You are using an older browser version. Please use a supported version for the best MSN experience.

6 Tips for Becoming a Private Lender

US News & World Report -  Money logo US News & World Report - Money 1/5/2018 Kayleigh Kulp
Woman taking batch of hundred dollar bills. Hands close up: Private lenders have to know how to take calculated risks and build a quality team. © (Getty Images) Private lenders have to know how to take calculated risks and build a quality team.

Mary Anschutz and her husband began privately funding real estate deals four years ago in Denver when they both lost their corporate jobs.

They rolled over the 401(k)s from their old positions into self-directed individual retirement accounts so they could lend it to fix-and-flip investors at a 12 to 20 percent rate of return. They also participated as equity partners in real estate deals in other states.

For those with ample net worth, becoming private lenders to real estate developers and builders, and other businesses, can make for big payouts, the ability to negotiate favorable terms, meet interesting people and associates, and increase cash flow. When it goes bad, however, borrowers may default and not pay.

[See: 7 of the Best Stocks to Buy for 2018.]

Those who may be interested in becoming "the bank" should consider the following before committing their funds.

Know how to take calculated risks. Private lenders can passively invest – or "park" their money – in larger projects such as apartment buildings and self-storage units until a project stabilizes or is sold, Anschutz says. But make sure you can recover from a loan that goes unpaid. If you can't, private lending is not for you.

"Surrounding yourselves with experts who can complement your knowledge is important. For us, doing a few fix-and-flips ourselves made us smarter lenders to others who were rehabbing homes," Anschutz says.

Know the subject. "To be successful as a private lender for fix-and-flips, you have to be able to critically evaluate proposed deals. You'll need knowledge of local construction costs, zoning and permit issues and real estate pricing trends at the neighborhood level," says Bobby Montagne, CEO of Walnut Street Finance, a private money real estate lender in Virginia.

If you don't have the knowledge, you could invest in a private fund administered by experts.

"Before we opened our private loan fund, we were developers and property managers who renovated about 1,200 units over 30 years in Washington, D.C. That gives us the ability to take over the project if one of our borrowers defaults," Montagne says.

Also, you should be able to physically see where the money is going, so opt to invest locally, says Adam Grossman, a certified financial advisor and founder of Mayport Wealth Management in Boston.

"If someone is pitching you to invest a medical device company, that's fine as long as you're a doctor and you can understand the science behind it," Grossman says. "If you don't, then stay away. If something isn't within your domain of knowledge, then you won't even know what questions to ask."

[See: 10 Skills the Best Investors Have.]

Have nerves of steel. If the money doesn't come in on time or as planned, you have to be prepared to stomach it, Anschutz says. It helps to have extensive knowledge about a project or deal so that you can assist if there is a problem.

Get a good attorney and team. Success as a private lender relies on having your documents organized and legal backup. You cannot do these deals on a handshake, Anschutz says. You'll also want to discuss the tax implications with an accountant and create a system for reviewing deals, making decisions and more. Advisors can help ensure you are being compensated sufficiently for the risk you are taking, Grossman says.

"If you can earn 1 percent in the bank and 2 percent or 3 percent in very safe bonds, then I'd say you need something closer to 10 percent before you put money into a private deal," he says.

Trust, but verify. Always run the numbers yourself to ensure they will work, Anschutz says. And "if it is too good to be true, it probably is," Grossman says. "The person on the other end of the transaction might not be a fraud, though that's obviously very possible, but he could just be incompetent, and then the result would be the same."

Evaluate the hassle factor. In addition to evaluating the rate of return you could achieve by lending privately, you want to look at that in dollar terms as well, Grossman says.

"Even if the interest is good, if your investment is relatively modest, then it might not even be worth the hassle," Grossman says.

And while many private lenders mitigate risk by securing the underlying asset, that may be the last thing you want to do because of its cost and intricacy, says David C. Barnett, author of "Invest Local."

"Instead, lenders need to focus on how their loan will actually improve the operating cash flow of the business or person they're lending to. This makes the deal win-win," Barnett says.

[See: 7 Ways to Invest for Income.]

"Even after you check all those boxes, make sure you risk only a small part of your net worth on a private deal," Grossman says. "Even the smartest people with the best ideas can sometimes fail."

Copyright 2017 U.S. News & World Report


More from U.S. News & World Report

US News & World Report -  Money
US News & World Report - Money
image beaconimage beaconimage beacon