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Definition: Private Money is Capital lent by private individuals or organizations not regulated on the same basis as public funds, or banking corporations. Risk capital is put up by by private individuals, lent to borrowers and secured by real estate. It generally carries a higher interest rate for the borrower, and higher rate of return for the lender. The intermediaries such as commercial banks or hedge funds are generally not in the loop, and therefore the management of the transaction is more closely handled by the investor, borrower and their financial consultants such as attorney and or accountants. The risk is considered higher for both parties as there is less regulation and scrutiny. The plus side is there is also considerably less "red tape" and more flexibility in terms and real estate collateral requirements. For information on what you should know about borrowing & lending private money, read Private Money, Opportunities & Consequences.
Opportunities & Consequences
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Who Should Consider Borrowing Private Money?
Private Money is no longer just one option for builders, land owners & vacant property owners. With banks illiquid or holding cash, funds are at an all time low for project financing and investments. Private money may for many be the only option to bridge the time from which they wish to renovate or sell, and when they actually do. Funds in 2009 from banks are not readily flowing to the private sector. When loans are made they will be made more to double income residential homeowners than to commercial property owners. For many commercial property owners to sell now is a disaster in terms of equity loss. Private money may be right for certain borrowers.
Commercial Property Owner-Users in Trouble, needing to bide time until they can refinance:
Not right for them. There is no guarantee financing options will get better with so much excess inventory in terms of real estate in general. Many commercial property owners in and around metro New York were given ready access to private money because of the prime location of their property. Now they can't get out and private investors are scrambling to recover money before the property values tank further. In some cases they just want to recover the funds, in other cases they may have eyed prime property and be ready to pounce on the opportunity to own a cash flowing piece of real estate. It all depends on the situation.
Commercial Property Owners Needing to Renovate so they can lease, who have plenty of equity, but little cash: Right for those situations. Private money can make a pivotal difference and turn a passive loss into a cash generator.
New Construction on Land with sales in the immediate area for similar projects selling within
90 days: Great option, as private money is only a few percent more than conventional financing, without all the red tape. More importantly it is much cheaper than a well healed partner who will want to divide the profit in most cases. When you own and have paid for, and built equity in land... it doesn't always make sense to take on a partner at the last stage of the project. Private money is your best friend if you can get in and get out of the construction and sell the property as planned. If you are held up through mismanagement or due to weak sales, private money may or may not be amenable to waiting for return on their investment. Be sure to review collection and renewal clauses carefully to avoid significant losses.
Homeowner in trouble: Wrong choice. Never take a private money loan from a less regulated entity. Homeowners may forgo procedures in place to assist them in the event they need a loan modification or bank workout. Private investors in most cases will simply want to expedite return of their capital. It seems harsh, but if it were your money, you might feel the same way. Thinking ahead, private money is a bad choice for homeowners. In fact it is terrible.
Spec Buying of Real Estate: Good Option. If you really have a good deal, and have a lot of your own money, but are not an all cash buyer.. Private money can be your best tool to amass a nice real estate portfolio in a buyers market.
Spec Buying With No Money Down: Wrong. If you don't have your own money - don't bother. Too many people call from their car asking for private money while looking up at skyscrapers for sale. They think they can get a building, or other piece of property at a discount and that the investor will consider the discount their part in the deal. Wrong. If they can get a discount, that's all its worth. Who wants to give a total stranger 100% financing in a bad market and hope they know how to manage a property. The fact that they are not putting risk capital in the deal is proof they are not realistic in their approach. Lenders understand first time buyers needing 100% financing to buy a modest home to avoid the trap of renting their life away. But when it comes to second homes, vacation homes, luxury homes, rental properties, commercial real estate, apartments or other spec deals, be real. Have made some successful deals, and be ready to reinvest the profits. To attempt to have someone finance all of any type of an investment property is to waste your time and the investors. The authors that sold that get rich quick book or seminar might be able to afford to lend an individual hundreds of thousands or millions of dollars on a lark, but real private investors are not interested in a losing deal. When it comes to investments, think what you would require if it were your money and you will understand how it works a lot quicker.
Buying Real Estate At Auction: May be the right choice. Private money is not guaranteed until you receive it. Don't go to an auction - put down real money and hope someone you spoke to once over the phone comes through with $300,000.
Do go to an auction prepared to buy a property at a discount, and put money down if 1) you have a lawyer that confirms the deal is subject to your getting the financing you need (a standard mortgage clause). 2) Do consider private money as an option if it is not to be your personal residence, and you feel you have enough money to manage the property until you obtain long term financing and or sell it for a profit. 3) Be wary of expecting a bank to finance your non owner occupied investment property right now. Funds are in short supply for investors. Do market research to support sales of similar properties at the amount you expect to sell it. Make room for downward prices, or you may lose your risk capital. Private money will seek to recover their investment if you do not repay on schedule, which could and does easily happen.
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Who should Lend Private Money?
Most people should never consider lending their money to others as there is high risk involved and they could lose their investment.
Wealthy individuals also do not necessarily belong involved in private money loans. For instance a person recently inheriting a large sum of money or real estate, should never consider investing in private money. They should keep their inheritance where it was that made the family successful, until such time as they reasonably understand how to prudently manage their estate. That can take years for those with no money management experience.
Wealthy individuals with significant investment experience, and with a proven track record of success, with a good relationship with an attorney & accountant, might be candidates for lending a small portion of their liquid assets to private money funds. Only a small portion, and never leveraged funds that would require they pay back a third party if they are not paid back on time. Private money is never a sure thing, when it comes to return on investment as some would tout it.
In fact many things can and do go wrong that are beyond the scope of what this article can fully describe. In summary, loans made with private money are generally non bankable loans for a reason or in fact sometimes for many reasons deeming the loans too risky for certain timely repayment. They may be set for collection before they even close. Therefore never lend private money with intention of seeing it back until it works it's way through the court system and hope the borrower doesn't convince the court they were a victim. Some of the borrowers of private funds are crafty wheeler dealers striving to obtain as many parcels of real estate as possible and are prepared to fight tooth and nail to keep their property and the investor's money if the slightest chance arises they can do so.
Some will simply delay the loan payback in court until they have a buyer which could also take longer you might expect causing true distress over prolonged periods of time to the private money investor.
Only true seasoned professional investors, with plenty of extra capital should ever consider lending private money for the chance of a slightly higher return.
The types of companies that make private money loans to real estate investors do so, most often with higher standards for their private money investors, than for the borrowers using the money.
In most private money lending companies, investors must be accredited. That means they must have a minimum net worth and meet other stringent criteria that sets them apart from an unwitting retiree.
If a grandmother were to invest her retirement with a private money lender and lose it, it would have a severe economic impact on her. The police would likely be called to find out who swindled grandma.
In Private Money lending institutions, great care is taken to avoid borrowing from Grandma. Real companies only and in most cases by law are legally allowed only to utilize private funds from accredited investors. And for good reason.
There are many ways to earn a higher rate of return. Attempting to lend to individuals promising a high return is generally a bad idea.
The wisest saying for all types of investing goes as follows: Return of Capital is more important than Return on Capital.
Never forget it this key to investing. |
