Exploring a Passive Path in Real Estate

Fundamental Principle

Private Money Lending is a strategy worth exploring for those seeking passive, stable, and high-yield returns in today’s volatile markets.

This week, we're taking a detour from our series on "Getting Started in Real Estate in 2021" to share a slightly different angle for those looking to invest passively in Real Estate this year. It felt like the right time - in this era of stock market volatility paired with historically low interest rates - many are looking for an investment strategy that offers both relative stability and a healthy return. While sourcing deals, rehabilitating properties, and managing rentals is our approach - we recognize the time commitment isn't for the faint of heart.

With the context of current market conditions, we're not surprised we've started to receive questions and inquiries from our network around the topic of "private money lending." We felt it was high time we shared our perspective - and a few guiding principles we'd recommend to safeguard your investment.

Unpacking the Jargon

Private money (in this instance) isn't the bank account you've forgotten to share with your spouse. 😉 Private money simply refers to any non-institutional money (i.e., not a bank or formal lender) that investors can use to take economic action. It doesn't have to be real estate investing - a more commonly known form of private money might be Angel investments.

In real estate, investors use private money to purchase real estate, typically to add incremental value to a property through rehab. Whereas "hard money" comes from private institutional lenders (for whom lending is a primary business), "private money" comes from individual investors as a part of their investment portfolio.

The Win-Win in Private Money

When we think of "borrowing money" to support a business or purchase a house, most of us think of our local bank - and with good reason! Banks are fantastic - they typically provide the best rates and terms for investors.

On the flip side, they also burden the closing process with significant red tape - meaning closings take at least 30 days (and often upwards of 60 for complex transactions). Limited by strict underwriting guidelines, banks also can't support loans on unique properties. What an investor gains in cheap financing, they must balance with an inflexible process.

Private lenders are an excellent alternative for investors who need to act quickly to secure the best deals, especially in our current market. They tend to have fewer restrictions and are most interested in the return, so investors can target unusual properties with upside and move quickly through the closing process. While private loans tend to carry a higher interest rate, most investors will look to refinance properties post-rehab. The flexibility tends to be well worth the temporarily higher cost of capital.

From the lender point of view, Private Money Lending with a qualified operator (investor deploying the capital) provides an ideal blend of yield, security, liquidity, and passivity that's tough to match.

• Yield: Most private lender terms are in the range of 8-12%, with 1-2 points at origination.
• Security: This is a collateralized loan. The lender holds a lien against the property.
• Liquidity: Most loans are short-term in nature (and as the lender, you can set the repayment terms with your operator).
• Passivity: After some up-front work to vet the operator, this is genuine mailbox money!

Responsible Lending

While private lending is a solid strategy for building wealth, all investments have risk - and you should never invest blindly. When considering lending money to an investor (or business owner of any kind), it's vital to vet the operator thoroughly. A few steps we'd recommend:

• Vetting Experience: The operator should point to deals they've successfully executed with a similar exit strategy, class, and market. They should be able to produce supporting documentation for past transactions.
• Vetting Reputation: Ask the operator for references - from their team, peers, and former lenders.
• Vetting the Strategy: The operator must be buying a deal with enough opportunity for you both to make a profit. In many cases, this means the investor buys a property below market value with a strategy to bring it up to market rates. Understanding the plan allows you to establish realistic timeline and process expectations with your operator - and know when the deal is off track.
• Vetting the Deal: Regardless of their approach - you'll want to ensure the numbers make sense - and this might mean getting a second opinion. As an initial sense check, check that the ARV (After Repair Value) exceeds the loan amount by comparing comparable properties selling in the area. We typically recommend a loan no higher than 70-75% of the ARV, as margin needs to remain for the investor (and for you, in the event of foreclosure).

Once you've determined the investor and the deal both make sense, you'll want to establish SLAs with your operator and ensure you both have a shared vision for the partnership. A few best practices include:

At closing:

• Validate that all payments are to the title company that records a lien at closing. We specifically mention this check - as these document(s) are what enable you to foreclose in the worst-case scenario.
• Ensure you're listed as an additional insured on the insurance policy, just as an institutional lender would be.

