We live in a bizarre time. The stock market can be at an all-time high one day, and crash the next. We’ve seen the single largest decline in GDP in history, and yet some pundits claim that we’re not in a recession. To say that things are uncertain and that traditional investment options lack security and permanence is an understatement.

It seems like now’s the time to turn to the most conservative investment options available – things like precious metals – since even real estate has peaked and it may be a long road to recovery. However, that way lies financial stagnation. Investors are starving for higher yields and measurable returns.

Real estate debt may be the solution.

Real estate debt can be a conservative hedge against risk, while simultaneously delivering high yields. At Pacific Private Money Inc., we offer four investment options, all of which deliver excellent potential for good returns while mitigating your risk exposure.

Of course, you might still be on the fence here. What is real estate debt all about? How does real estate debt protect against risk and yet still deliver good ROI? We’ll cover those topics and more below to help ensure you’re able to make an informed, accurate decision and build a strong, stable financial future.

What Is Real Estate Debt?

Real estate debt is precisely what it sounds like. Most of us carry it in some form or another, as well. That 30-year mortgage you have? That’s real estate debt. You’ll find plenty of other examples of real estate debt investments out there, ranging from SBA loans to purchase new business facilities to home improvement loans secured by the equity in a home.

What Are Real Estate Debt Investments?

Understanding real estate debt investments requires something of a shift in mindset. You need to take yourself out of the consumer mindset and, instead, put yourself into the lender’s shoes. Essentially, that’s what this real estate debt investment model entails – you become the lender, helping other people realize their dreams of homeownership or establishing a business. In return, you’re repaid on your capital investment, plus interest.

How Does It Work?

Real estate debt investing is pretty simple to understand. It’s much more straightforward than other investment options, most of which offer a fraction of the return and come with much greater risk. Here’s a quick example:

  • A family wants to sell their home and purchase a new one.
  • They cannot afford a down payment until their current home sells, but cannot sell until they have somewhere to move.
  • A bridge loan can provide the financial fluidity necessary by giving the family the money necessary for a down payment and to cover closing costs and other costs while waiting for the first property to sell.
  • The family approaches a real estate debt investment company (e.g. a hard money lender).
  • The company assesses the situation and the properties and alerts its investors to the opportunity.
  • The company provides a bridge loan the family can use to get into their new home.
  • The family’s original home sells and they use the proceeds to repay the bridge loan.
  • The company gets repaid, and it shares the interest in the form of a healthy rate of return to the individual investor or investors who provided the capital.

Of course, this is a relatively simplistic example. It’s also just one example of what is possible with real estate debt investment – there are as many variations as there are potential borrowers. However, it does illustrate the underlying concept and just how simple the process truly is. Some of the most common types of real estate debt include bridge loans (as evinced above), investment property loans, construction loans, and property rehab loans.

Understanding the Benefits and Advantages of Real Estate Debt Investment

From the introduction above, it should be pretty clear that there are numerous advantages and benefits available with real estate debt investment. However, further discussion is necessary to explore those and what they offer you, the investor. In this section, we’ll break it all down for clarity and understanding.

You’re at the Bottom of the Stack

Being at the bottom of the capital stack is important. It means that you’re first in line to be repaid if something goes wrong and the situation goes south. That offers peace of mind, security, and protection for your investment, but also your financial future.

Secured by the Property

Like any other mortgage, these real estate debt loans are secured by the value of the property in question. If the borrower fails to live up to their end of the deal, the property will be sold and your investment will be recouped. Because of that security, these real estate debt investments offer dramatically lower risk in comparison to some traditional vehicles, such as stocks, which are dependent on company performance and come with no guarantee of any return at all, not even your initial investment amount.

Less Time Spent Waiting

With stocks and other investments, you need to practice a buy and hold strategy, which leaves your money tied up for what might be decades. While it’s hoped that you’ll see a return during that time, you may see no growth, or even lose your investment entirely. With real estate debt, on the other hand, the time horizons are much, much shorter.

