Invest in private lending and earn money from interest
Smart investors are on the lookout for alternatives when it comes to investment options with the ability to provide decent returns as well as balancing risk with reward. The good news is private lending ticks a lot of these boxes, but it’s an investment option that often flies under the radar.
Private lending is attracting more and more investors because of the potential for passive income and higher returns. With interest rates in Australia at an all-time low, seeking out alternative options with the potential of providing a better rate of return makes sense.
So let’s take a look at a few private lending investment secrets, to help you decide if this investment option is right for you. But first, it helps to understand how investing in private lending works.
What is a private lender?
Essentially a private lender lends money to borrowers primarily for short-term business purposes. Private loans are mostly secured against property with most private lenders being “asset lenders”.
This means they lend money against the value of a traditional asset, such as property. When entering a private loan the borrower agrees to pay the lender an agreed amount over an agreed term.
How do private lenders make money?
Borrowers who seek finance from private lenders are willing to pay a premium for the speed and flexibility private lending arrangements can offer them.
Private lending rates are usually higher than banks and other lending institutions. And the term of the loan is often much more flexible and can be offered over a shorter term. Think 6-12 months compared to a 30-year bank loan.
Private lenders find borrowers and conduct extensive due diligence before lending out funds that are provided by investors. They then manage the loan and collect interest payments which are passed on to the investors.
Loan to Value Ratio (LVR)
One important aspect of private lending is deciding how much money to lend to a borrower. The private lender or mortgage manager will generally lend no more than 80% (usually a lot less) of the value of the security property being used to secure the loan. This is called the Loan-to-Value Ratio (LVR).
For example if the private loan was secured by a property worth $1M and the private lender decided they would lend $650,000 then the LVR would be 65%. The LVR is used to determine how much risk you’re taking on with a loan. It measures the relationship between the loan amount and the market value of the asset.
The LVR mostly comes into play if a borrower can’t pay a loan back. Because the private lender has a mortgage over the security property they can sell the property to recuperate the funds lent. If they had lent 100% of the property value and property prices dropped then it’s unlikely they’d be able to make back all the loan.That’s why it’s important to lend at a lower LVR.
Six private lending investment secrets
Like all investments, the best thing you can do to set yourself on a path to success is due diligence to understand how the investment works, what the risks are and how it suits your personal situation. But there are a few secrets we can share to help you on your way to making the decision about private lending investment:
- Potential for higher returns
Because borrowers are wanting speed and flexibility, they’re willing to pay a premium. And that means higher returns for you, the investor.
- Passive income can be easy with private lending
Investing with a private lender means you’re relying on the expertise of an experienced mortgage manager, so you don’t need to actively manage the investment. The income you earn is both passive and regular.
- You don’t need a large amount to get started
Active Property Group investments start from as little as $10,000 so there’s no huge outlay of cash to get started.
- Suits all investor types
It’s a myth you need to be a seasoned investor to invest in private lending. With small buy-in amounts, investment options with conservative LVRs and experienced fund managers, it’s a great option for beginners, experienced investors, SMSFs, couples and singles.
- No long lock in periods
Not only does the borrower get the flexibility they’re looking for, so do you as an investor. Redemptions are usually offered every quarter.
Not having your eggs all in one basket is a great investment strategy. Investing in a private lending fund will mean you are invested in a portfolio of loans so your investment is diversified.
How can I succeed in private money lending?
Private lenders operate ‘mortgage funds’ which allow investors to put their funds towards the loans and then earn the interest paid by the borrowers. Investing in private money lending isn’t for everyone.
Despite the many potential benefits, there are also risks you need to consider. Due diligence to understand your risk Investing should never feel like gambling. Good investment takes due diligence to understand the risks, how the investment works and your threshold to handle any worst-case scenarios if they arise.
When you choose to invest with an experienced, established and respected private lender, you’ll be minimising much of that risk. And because borrowers provide real-estate security for the loan, the asset can be sold to recoup the loan amount.
When investing in a fund like APG’s Pooled Mortgage Fund, your funds are used to finance a portfolio of between 20-30 loans, so if one loan goes into default, the other loans will hopefully still be performing and delivering a return.
