As a flipper, you’re under very tight deadlines, dealing with contractors at the job site, difficulty getting materials, or even finding more problems with the project than initially thought. Why not take a break and earn some passive cash flow by becoming a lender on a project instead or doing a flip yourself?
A phone call can come in anytime with a potential (and sometimes literal) fire to be put out. In private money lending, rarely is there an emergency moment that must be addressed immediately. This allows an investor to regain the one asset no one can buy more of: time. When active investors start transitioning to private lending, they still underwrite the project the way they would if they were to purchase the flip themselves. The bonus this time is that they get to sit back and watch the interest income stream monthly without the hassle of dealing with project budgets, sub-contractors, and supply chain issues.
Lending Money Instead of Managing Rental Properties
One strategy to acquire buy-and-hold properties is to use the “BRRRR” method. Which stands for Buy, Rehab, Rent, Refinance, Repeat. Investors who typically use the “BRRRR” method to acquire and stabilize buy & hold investments are increasingly concerned about how rising interest rates might affect their ability to refinance and maintain cash flow, much less get most or all of their capital back out of the deal. Instead of rolling the dice in a fluctuating market, rental property owners may choose to lend out their capital to other active investors while they wait and see what interest rates will do in the long term. Rising interest rates are good for lenders, and private money lenders are no different!
Don’t think the benefits are just for the active and scaling investor. Landlords who aren’t interested in growing their portfolios can choose to unlock the equity in their investment properties. You can do this through cash-out refinances or a home equity line of credit (HELOC), arbitraging the funds into private money loans and earning a spread on the interest. In other words, if a HELOC is worth $100,000 at a variable interest rate of around 5%, and then you lend those funds out to an investor at 10%, you will earn the difference between these two rates. In this case, 5%.
Landlords approaching retirement age and making plans for their families may also turn to private lending to continue cash flow from real estate without having heirs take on the burden of rental units. If market conditions make selling these rentals attractive, landlords may choose to transition that capital into private money lending to keep the income stream they acquired through rental units. Some landlords may own properties in multiple states and want to downsize to make managing the portfolio easier with fewer vendors needed and less complication with income taxes. These opportunities to pivot make a great segway into private money lending!
The Benefits of Learning About Private Lending
Try incorporating this passive income opportunity into your real estate investment strategy. First, the lender gets to set the rules. The lender can choose how much to charge in interest rates (within state and federal regulations) and the terms and conditions of the loan. Private lenders can walk into any deal knowing ahead of time what they will be making, which likely isn’t possible with other methods of investing in real estate. Each time the capital is turned over, it is another opportunity to earn origination points and any associated fees with the loan.
Additionally, the underwriting associated with being the creditor, or lender, on an investment project is similar to the due diligence of the active investor. For novice real estate investors, this is a relatively safe way to learn the ropes while a lot of the heavy lifting is done by your more experienced borrower. Private money lending is also a team sport. The lender has multiple professionals to help advise and protect the capital in the loan.
Private money lenders have legal help in drawing up documents for the loan, a title representative to do a title search and assure clear title, a hazard insurance broker to help review insurance quotes from the borrower, and even other private lenders in their network to help balance out their risks and rewards in the loan. If a private lender builds a solid virtual team, many simply become the reviewer of information instead of the collector, which is even better.
Perhaps one of the best benefits of private money lending is that it can be done anywhere at any time. A business in a backpack, if you will.
This isn’t just financial freedom but more of a lifestyle choice. Those seeking more time back in their busy lives but want to make their money work for them in real estate-backed private money lending while living their best life. Most people pursue real estate investing for financial freedom, but most of the time, what they are really seeking is time freedom or even geographical freedom. Their “why” often revolves around wanting to do what they want, where they want, not necessarily having $10,000 per month coming in as income. For those who value time freedom over anything else, building a private lending practice from anywhere in the world is easy!