Private Lenders In Real Estate
We have all heard the real estate gurus talk about the term “OPM,” Other People’s Money. Starting out as a new investor, it's easy to roll our eyes and think that utilizing other people’s money is impossible and an unrealistic option.
A million things run through our minds like...
“Why would anyone want to lend ME money?”
“What's in it for them?”
“How do I sell my value?”
“What do I present to them?”
“How do I even know what to say?”
"What if they find out I've never done a deal?"
...and so on.
As crazy as it sounds, it’s a lot easier than we make it out to be in our heads. So let’s dive right in.
Let’s pretend that we know a group of people, each with an extra $500,000 in cash; where would be some places that those people could put their "extra" money?
- They could put it in the bank and make a whopping 0.5% interest.
- They could put it in some sort of safety deposit box, in a mattress, or a piggy bank and make nothing.
- They could invest it in the stock market, mutual fund, health savings account, or some sort of retirement account and risk losing it, like I did back in 2008; I lost half of my retirement, but that risk was something that no one could have predicted.
OR they could invest that $500,000 in real estate deals that produce attractive returns.
But where do you even look for a private lender?
Private lenders are anywhere and everywhere. Anyone can be a private lender; fellow investors, family members, relatives, friends, business professionals, friends of friends, people who have equity in their personal homes (HELOCs), people with retirement accounts, or anyone who has the ability to fund a real estate transaction and is looking for a positive return on their money.
The key here is to build a list of potential lenders from all walks of life and schedule some time to meet with them over a meal.
Private lending is also called “relationship lending” because a large component of getting a definite “yes” is dependent upon how well you communicate and how much rapport, or credibility, you have built with the person on the other side of the table. In fact, 85% of the meeting with a private lender will be based on effective communication.
One of the beautiful things about real estate is that it seems to interest a lot of people. A lot of people enjoy the real estate TV shows, they love hearing about people “flipping houses,” and they would certainly love to attempt something similar, but their fear gets in the way.
Private Lending can be a perfect fit for those people.
With that in mind, my first bit of advice is to talk about what you do in real estate, as often as possible, and to as many people as possible.
People will be genuinely interested in hearing more so go ahead and post your real estate opportunities on social media, or your website, to update people on your latest ventures and give them the opportunity to follow along.
It won’t be long until people start asking what you're up to, which gives you the perfect opportunity to tell them more about exactly what you're doing with real estate.
I can remember being at a yearly doctor check-up, and my doctor simply asking, "How's your job going ?" At that point, I had recently gotten into real estate and started talking about the five projects that I was in the process of purchasing.
My doctor sat back and said, “Wow, five projects, how do you even pay for all of that?”
That was all I needed... I leaned forward and said in a secret tone, “I don’t; I use private lenders and they make as much money as I do”.
My doctor pondered this for a second and then said, “Do you think you would ever let me lend on a deal sometime?”
See how easy that was?
It can be as simple as talking about what you do, building the curiosity, building the trust, and selling the deal’s value to someone.
Once you have someone who is potentially interested in investing with you, it is your job to sell your value and the deal to them which, as you've just seen, isn't all that hard to do.
First, you need to understand a little bit about what interested the person in the first place so you can determine how to position the deal to them. If they ask for more information on private lending, I like to ask them, "What is it about private lending that interests you most?”
This points me in the direction of how I need to communicate with that person. If someone consistently talks about making money, I will talk more about the returns and the money that they will make on the deal than about the actual property.
If someone is more interested in the excitement of real estate, or doing deals without the risk of their own neck on the line, then I will talk about our proven track record and the safety of working with us.
Basically, I want to get them to talk about "why" they want to lend because it allows them to say it out loud and sell the idea to themselves.
At the beginning of a meeting, or general conversation, with a potential private lender, the first ten minutes will be spent on building rapport and creating commonality.
You always want to be genuinely interested in their responses, allow them to be the hero with their life’s successes, make them feel important, analyze their personality type, and listen to the way that they communicate so you can do your best to mirror it.
Focus on some common words that they use and make a mental note to use those specific words at a later point in the conversation, without seeming awkward or fake.
Later in the conversation with your potential private lender, ask about their current investments. It is very important to find out if they've ever done any type of private lending so you can determine their level of understanding and how you should be communicating with them.
For example, someone who has been lending for years may not require a detailed explanation of the process, whereas, a brand new lender will count on you for a detailed explanation of exactly what will happen. Do not assume anything, and do not talk over their head. No one likes to feel misinformed, stupid, or insecure.
You also need to know about their current investments to get an idea of where their money is currently located, and what type of turnaround time you're looking at if they decide to lend to you.
If their money is sitting in a savings account, the turnaround time on being able to access that money will be much quicker than if they have to pull it out of the stock market.
We work with great companies that can assist our private lenders with gaining checkbook control of those types of investments within a 30-day turnaround period, so no situation is too difficult for us. That may be something that you'll want to think about too, so you never have to turn down a potential private lender due to timing.
After finding out about where their money is currently invested, one of my favorite questions to ask is, “What type of returns are you getting?”
You need to ask this question lightly because we aren’t trying to shame them or embarrass them if their money is not performing as well as they would like. We are simply asking so we can show the increased value of working with us. Another reason for asking this question is to get an idea of the interest rates that they have settled for in the past.
A lot of new real estate investors like to say that they will pay, “12% interest.” But why would I instantly offer 12% interest if my potential lender tells me that they have been getting 5% interest for the past several years?
