This blog is written by Jen Josey, Real Estate Investor, and REIGN Coach. She is not a professional writer and writes like she talks so put your red pen away. Jen is extremely opinionated but reserves the right to change her opinion at any time because, well, that's the way she rolls. She may also use colorful language so don't be offended. Jen does not claim to be an expert, she is just sharing her personal thoughts and adding a perspective on investor topics that may benefit her readers. Jen also finds it strange to write in the third person. Enjoy!
Wait, what?
You read that right, I run my business using other people's money, and sometimes, I can't spend their money quick enough! We work with private money lenders who invest in one of our projects for a few months, and once that home is sold, their cash goes back to them with double-digit returns! I like to think of myself as a matchmaker for their money. Lenders drop their cash off to me, I dress them up and take them to a few parties where they make friends to bring home to mama.
Well, it kinda works that way...
Essentially, being a private money lender is your opportunity to become the bank, earning the profits just like a bank would. It’s a great way to generate cash flow and produce a predictable income stream while at the same time, provide excellent security and safety for your principal investment. You can do what the banks have been doing for years…make a profitable return on investments backed by real estate. There is no other investment vehicle like it.
When we work with private money lenders, the process is simple. We find an undervalued property and then borrow the funds from you to purchase and renovate the property. At closing, you receive a mortgage on the home along with a promissory note, deed of trust, and hazard insurance policy where you are named the mortgage holder for your protection, in case of fire or natural disaster, etc. The next stage is the property renovation. Once the renovations are complete, we’ll list and sell the property. When it’s time for closing, you’ll receive your principle plus interest payment, typically 10%. It’s just that simple! The goal is to continue turning that money for you while you make substantial profits so you keep coming back to us, building a long-term, mutually beneficial relationship.
Our equity is built in the purchase of the home, where we are buying 20% to 30% below a retail buyer that creates instant equity at purchase. Also, in a typical transaction, we cut out the middleman cost, such as commissions, mortgage broker fees, and loan fees. Our attorney costs are also lower because there is less work for them to review. In addition, we provide a higher volume of work for our contractors so they offer deep discounts that help to keep renovation costs down.
Because of our buying strategy, we are able to offer potential home buyers a fully renovated home at or below everything else in the neighborhood. We do an extensive evaluation of a property before we extend an offer and will walk away from deals that do not meet our specific buying criteria. We only move forward on a project if it makes financial sense for everyone involved.
Private money lenders bring speed and efficiency to our transactions, and our leverage is far greater when we purchase using private cash funds. Many of the homes we are purchasing are in need of quick sale within 10-14 days. A traditional bank requires 30-45 days to close a loan. Many traditional home sales fall out of the contract because of financing issues. Using quick cash as leverage allows us to negotiate a lower purchase price and reduce our risk.
Being able to offer a fast closing with private funds motivates sellers to take our offer over the competition, and entices them to take a lower price than they would from a conventional buyer. Also, lending guidelines are continually changing and are requiring applications, approvals, junk fees, and strict investor guidelines. They also limit the number of investment properties that can be purchased by one company.
While your first intention to read this blog was to see what kind of crazy system I used to run my business with other people's money, I bet you didn't realize that you too, could be a private money lender. I know, I know...who has cash like that laying around? Let me share with you how my broke ass became a private money lender with money I didn't even realize I could use!
A popular way investors lend money is through a self-directed IRA.
You may be more familiar with his much more popular brother, the 401k so I'll start there...
Many employers allow employees to make pre-tax contributions every month towards a tax-deferred retirement account. You, the employee, determine what portion of your paycheck goes into this account called a 401k or if you were a teacher like me, a 403b annuity. There are tax laws out there that I don't pretend to understand but I know there is a limit on how much money you can have deducted from your paycheck. From there, this money...YOUR hard-earned money...is invested on your behalf into the stock market and mutual funds. You may have the opportunity for a little protection by choosing a risk level you are comfortable with. From my working days, I remember getting a statement here and there and throwing it into a file folder. The thought of retirement at the time was so far removed that I honestly didn't pay much attention.
When you leave a job and transition into another job, your current 401k can typically be rolled over into your new employer's 401k plan. But in my case, when I left teaching, Janet in HR didn't do a great job of explaining how to transfer those funds so there they sat...collecting dust. Again, I was young and retirement seemed so far away. I'm sure there was a flyer somewhere in my stack of "goodbye papers" but I was more focused on gathering up my favorite student mementos. When I accepted a position with a Fortune 500 company a few years later, they had a great 401k program where they matched 100% of my contributions up to 6% of my salary. Now that I was older, I started to pay more attention. I still contributed the max I could for each year because I was newly married and had another human to help with the bills. I also rolled my most recent 401k into my new employer's fund.
