Private Lending vs REI

[Jimmy H.]

I know the definition of "REI" can be very broad. But, in a very general sense I have been having the realization that even in some of the best REI scenarios 10%-15% return on your money is pretty good (this of course varies with the amount of risk you ar etaking on, etc.). In private lending you can very well make 10%+ without all of the legwork and although you assume risk, if you lend only less than 70% LTV and know your market and borrower, in a worst case scenario you can foreclose and generally get your money back - maybe even more.

If I have a decent pool of capital - say 500k - why wouldn't you sit back and collect 10%+ in private lending without as much legwork or risk. Especially in this market when private financing is in higher demand; let others seek out the deals and you evaluate them and finance them if they sound feasible.

Again, I know this depends on a variety of factors: your REI strategy, how much money you have, if you have a good day job without time for REI, etc. Also, I will likely do a bit of both just as diversification and for the fun of doing some hand-on deals.

Ultimately, in terms of the work you do and risk you assume, it seems private lending is one of the least risky and most profitable endeavors in the industry. In fact, when you look at guys who have a great portfolio and great REI experience, many end up doing primarily private lending later in their careers. If i'm lucky enough to have a decent chunk of capital now, shouldn't I learn from their wisdom and jump straight to lending and skip the hassle?

As an aside, how much capital do you think you should have, as a minimum, to get started in private lending?

[Don Konipol]

Private mortgage lending can provide a very high return, but no chance for appreciation and no inflation protection.

Owning income properties will provide a smaller amount of current income, but provide inflation protection, capital appreciation potential and sometimes the possibility for outsized gains.

Ownership of real estate can also be leveraged, allowing for the arbitrage between cap rate and interest paid known as mortgage reduction.

For the experienced, knowledgable investor, I recommend splitting your portfolio equally between the two.

Also, IMO, hard money lending requires greater knowledge and has more risk. A good property has to be purchased only once, it can than be held for 30 years throwing off increasing cash flow via rising rents, and appreciating in value. Most HMLs are for 6 months or one year, a new investment must be found, and each new loan carries the risk of a bad investment, however small. So in owning a good property 30 years you have a one time investment risk. 30 years of making a hard money loan turning over twice a year will be making 60 loans, with a fairly high risk that some of them will be bad.

Further, owning real estate you decide when and if to sell; making loans the borrower may pay you off at the most inopportune times. Further, in lending the good loans tend to pay off, the bad ones are hard to collect.

The amount of cash needed to begin a loan portfolio varies with the risk the investor is wiling to incurr and the knowledge and experience of the investor. Obviously, a small amount to invest may mean having a portfolio of a single loan, this is more risky than having more money invested and a diversified portfolio of 20 loans.

The mostly passive investor can achieve a return of 12-14% annually in private lending, the more active investor 16 -20%.

Direct property investment may have current yield of 8-10% for the passive investor, 10-12% for the more active investor. However, this does not take into account price appreciation which historically on commercial property has averaged 5 - 6 % over the last half century. Further, the arbitrage between the cap rate earned and the interest rate paid will enhance the cash on cash return. Part of your income in direct real estate investment will be tax deferred and ultimately taxed at the lower capital gains rate.