While anyone can purchase stocks and bonds, hard money loans stand out as a compelling vehicle for portfolio diversification. Secured lending can yield reliable returns, but understanding the risks will ultimately determine if it makes sense for your investment strategy.
Here’s what you need to consider as you evaluate whether hard money lender investing aligns with your goals.
There are many types of hard money loans and investments, including mortgage funds, individual bridge loans, buy-and-hold loans for investment properties, and cash-out refinancing for business purposes. If these types of transactions are unfamiliar, collaborating with more knowledgeable professionals will go a long way to protecting your capital.
Hard money lenders offer expertise in evaluating property-backed loans and steady access to investment opportunities. They can offer valuable support, such as underwriting, legal, compliance, and management services, to reduce the amount of hands-on effort required from you.
Their broader lending services also position you to invest in more than one loan or project. As you diversify further, hard money lender investing will provide access to a network of strategic partners, including specialized brokers, appraisers, and builders.
Private investments, such as hard money loans, aren’t as easily converted into cash as traditional stocks and bonds, so the Securities and Exchange Commission sets financial and professional thresholds for investing in these alternative assets. Accredited investors are in a uniquely qualified position to access investments of varying risk profiles and liquidity, so substantial net worth, income, or licensing are foundational prerequisites.
Every investment includes varying degrees of risk, liquidity, security, and leverage, so as an investor, performing due diligence will be essential to diversify your portfolio without overextending yourself. Be sure you understand the terms of the individual loans or mortgage pools you are considering so your capital is where you need it when you need it.
Individual loans have a life of their own and can sometimes take longer to pay off than expected. Defaults can lead to bankruptcies, legal bills, and more to protect your position. Only commit capital that you expect to be OK with not accessing for a period of time that can often go longer than just the term of the loan.
Collaborating with an established lender may mean taking a back seat when it comes to determining strategy details and loan terms. You may be competing with other interested parties, or you could just be one fractional lender of a larger loan. If you’re a control freak, it might mean it’s time for you to go out and get your own broker license.
Nothing is guaranteed. Understand your risk profile and let that dictate which types of opportunities you choose to pursue. Ask yourself what you’re trying to achieve and make sure that the loan is structured in a way that matches those objectives.
Business purpose loans are typically subject to little regulation, and they’re not subject to the same rules and limitations that consumer loans require. That said, there are still rules that you must follow to protect your investment.
If you’ve done your homework and are convinced you’ve found the right opportunity, you may see the following rewards when you invest with a hard money lender:
Higher interest rates and short terms work together for strong risk-adjusted returns and consistent cash flow while giving up a modest degree of liquidity.
In most cases, the private lender will vet borrowers on your behalf, and a broker will manage and service the loan. You should still conduct your own due diligence, but they’ll do the heavy lifting for you.
Investing through a private lender can be relatively low-risk when the loans are structured with low loan-to-value ratios and proper underwriting. Even when borrowers default, the primary investment can often be partially or fully recovered. Because the loans are secured by real estate, if the borrower doesn’t pay off the loan, they lose their equity and the loan goes to a foreclosure auction.
When underwritten conservatively, hard money loans are stable and mitigate the risk of stock market volatility. The borrower should always have plenty at stake in the loan as equity or a cash-down payment.
To get started, keep some important tips in mind.
Research hard money lenders for an established history and consistent record of successful outcomes. Make sure to ask about their expectations for investors, fees, terms, and rates of return so there aren’t any surprises. Knowing borrowers' qualifications will also allow you to evaluate the idiosyncratic risks involved.
Don’t spread yourself too thin and exceed the level of risk you can manage. Assess your finances and identify the right allocation balance to invest in hard money lending.
Portfolio diversification is best when you not only have a mix of assets in play but also a mix of products within a given asset class. For property-backed loans, consider investing in a range of loan and property types and different regions to mitigate targeted fluctuations in the market (commercial versus residential, urban versus suburban, and so on.).
Continue to research and enhance your understanding of the assets. Even if you aren’t directly acting as the lender, you still have a stake as the investor, and it’s in your best interest to stay on top of market trends and news.
If you’re considering how investments in hard money loans might fit into your portfolio, the next step is to get to know the opportunities available to you. Verify your status as an accredited investor and receive access to our detailed investor guide.
Socotra Capital has earned a reputation with investors for consistent performance, reliable service, and fast delivery. Since 2007, we’ve funded more than 1,500 private money loans totaling more than $1 billion.
For more information about diversifying with non-correlated investments, download our Guide to Building a Resilient Portfolio.