A few more years later, when I left my corporate America job, I had two separate retirement funds. My 403b was just over $26,000 from 10 years of teaching (sad, right?) and my current job had $37,000 (4 years worth) in my 401k. Since I left my job to work our business full time, I no longer had an employer-based 401k. This is when one of my real estate investor coaches taught me about self-directed IRAs. I found a third-party custodian and combined both of my funds into one retirement account where I get to decide how that money is invested. I can continue to invest in the stock market or I can invest in a franchise, gold, real estate, heck...I can invest in a llama farm if I want, I just can't invest in my own company. (You can borrow a limited amount per year but you have to pay yourself interest...please refer to the professionals on this topic.)
Once I created my self-directed IRA, after fees, I had just over $62k in there. I started to lend that money out to other real estate investors between 10% and 12%. That percentage is an annual percentage rate so, in my first transaction, I lent $50k at 10% for 6 months and made $2,500. Now, don't get too excited because that earned interest went right back into my retirement account for when I actually retire. However...that money is not taxed so Uncle Sam can keep his sticky little fingers off it! The next time, I lent $60k at 12% for 8 months and made $4,800 interest. In just over a year, my retirement account went from $62k to $69,300! Start watching your 401k at work and see how the interest earned from the stock market compares to investing in real estate.
So here's a sucker punch for you...
My dinky and dusty little 403b with $26k from my teaching days sat for 10 years. 10 STINKIN' YEARS! If I had known what I know now, I would have rolled it into a self-directed IRA. After fees, I would have around $25k to invest. If I lent that out for 10 years to the Little Llama Mama Farm at 10%, I would have DOUBLED that money to $50k! If I lent that money out on 10 real estate deals, one per year at 10%, here are THOSE numbers thru my favorite financial term...the snowball effect:
Year 1: $25,000 at 10% becomes $27,500
Year 2: $27,500 at 10% becomes $30,250
Year 3: $30,250 at 10% becomes $33,275
Year 4: $33,275 at 10% becomes $36,602
Year 5: $36,602 at 10% becomes $40,262
Year 6: $40,262 at 10% becomes $44,288
Year 7: $44,288 at 10% becomes $48,716
Year 8: $48,716 at 10% becomes $53,587
Year 9: $53,587 at 10% becomes $58,945
Year 10: $58,945 at 10% totaling $64,839!!!
Even though I could blame the HR lady (damn it, Janet) I should have educated myself on all the options. If you are ever in a situation where you are changing from one employer to another, look into rolling your retirement fund into a self-directed IRA so you can diversify your investment opportunities. There is a limit on the maximum contribution you can make per year, so by transferring your 401k, you start out with a much larger pot of money to invest. Other retirement accounts that can be rolled into a self-directed IRA include, but are not limited to, health savings accounts, Roth IRAs, traditional IRAs, and educational savings accounts.
No 401k sitting around? I've got a couple of other options for you...
If you've owned a home for a while and have built up some equity, you can use a home equity line of credit (HELOC) to invest in real estate. Say you get a HELOC for $50,000...I think the current interest rates are about 3.5%. You lend that money at 10% and make 6.5% interest. That's $1,625 earned on a 6-month loan. Think of all the extra spending money you'll have during the holiday season!
For those of you that were taught to save every penny, the highest interest rate I've seen on a savings account was 2.2%...which is very rare. Typical interest earned on an average savings account is less than 1% annually. CDs are not much higher. Break those lonely dollars out of jail and let them make friends!
So...is there a guarantee on your money when investing in real estate? No, but the risk can be much lower than investing in the stock market:
There is no government-backed guarantee on privately held real estate notes. You’re deriving protection from the equity in the real estate. If at any time, the deal goes south and the borrower was to default on the note, you have the legal right to take them home (essentially foreclose on them). As a private money lender, you get paid first. Private money lenders, like the bank, are on the debt side of the investment which means when a property is sold the lender gets paid first. The borrower is on the equity side of the investment which means any losses or gains are absorbed by them. In a worst-case scenario, often times the borrower just doesn't make as much profit as they originally hoped for.
I hope this blog has opened up some possibilities for you to diversify where you invest your money. You should always consult with a professional when investing your money, just want to add a few more tools to your money bag. I was raised in a home where it was not polite to discuss money, you just put it away for a rainy day. Had I fought the "ignorance is bliss" mentality twenty years ago, I would be much better off financially today. The good news is that the rainy day has arrived and my retirement account is starting to flood from the downpour.
Make it a great day! Whoop whoop!
*Read more blogs by Jen Josey at www.REIGNmastermind.com.