If you’re not going to put money in real estate, where else? –Tamir Sapir
Last week we talked about what kind of return you can get from actually owning a rental property. There’s quite a range. And let’s face it, anyone who thinks owning a rental house is passive income is kidding themselves. It’s work. You either have to manage the place yourself; dealing with tenants and turnover and every excuse in the world for why they can’t pay their rent on time and why it isn’t their fault, or you have to pay someone 6-10% of your gross rent plus a leasing fee to manage it for you. That cuts into a lot of your profit. And, I’ve never met a management company that amounted to anything.
Owning real estate is a business.
But, say you had some extra bucks lying around and you like the security of real estate but not the headache of ownership. In most states, it’s still legal to loan your personal money on a piece of real estate. (I say most states, because California has made it very difficult for average people with less than a million dollars to legally loan out money. Don’t get me wrong, people still do it all the time, but that doesn’t mean it’s legal.)
Right now, an investor can get conventional financing at right around 5%. Historically, that’s pretty darned good. But the problem is, these loans are hard to qualify for. The investor has to have those pesky things like tax returns and verifiable income for several years etc. The good old days of the buyer telling the bank what they make are over… Well, they’re over for now. Don’t worry, they’ll probably be back in one form or another. Banks have notoriously short memories and are really a lagging economic indicator in their lending policies. (I’m being facetious; no doc loans were always stupid.)
That’s where investors and specialty lenders come in. Some investors loan their money out usually between 6 and 10% on rental houses. The property owner usually needs between 20 and 30% equity in the property, and the investor will loan based on the property itself. They put up 70%, and secure the note on the house itself. That way, if the investor doesn’t pay, the “bank” gets the house at a pretty good sized discount and they are still able to collect a decent safe return on their money. It’s this type of investment that I was referring to last week when I basically said anyone who is working hard for less than a 6-7% return doesn’t know what they’re doing. These longer term private loans are usually two to four years. The downside is, you won’t get your money back until the loan matures or the investor otherwise pays off the property through a refinance or sale. The upside is these are fairly secure passive income loans.
The highest ROI lending is in hard money lending for flippers. These are usually short term construction bridge loans. These are more expensive, but also have more turnover and nominally more risk. The note is still secured on the property, and most lenders require 30% equity in the property at all times. Other than that, there are numerous terms. Most of these loans are between 10 and 14% annually, and also include 2-4 upfront origination points. These loans can have a 12 month term, but often they only have a 6 month term. That isn’t a bad return if you can stay 100% invested, and find someone willing to pay you 14% and 4 points (an 18% annualized return) on a six month turnover. If you did this twice in a year you could make 22%. That isn’t bad. The downsides are, this is a very competitive market and you would be competing against banks and larger institutions for placing your money. There are quite a few brokers who source properties and service these loans. But they usually take the origination points as their cut.
All of these lending options are less work and less risk than trying to flip a property. On paper, they should also be less return. But, a lot of people don’t understand all the potential pitfalls of flipping a house or owning a rental property before they get in. This game isn’t a get rich quick deal. It’s a get rich eventually with a lot of work and with a potential to really lose a lot of money. Be careful before you jump in.
THE BOTTOM LINE
However you slice it, there are ways to make money in this game. But, it’s important to know what you’re getting yourself into and what the risks and time commitments involved are.