Depending on the real estate debt investment opportunity in question, it could be as short as six months. Even in a longer-term situation, you might only have to wait two years for your return. That means you get your capital back faster, plus the interest on the investment.

Not only does real estate debt investment mean faster returns and faster exits, but it means that you have greater agility overall. Because your capital isn’t tied up for decades, you can put it to work in many different ways. You can take advantage of unique opportunities as they present themselves, rather than missing out because your capital was locked into a stock or investment fund and, thus, inaccessible.

Plan on Ongoing Income

Real estate debt investments offer additional security in the form of ongoing, steady income. They’re much more predictable than equity investments in this way, and can also offer higher returns. It’s not unusual to see high investment yields over a year with real estate debt investment, although this will vary significantly depending on the situation and lending partner in question. For instance, at Pacific Private Money Inc., we offer annual yields of 7% and up to our investors.

Potential Drawbacks of Real Estate Debt Investment

In addition to the benefits and advantages we explored above, it’s important to understand that all investment opportunities come with some potential drawbacks. Real estate debt is no different, although there are fewer drawbacks than you’ll find with many other investment options. Below, we’ll cover what you should know.

Return Is Capped

With some investments, your return potential is unlimited (at least in theory). With real estate debt investment, that’s not the case. Your return is capped by the interest rate charged on the loan (you’ll earn a percentage of what the borrower pays in interest). However, that comes with reduced risk and a shorter investment horizon, which means that you can usually grow your wealth more (and faster) than you could with those investment options that come with a theoretically limitless return threshold.

The Potential for Prepayment

Because you assume the position of a lender in this real estate debt situation, your return is predicated on the borrower repaying the loan over the specified period. If they pay it off early, that will affect the profit you earn. Obviously, you don’t have to worry about that with other forms of investment, including stocks, bonds, 401(k)s, and the like, but those investment methods don’t come with the predictable stream of income, reduced risk, and enhanced flexibility found with real estate debt investment.

The Costs Involved

All investments come with some cost. Real estate debt investment is no different. In this situation, you’ll have several cost factors to consider, including:

  • Fund Expenses: Fund expenses are taken off the top of each loan payment.
  • Management Fees: Management fees are also taken off the top and can vary dramatically from investment platform to investment platform.
  • Minimum Investment Amounts: Most real estate debt investment requires that you invest a minimum dollar amount or higher.
  • Loan Origination Fees: Sometimes loan origination fees are passed along to investors.
  • Tax Consequences: Funds can be treated in different ways for income tax. Consult with your tax advisor for guidance in your specific situation.

What to Look for in an Investment Partner

Real estate debt investment can offer some pretty impressive benefits. However, a lot of the value you’ll see here hinges on the investment partner/platform that you choose. You’ll find many different options out there, and they’re far from equal. You must know what to look for in a qualified, trusted real estate debt investment partner, so we’ll delve into those considerations in this section.

Loans Funded

One significant metric to consider is the number of real estate loans a potential partner has funded. A low number might indicate that the organization is just getting up and running, which may be a sign that you should use caution. A high number usually indicates that the company has been around for several years, but it may also indicate that the firm is engaged in rapid-fire lending, which can be disastrous.

You’ll want to compare the number of loans funded with the firm’s length of time in the industry to get a good feel here. There’s nothing technically wrong with choosing a startup, but there’s a lot to be said for the stability and peace of mind that comes from working with an industry veteran. Finally, a significant number of loans made over a short period could be a warning sign.

Loans Paid Off

The number of loans paid off is an excellent indicator of the partner’s value to your real estate debt investment needs. Compare this number to how many loans have been funded. They should be pretty close, although you’ll need to leave room for the number of loans currently active.

Loan Losses

Loan losses are those where the borrower has defaulted or another similar situation has led to the loan falling through. Ideally, the partner you choose will have no loan losses at all. Some platforms do not provide this information upfront. Instead, they try to bury it in the loans funded to loans paid off ratio. You should also consider the firm’s loan default rate. Look for a rate of under 1%.