Wouldn’t it make more sense for me to wait and hear from the lender first so that I can strategically follow up with saying, “So you’ve been getting 5% interest for the past several years; if I were able to pay you 8% interest, would that be something that would interest you?”
By just listening first, I would be able to potentially save myself 4% and still create a win/win deal for everyone.
So what are typical interest rates for private lenders?
Most commonly you will hear anywhere between 8-12% interest and 0-2 points, but this is dependent upon the lender, the deal, their experience level, your experience level, the time frame, and so on.
The point is that it is negotiable. One important thing to remember is, yes they are helping us by funding our deals, but we are the ones providing them with an unbelievable opportunity to make sizable returns on their investment.
Remember that; you are providing them with an opportunity.
You should never go into these meetings with the mentality that you are begging for money. You aren’t asking for donations; you are allowing them to lend their money, make a sizable return, and receive their initial principle money back when the property sells; that sounds like an opportunity to me!
It is always a good idea to have some sort of credibility kit for yourself and your business, or some sort of document that talks a little bit about what you do. You may be nervous going into these meetings, especially the first few, so these documents will help you convey everything that you want to say, even if you forget to say some of it in person.
I recommend providing these documents prior to the meeting so it doesn’t cause a distraction and allows you to ask if they've had a chance to review the information. Make sure your credibility kit discusses who you are, what you do, and how you do it. It should explain what types of properties you purchase and your buying criteria.
These documents are designed to provide the assurance that you know what you are doing so the lender feels confident investing their money with you.
Every potential private lender wants to see a clear cut plan of what you buy, how you buy it, and how your evaluation criteria makes it safe for them to invest their hard earned money with you.
This takes you into the “documents and protection” phase of your conversation. Lenders want to feel safe and know that their investment with you is safe. Make sure that you are able to explain the documents and the closing process to your lender at this point.
Prior to our potential private lenders ever wiring funding for the deal, they will receive:
- Promissory Note - This states the terms of the agreement, the interest rate, time frames, etc.
- Deed of Trust - This is a mortgage from the lender to you. Assuming that they are the only lender on the property, they will be the 1st lien holder. This document is recorded at the county courthouse and the property cannot be sold without their lien first being satisfied.
- Hazard Insurance - You will obtain a vacant property insurance policy prior to the purchase, which also provides protection for the lender. Here's how it works: the lender is listed as “loss payee” for the entirety of their investment. If the property were to burn to the ground, the private lender is listed as the person who would be paid back.
- Personal Guarantee - The personal guarantee is not required, but shows your level of commitment to the deal. It is your legal promise that if you cannot repay this specific loan, you are held personally liable.
These documents will need to be presented for the lender’s review, approval, and protection prior to wiring the funds. Depending on your state, your title company or real estate attorney can generate these documents for you.
Flipping the table, if you are personally considering lending on someone else’s deal, these documents are what you should expect, and require, for your own protection.
Here is an abbreviated closing process from start to finish. Depending on your state, you may either use a real estate attorney or title company to conduct closings/generate docs but, to prevent redundancy, I will simply use the term “attorney” below:
- You find the property.
- You get the property under contract with the seller.
- You submit the earnest money/down payment to the attorney to hold in escrow until deal closes.
- Your attorney generates the promissory note, deed of trust, and the personal guarantee for your lender’s approval. (Meanwhile, you secure the hazard insurance and list lender as loss payee).
- Prior to closing, your lender wires or sends funds to attorney. Funds are for both purchase of the property and rehab.
- At closing, the documents are signed, the seller is paid, and the remaining rehab funds are dispersed to you in full. Some private lenders may require rehab funds to be dispersed in draws (payments), but this is rare for private lenders.
- You rehab the property as promised.
- You find a buyer for the property.
When you resell the property, the same process is very similar:
- You find a buyer for the property.
- You and your buyer get the property under contract.
- Your buyer submits their earnest money/deposit to their attorney.
- Your buyer works with their bank for financing.
- Their bank generates docs, and your buyer secures insurance. (The closing will likely be performed at their banking institution with their attorney present or legal banking representative available to review their loan information.)
- At the closing, their bank or attorney will pay off the liens on the property; this will repay the private lender's principle and interest. It is the job of their bank or attorney to ensure that the liens are satisfied and documented at the courthouse.
- Their bank or attorney will cut you a check for the remaining balance, which is your profit.
Now is the time for you to gauge the potential private lender’s level of interest and commitment to lending. Ask them, “From everything that I have explained to you, does this sound like something that interests you?”
You aren’t asking for them to hand over a check today; you are simply asking for their commitment to lend on the next deal that you get.
When you do have the next deal available, you will provide detailed information to them so they can review the deal before proceeding. Private Lenders should receive:
- Detailed photo gallery of the property, aka a virtual walkthrough
- Repair estimate of the entire rehab project
- Deal analysis
- 3-5 comparable sales to show the After Repair Value (ARV)
By this point in the conversation, your goal is to hear a definite yes. Hearing, “I’ll have to think about it or talk to someone else,” means there was something unanswered or that you did not entirely convey something about the process.
You always want to evaluate every option possible, so ask them if they know anyone else who may also be interested in receiving a positive return on their money. Keep your private lender list growing and you'll never have to pass on a deal for lack of funding.
In conclusion, private lenders are everywhere; you just have to learn how to effectively communicate with them and show your value. You are providing them with an unbelievable opportunity to be a part of your real estate journey and, if you do your job correctly, they will quickly agree.
What are some of things you've learned from meeting with private lenders? Leave them in the comments below...