Duration of the loan:

• Establishing a regular update cadence from your operator throughout the rehab/refinance process (or whatever steps are necessary for your operator's exit strategy). Active communication helps you stay in sync and ensures you're aware of speedbumps as they occur (and before they become roadblocks).

Exceptional Lenders & Operators

High-performing operators will look to partner with exceptional lenders time and again. The best lenders are responsive and are prepared to move quickly for the right opportunity - often the same day. A few hours can be the difference in securing or losing a deal - especially in current market conditions.

Lenders can also differentiate their offering by developing expertise in a particular market or strategy. Lenders with expertise in a specific market or strategy tend to ask better questions, establish the right expectations up-front, and then step aside to let seasoned operators do what they do best.

Operators carry the more considerable responsibility in the partnership, and accordingly, it takes more to play their part well. Signals that you're partnering with a viable operator include:

• They're proactive, with organized documentation ready at each stage of the process.
• They're communicative and provide regular updates on a specified timeline or continuously through a deal portal.
• They're meticulous and can speak reliably to their numbers and deal progression whenever asked.
• They're running a business - not a side project. They've built an established team with systems in place, and it's clear they're running the show - so you don't have to.

If you notice the following in your operating partner, you may want to think twice:

• They scramble - they don't have documents ready at closing, and they can't answer questions promptly.
• Their communication is spotty - they go dark for long periods, then need things in a hurry.
• They lack an established, reliable team.
• They don't have systems in place - each piece of the process is a one-off.
• They don't own the process and provide regular updates. If you own the process - you have a problem.
• Progress is inconsistent. Forward progress should feel steady. While externalities occur, good operators build flex into their timing. Unforeseen circumstances (e.g., covid-19) may arise - but the operator should have (or develop) a plan and communicate actively throughout.

Recourse as a Private Money Lender

You should set clear expectations upfront with your operator, including the rate, minimum/maximum duration, and process/SLA's. If your operator isn't performing, it's best to address the situation immediately - they've entered into a contract with you, and there should be contingencies.

If you don't see signs of change, you'll want to take legal action (you secured a lien on the property at closing). You do have the option to foreclose on the property should the situation become dire, and the title company can assist you in beginning the process. While that's not our recommendation unless circumstances have devolved - you do have that downside protection.

As a note, there is a wide margin between a project that's exceeding the anticipated duration and a truly non-performing project. We've had projects run longer than anticipated, and in those cases, we've worked with our lender to renegotiate terms that profit both parties.

Bringing It To Life

Note: While this is not a solicitation for Giulioni Real Estate Investors, we thought an actual example might bring some of these concepts to life.

In 2021, we've worked with several private lenders, offering 8-10% with 1-2 points depending on the deal, with terms ranging from 3-12 months. All our lenders take a lien and are listed as additional insured at closing as we've recommended.

Recently, we engaged a private lender to help us secure an unusual yet high-potential property we couldn't have traditionally financed. The lender was contemplating paying off 3% mortgages at the time, hesitant to invest further in a volatile stock market. Instead, we were able to offer a 9% return with 1 point.

After a walk-through of the deal and our strategy, the lender chose to invest. Their responsibilities were limited to signing a single document at closing and wiring the cash to the title company - a turnkey experience. We invested heavily on the frontend to create such an experience for our partners - but we believe private lenders deserve an effortless experience.

Our lender now receives ongoing updates through our real estate portal (example here). We're ahead of schedule on rehab - thanks to exceptional work from the team we've spent the last several years solidifying. Our partners are well-positioned for a great return and are eager to redeploy capital as soon as we finish this project. Thanks to strong relationships with wholesalers and in-house deal sourcing, we'll have options ready for them to consider as soon as they're ready.

If you've found yourself curious about private lending, there are experienced investors in markets across the United States who can offer an exceptional return and experience. The core things to remember in choosing an operator (or any partner) are their track record, their team, their systems, and their ethics. If you'd like to learn more - feel free to check out our investor's page or chat with Nick directly!