InspireMyCapital.com | How to Earn Attractive Returns on Investment Property Without Being a Landlord (Part 2)
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13 Aug How to Earn Attractive Returns on Investment Property Without Being a Landlord (Part 2)

On the last post, we discussed private lending as one strategy to earn attractive returns backed by real estate without the headaches of tenants and toilets. We talked about the investment security, leverage and passive nature (no tenant calls in the middle of the night) of being “the bank” rather than the landlord. This concept of “control without ownership” is very powerful but also very different than the traditional approach to investing in real estate.

Today, we’re going to go into more detail on the two principal approaches to becoming a private lender – either as a trust deed investor (one deal at a time) or through private mortgage pool investing. Both can earn you very attractive returns but choosing the right approach depends on many factors including your personal risk/reward comfort level of investing, desired level of involvement, desired return or income stream, expertise in real estate and private lending, timeline of investment, etc. There are clearly pros and cons of each approach so let’s address some of the bigger differences:

LENDING ON INDIVIDUAL DEALS

Pros

Choice of Investment: Investor actively chooses a specific borrower and property in which to lend money on.  He/she can do his/her own due diligence and ultimately decide if it’s an investment that satisfies his/her risk/reward parameters.

Negotiate Terms: Investor can negotiate his/her own terms (points, interest, payment schedule, etc.) of the loan as he/she personally sees fit.

“Touch” Property: Investor can usually “touch” the property as it most likely will be in an area close to his/her home or work in which he/she is familiar.  This can provide some investors greater peace of mind.

Active Involvement: For those who want an “active” role in their investment – deal directly with the borrower, touch the property, complete the loan docs, collect payments, etc. – this can provide the investor with “something to do” in addition to being a financial investment.  This can be very important to some investors who have their mind set on the traditional approach to investing in real estate.

Relative Liquidity: Investors control the length of the loan and therefore when their funds become available for alternative investments (assuming the borrower pays in accordance with the loan).

Cons

Need Real Estate Expertise: Investor must either have extensive knowledge on how to evaluate real estate investments and underwrite private mortgage loans OR work with a loan originator who can do this for him/her.

Need to Find Investment Opportunity: Investor must seek out borrower & property and then match loan with funds needed OR work with a loan originator who can do this for him/her.

Capital Not Working 24/7: Once investor’s loan is paid off, investor stops earning a return and must find another borrower & property, complete due diligence, etc. to put their capital back in use OR work with a loan originator who can do this for him/her.

100% Risk Exposure: Investor’s capital is only secured by one property and therefore entire amount of capital is exposed should something go wrong with the investment.

Risk of Income Stream: Investor’s income stream is tied to one property and may be eliminated entirely should borrower stop paying.

Costs of Default: Investor is responsible for all costs necessary to remedy property if borrower is in default (i.e. costs of foreclosure process).

Active Management: Investor must have the time and willingness to take an “active” management role in the investment from start to finish.

 

INVESTING IN PRIVATE MORTGAGE POOL FUND

Pros

Greater Security: Your money is pooled in the fund and secured by multiple real estate loans across the portfolio.  This mitigates the traditional private money risk of lending on one property, to one borrower, in one region, on one loan type, etc.

Constant Deal Flow: Your money works 24/7 to earn consistent returns no matter how much money you have invested in the fund. This is unlike most individual notes that when paid off, earn you no returns until you find the next deal to lend on.

Priority Lien Position: Your money is pooled into the fund to reduce risk and leverage the large buying power gained from multiple investors so the fund ensures priority lien position and well-secured returns.

Time & Effort Savings: The fund sources and analyzes the deals, underwrites the loans, and secures the loans against the real estate.  All the legwork is done for you so your money works hard, not you. That’s the definition of passive income.

Higher Annualized Returns: Research shows that mortgage pool funds pay higher annualized returns than private lending on short-term loans because money never sits idle waiting for the next deal to fund.

Unlimited Investment Opportunities: Once you invest in a mortgage pool fund, you can invest additional funds at any time that start earning returns immediately.  No more passive money sitting on the sidelines.

Cons

“Blind” Investment: The fund makes investments on deals according to stipulated regulations of the fund and fund managers.  It does not inform investors on every deal so investors are subscribing to fund guidelines and decisions made by the managers.

Fixed Returns: Investors cannot change the terms of the fund’s loans. The fund pays investors a stipulated return based on guidelines established in the private placement memorandum.

Passive Investment: Some investors want to take an active, hands-on approach to every deal in which they invest.  The fund does this for investors.

Holding Period: Most funds require investors to commit to a two-year lock up period of their investment.  This enables the managers to better control fund investment but limits when investors can withdraw their funds.

Again, everyone’s situation is unique. In my experience, the Individual Deal approach is best for someone who already works in the real estate investment or loan origination industry and wants to take an active role in the management of the loan. These investors typically feel safer if they are in control of their investment because they are the experts. Alternatively, less knowledgeable investors can work with a loan originator on individual deals but then they are relying on the originator’s expertise and therefore less “active” in the decision making of the investment.

The mortgage pool fund, on the other hand, is where most accredited investors (high net worth individuals) and money managers choose to invest their capital. These investors are seeking secure, reliable, consistent streams of income (typically 8-12%) and passive involvement. They understand both the value of their time and the value of expertise in making their hard earned money work as hard as they do. It’s also where most individual deal investors ultimately place their funds after realizing that, in the long run, consistent use of their capital produces higher returns than one-off individual deals.

If you’d like to discuss how best to use this information in your investments, please feel free to contact us at 626.788.9700 or click here.