The private lender you’re considering investing with should always conduct extensive due diligence to determine the reliability of the borrower and the security property including:
- a solid exit strategy for being able to repay the loan
- multiple valuations of the security property
- any financial offenses like bankruptcy the borrower may have previously had
Pros of investing in private mortgages
The biggest benefit of deciding to invest with a private lender is being able to participate in the real estate market passively while receiving a return on investment. As the investor, you don’t need to get involved with managing the loan. The hard work is left up to the private lender.
You play a passive role, once you’ve put up your money you can sit back and wait for your regular payments in return. Plus those returns are typically at a higher rate than many other investment options.
Cons of investing in private mortgages
Investing in private money lending does carry the risk of borrower default. But with the investment secured by real estate, recovering the loan is usually possible. You can minimise the risk associated with borrower defaults by investing in a pooled fund where your funds are diversified across a portfolio of loans. So even if one borrower doesn’t pay back their loan on time, hopefully, the others will.
Additionally, doing your homework before you invest is recommended. And that takes both effort and time. While private lending is a passive investment, it’s best to do some research upfront and make sure you’re investing with a respected private lender and funds management company.
As an investor, you should be confident you understand the investment strategy you’re considering. And remember to check the private money lender operates under an Australian Financial Services Licence.
How much can you make when investing in private mortgages?
Private lending has the potential to provide attractive returns to investors, especially when having money in the bank is returning so little interest.
Most private mortgage funds will offer investors a return of between 5-10% p.a.. Active Property Group’s Pooled Mortgage Fund delivered a 9.15% p.a. return in the 2021 financial year. Please keep in mind that past returns do not indicate future performance. Also keep in mind any fees that might be involved with investing too, make sure you ask about those before investing.
How to invest in private loans
There are many mortgage fund providers around that will allow you to invest in private loans. Some will only accept investments from Wholesale Investors (see definition below) while others, like Active Property Group, will accept both Wholesale and Retail investors.
Most funds will also have a minimum investment amount, some start as low as $10,000 while others might be $250,000+. So as long as you have the minimum investment amount you should be fine to invest.
If you decide to move ahead with an investment, you will usually fill out an Application Form stating how much you’d like to invest and which entity you will be investing through. You can usually invest as an individual, jointly, self-managed super fund, Trust or Company.
Once you’ve applied the fund manager will ask you for some ID to confirm you are who you say you are and then once you’re ‘onboarded’ you’ll be able to transfer your funds.
Here are a few things to think about when choosing a private mortgage fund manager:
- What’s the historical performance of the fund (keeping in mind that past returns do not indicate future performance)
- Does the fund accept Wholesale and/or Retail investors?
- What is the minimum investment amount?
- When do I receive distributions?
- How long do I have to leave my money in for?
- Are there any fees I need to pay?
- Do the fund manager and private lender have extensive experience?
- Is the fund operated under an Australian Financial Services Licence
And here’s a few answers in relation to Active Property Group’s Pooled Mortgage Fund:
- Our Pooled Fund delivered a 9.15% p.a. Return in the 2021 financial year
- We accept investments from Wholesale and Retail investments
- The minimum investment amount is $10,000 for Retail investors and $25,000 for Wholesale investors
- Distributions are paid on a quarterly basis?
- There’s no minimum term for your investment and we process redemptions once a quarter (at the same time as we pay distributions)?
- The return quoted above is net of fees for Wholesale investors. Retail investors pay a 0.5% p.a. Fee which is deducted from their quarterly distribution.
- The team managing the loans and your investment have over 50 years of experience in the industry.
- APG has an independent trustee called Primary Securities Ltd who have an Australian Financial Services Licence
What is a Wholesale or Retail investor?
A Wholesale investor is:
- A person or entity who initially invests at least $500,000 or
- A person or entity that has obtained an accountant’s certificate within the preceding six months stating that they:
- have net assets of at least $2.5 million, or
- have a gross income of $250,000 p.a. for each of the last two financial years.
A Retail investor is:
- Anyone else who doesn’t fall within the Wholesale classification above.
Look for a fund manager where the team looking after your investment is also invested. This means they have ‘skin in the game’ and therefore want to deliver great returns to not only keep their investors happy but to keep themselves happy too!
If you would like to find out any more information about Active Property Group’s private mortgage investments then please get in touch with [email protected]