For many of us, when we think of investing in real estate, our frame of reference may first be of popular reality TV shows such as Flip That House or Flipping Out. These fast-paced, drama-laden, high-dollar, hammer-swinging, home improvement free-for-all shows do make for great entertainment! Even This Old House with Bob Villa reminds us of the numerous home improvement projects associated with owning a property. For investors looking to own rental properties, receiving tenant calls about toilets, appliances, and needed property repairs isn’t generally the ideal side job. Not to mention, being on call 24/7 for any tenant complaints or emergency repair requests can be exhausting. In many cases, investors hire a third-party property manager. This can be handy, however it adds to the investors’ overall expenses. With that said, real estate remains a vibrant part of many investors’ portfolios. Active real estate investment may be a good fit for some, but not necessarily for most investors.
In recent years, a new trend has emerged for investing in real estate on a passive basis. This means, the investor does not need to fix up and resell a property or be responsible for ongoing expenses associated with owning a property. This is where the rise of private mortgage investing has begun to gain traction in the real estate marketplace. As the real estate credit markets began to tighten in 2007, an opportunity arose to fund quality real estate transactions that fell just outside banks’ underwriting requirements. This increased demand for loans presents an opportunity for investors to make private mortgages and capitalize on this market inefficiency. Private mortgage loans allow investors to finance real estate with a first lien position, collect monthly payments, and passively earn interest income with the property serving as collateral in the event of non-payment. There are companies and funds around the country that provide investors assistance with due diligence and structuring new loan opportunities. For most investors employing this strategy, capital preservation is the primary focus with earning a healthy yield as the secondary objective. In many cases, there is at least 40% equity within the real estate that serves as collateral for the loan. It is important for investors to have experience in real estate investment or to rely on professional companies that can help ensure quality loan underwriting.
The many baby boomers nearing their retirement age are slowing their accumulation of additional assets and the purpose of their retirement funds is shifting to a more conservative fixed-income yield. Ideally, most investors seek a retirement-type strategy whereby they only need to take out a distribution from their portfolios to subsidize their living expenses and not necessarily spend down the money in their accounts. This is where private mortgages or investment within a mortgage fund is appealing, because it provides ongoing interest income with a limited downside risk on the capital being invested.
For example, someone who has $500,000 in a retirement account that invests in private mortgages at an 8% return would receive $40,000 per year in interest income. This equates to $3,333 per month, all without spending down the $500,000 value of their nest egg. The $500,000 investment would typically be secured by at least $825,000 worth of real estate, which limits the risk of losing the capital invested. Many Registered Investment Advisors (RIAs) and Financial Planners have begun pursuing alternative asset classes like real estate as a way to diversify their clients’ portfolios. As more baby boomers take account distributions in retirement, the potential exists for downward pricing pressure on the overall stock market, with increased market demand for liquidity being generated by retirees. Investing in a non-market correlated asset class such as real estate lessens the volatility risk when it comes time to take distributions from your retirement account.
Josh Manier has been a real estate and mortgage instructor at Kaplan Professional Schools for the past 5 years. He is also managing partner of Island View Private Loan Fund, LP, which provides real estate investment loans to investors throughout the country.
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