Real estate investor Justin Pierce writes an occasional column about his experiences buying and selling houses in the Washington area.
I am struck by how people struggle to find ways to put their money to work. Most people think their only option is to put money into stocks or mutual funds.
People are intimidated by real estate and other direct investing strategies. They think they’re too risky. Yet they’ll run off and sink their entire life’s savings into a blue chip company not knowing a single thing about the organization because large American companies can’t fail, right?
There are good solid real estate investments all around you, and there are ways you can hedge your bets to protect your investment.
Private or hard money lenders are often just people who have saved up a good chunk of money. They lend that money to real estate investors just like mortgage companies. They normally only lend about 65 percent of what the property is ultimately worth. The real estate investor has to either find really good deals or has to bring money to the table, often both.
The private lenders normally demand 12 to 18 percent annual interest on their money, plus four to eight points up front. They have a lawyer write up all the documents that big conventional lenders require. The borrower will sign a promissory note at closing agreeing to the lender’s terms and the lawyer will record a deed of trust securing the promissory note to the property. The best part about it, the borrower pays for that lawyer.
So, if a real estate investor wants to buy a home that is worth $100,000, the private lender will probably give the investor about $65,000 max. If the investor is successful and flips the home in six months, which is about the normal time frame, then the lender will probably make about a 10 to 14 percent return on their money in just six months. If the investor defaults, then the lender takes a property with 35 percent equity.
Lenders are protected in several ways. They have collateral to secure their money. That collateral is worth 35 to 40 percent more than what they put out. A deed of trust is recorded to protect their claim. Imagine if you could buy a stock at 60 percent of its value with a guarantee that someone will pay you 12 to18 percent on your money or you get the stock at full value.
I bet many of you are thinking those rates are criminal. Some debt, though, really is good debt. People will scoff at a deal like this and then go take out a $50,000 loan at 5 percent on a car (a rapidly depreciating asset) that is worth 20 percent less the minute you drive it off the lot and think it’s a great deal. A 5 percent rate on a depreciating asset is a much worse deal than a 16 percent rate on a deal with a 30 percent profit margin.
You also don’t need millions of dollars to do this. There are local brokers who pool money from smaller investors. In the past jobs bill, the federal government opened up the door for crowd funding. When fully implemented, this could allow smaller investors to pool their money to get the kind of returns that were available only to the super rich in the past. People literally would be able to get in for just $100.
You can also lend directly to legitimate real estate professionals with proven track records. As a warning, just about everyone who attends a real estate seminar is looking for money and calling himself or herself a pro.
Be sure to ask for past performance. Most pros will happily submit to you a portfolio of their past projects, their personal and business balance sheets and even let you pull their credit. Don’t be afraid to ask for it.
Remember, there is no such thing as risk free investing or easy money. Anyone who says otherwise is probably a conman.
Seek professionals with a track record of performance and get an attorney involved early.
Justin Pierce is a real estate investor in Northern Virginia. Follow him on Twitter at @justinpierce1.