Lending to real estate investors - more considerations to protect yourself

Part 6 of a series

I'm continuing a discussion of lending money to real estate investors. My company lends money exclusively to real estate investors in a specific geographic area. This allows us to be local to any property used to collateralize the loan, stay on top of legislative changes through our network of local attorneys and professionals, and to understand local trends, since all real estate is local.

How do you protect yourself from fraud or incompetence?  First of all, know who you are dealing with.  If you are lending directly to an investor, ASK AROUND!  It's amazing to me how many people invest or lend with one real estate investor without getting references from other people who are in a position to know.  If you are going to put money into a deal, the people involved should be 100% transparent in their dealings.  Both from an ethical perspective and from a competency view.

• Google them.  You can't always find everything about them that way, but you might see a pattern one way or the other.  I once was approached by an investor for a loan, and when I googled him, it turned out he was a disbarred real estate attorney who had twice misappropriated escrowed funds.  Not someone I want to do business with.
• Ask around.  Ask at local Real Estate Investor Associations.  Ask your network of attorneys and accountants.  Sometimes what they won't say tells you a lot.  People are careful about giving bad references, but will usually give you enthusiastic recommendations if everything they know is positive.
• Do your due diligence.  If you are investing with one person, you have to research the property ad market yourself.  If you are investing with a hard money company, the company does the due diligence.  Ask the company how much of that research on each deal is available for you to review.  If you are investing in a fund, the answer is probably none, because you aren't investing in an individual deal, but if you are working with a company where you get to choose the deal your money goes to, you should be able to get information about the person and the deal.  
• Go to each property yourself.  Each deal is different, and a property photo can be edited to not show the railroad tracks in the back and the auto junk yard next door. Pay attention to the neighborhood as you drive there, and leave the property in another direction.  
• Trust your instincts.  I don't want to get all fuzzy here, but if you get that uncomfortable little niggling doubt, then do more research to find out why.  You should reach the point at which your discomfort is resolved.

What happens if the borrower stops paying? Well, you are going to take the necessary steps to resolve the situation.  If you are working with a borrower directly, then you should talk with the borrower to get to the underlying problems and then determine the appropriate actions.    If you are working with a hard money company, the company will be the intermediary working with the borrower.  If you are in a pool, you won't be involved at all, because you are not the lender, the pool is.  In a declining market, time is not on your side, but since this is a business transaction, you are not dealing with a homeowner, you are working with a businessperson.

How much of my portfolio should I allocate to lending?   I'm not a financial advisor, so you should speak to your own professional for personalized investing and allocation advice.  However, if you are a knowledgeable real estate investor yourself, you probably are comfortable with a large percentage in lending, because you have the expertise and resources to finish the project yourself.  In fact some lenders hope to take the property.  We don't "loan to own" be be aware that some do.  If you have limited real estate investing experience, then limit your exposure by doing just one or two deals at a time.

These questions have partially addressed some of the risks in lending.  A much more detailed discussion is beyond the scope of an education blog post.  If you have interest and want to know more of the what if's, then contact me.  It will help you decide if lending is for you.

Next post we will discuss the following questions:

•Should I form an entity to lend?

•Should I lend outside of my geographic area?

 •What about business loans instead of real estate loans?