Earnings and Distribution Period

Two of the major questions that you’ll need to answer before choosing an investment platform are how much will you earn and when will those earnings be paid? The earnings are usually listed as a percentage, but the payout can be monthly, quarterly, or annually. Obviously, the more frequent the payout, the more accessible your funds will be and the better you’ll be able to plan your finances.

Lending Options

Each investor has a unique tolerance for risk, as well as specific goals. You cannot offer a one-size-fits-all debt investment and expect it to deliver value to all investors. Instead, look for a partner that can offer multiple investment choices so that you can pick the one that best matches your investment and return needs, your time horizon, and your individual appetite for risk. For instance, at Pacific Private Money Inc., we’re proud to offer five different ways to invest. These are as follows:

Pacific Private Money Fund

Founded in 2013, this program is focused on primarily SFR investment and consumer loans. It delivers 7% to 8% to investors annually on average in monthly distributions.

North Star Capital Fund

Launched in 2020, this fund focuses on funding construction and major remodeling projects, and is designed to deliver returns between 8% and 10% with quarterly distributions.

Pacific Freedom Fund

We launched this fund in 2020, and it’s designed to work similarly to a money market account. It pays investors 7% on the investment per month, and there are no penalties for withdrawing.

Pacific Southwest Fund

Also launched in 2020, this fund specializes in purchasing discounted seller carry-back notes in Texas and other nearby states. This fund has monthly distributions and pays a 9% preferred return plus 50% of the excess profits.

Whole of Fractional Notes

Finally, we offer whole or fractional notes that allow you to invest in all or a portion of a single real estate-secured loan. You might be more familiar with this as “trust deed investing”. They typically deliver between 7% and 9%, although the amount varies based on LTV, as well as loan positioning.

Risk Mitigation

Yet another critical consideration when choosing a real estate debt lending partner is the firm’s lending mitigation plan. All real estate debt investments come with risk. However, the lending platform should have a strategy in place to help reduce your exposure. At Pacific Private Money Inc., we follow a six-step risk mitigation plan that focuses on the following:

  1. Assessing the value
  2. Checking for a clear title
  3. Verifying income/ability to pay
  4. Ensuring good hazard insurance is in place
  5. First mortgage review in the select instances we take second position
  6. The borrower’s creditworthiness

Is Real Estate Debt Right for You?

You deserve the ability to create a vibrant, worry-free financial future. However, conventional investments lack either the high yield necessary or carry so much risk as to make them foolhardy choices. Real estate debt might be a viable option to help you create a nest egg, enjoy the agility that comes from shorter-term investments, and benefit from high yields while still hedging your wealth from loss.

With that being said, every investor’s situation is unique. What is right for you might be anathema for another. We recommend speaking with a tax advisor before deciding whether real estate debt investing is right for you.

Choosing Your Path Forward

Real estate debt can be a sound investment option. It can offer an ongoing, predictable stream of revenue, higher returns than many traditional investments, and still provide you with the hedge against risk that you need. However, not all real estate debt investments are equal. You need the support of a leading real estate debt investment partner and the right fund to intelligently build your wealth and create a bright, stable financial future.

At Pacific Private Money Inc., our goal is to help our investors achieve success while also ensuring that borrowers can fund their projects, whether that’s buying their dream home or starting a new business. We serve clients throughout the state of California, but we’re dedicated to safeguarding our investors’ hard-earned capital. We scrutinize each lending situation, apply our six-step risk mitigation plan, vet borrowers and properties in great depth, and perform due diligence procedures.

Our unique approach offers both investors and borrowers significant advantages, including agility, flexibility, safety during a turbulent economy, and the ability to realize lifelong dreams of homeownership, entrepreneurship, and investment success/financial stability. Contact us today to learn more about our investment opportunities, or how real estate debt works.

Author: Mark Hanf

CA. DRE # 01811186 | NMLS No. 331091

Mark is Founder, President, and CEO of the San Francisco Bay Area-based Pacific Private Money Group of companies. Pacific Private Money Inc., the flagship company, is an alternative real estate mortgage lender founded in 2008 to provide consumers and real estate investors access to fast, reliable, and convenient capital.