Lending on real estate is hands off real estate investing

Lending money to real estate investors can be a lucrative way to participate in a project without running the project yourself.  It can lessen your risk, because of where you stand in the line of people waiting to get paid.

First, lets make it clear we are talking about real estate investment deals here - not a homeowner purchasing a home to live in.  The real estate investor will probably sell to an end buyer, but a lot happens before that.

Irving Investor is going to buy a property in disrepair, using some of his own money and some of yours.  He's going to fix it up, probably using your money, and then sell it to an end buyer in this example.  When he sells to an end buyer, everyone gets paid off:  The taxes, the utilities, the mortgages and the agent if Irving used one.  Irving pockets what's left over.  For purposes of this discussion, we're going to leave the agent out of the picture, simply because it's not relevant to the issue I'm illustrating.  If there is not enough money, someone at the end of the line is left out in the cold.

Here is the order of payment:

• Property Taxes
• Condo fees
• Utility Liens
• 1st position mortgage holder
• Mechanics and medical liens (The contractor you didn’t pay, Medicare, etc)
• Additional liens
• Equity investor

So since you are not the town levying the taxes and you're not a condo association, the next best position is first mortgage holder.  Notice that the owner and/or equity investor gets paid last.  He takes the most risk.

Now, I'm not saying that the equity investor won't make more profit - he might.  Or if something goes wrong, he might not.  The point is, the lender is paid before Irving Investor is paid.

Before you jump into lending with both feet, there are some things you need to know.  I'm going to cover a few here, and then some more over the next couple of posts.

First the disclaimer:  I am not an attorney, don't play one on TV, but I know lots of them in New Hampshire and Massachusetts.  This information is presented as educational only, and if you are considering an investment, alway consult a professional.  A good real estate attorney is essential. 

Do you need to be an accredited investor?  No, not if you are lending directly to a borrower.  But by all means, take this to your attorney and speak to him about it first.

Do you need to be licensed?  What about the SAFE Act?  Ok, here is another "consult your attorney" disclaimer.  But I've consulted several, and the concensus seems to be that commercial transactions are exempt from licensing requirements.  Since all my loans are made to companies acquiring property for business purposes, the licensing requirement doesn't come into play.  All of our borrowers take title in an entity, such as an LLC, and do this as a business.

Should you buy into a "pool" or lend directly?  Well, that depends on how much you are allocating to the endeavor, your experience level and your comfort level with the deal.  You should always make sure than anyone you do business with comes recommended by others and is someone you trust.

Buying into a pool may require (generally speaking) that you be an accredited investor, because you are pooling your funds with others, and that is considered to be a security.  You are likely to get a lower return in a pool than lending directly, because the fund keeps a larger part of the return.

Buying into a pool removes any decision makng about individual loans or borrowers, because the fund managers make all those decisions.  Individual lending leaves the control and the decision making about a particular deal in your hands.  You are also free to set the interest rate and terms, within state usury limits.

Here are some of the questions I'll address in my next post, this one is long enough for today.

• How do you choose the deal you will lend on? 
• How do you find these good deals to lend on? 
• Should you ever lend in second position? 
• What about business loans instead of real estate loans? 
• How do you protect yourself from fraud or incompetence? 
• How much of my portfolio should I allocate to lending? 
• What happens if the borrower stops paying? 
• Should I form an entity to lend? 
• Should I lend outside of my geographic area?