How To Invest In Real Estate Without Owning Real Estate

Real estate is an awesome asset class, but can also be a hassle. Private lending and crowdfunding let you get into the game without the headaches.

The renters across the street left the home a disaster. And considering the way the they moved out, it wasn’t a surprise.

Late one evening, the tenants loaded all of their belongings into a moving truck at a furious pace. Within a couple of hours, they were gone. They left garbage all over the front lawn. There was broken furniture and an old refrigerator in the driveway. They opened the windows and they didn’t even bother to close the front door. I called the landlord (John) and told him what had happened.

When I saw John’s truck pull up, I walked across the street to say ‘Hi’.

  • John: Do you really think they’re gone?
  • Me: I’m sure of it.
  • John: Let’s have a look.

When we got about 10 feet from the front door, the smell hit us; urine. The renters had multiple animals and they apparently weren’t housebroken. The first thing we saw after entering was a pile of animal waste in the foyer. Not good. And it was all over the house. The animals had used the home as a giant litter box. The laminate floors were buckling because of the urine and all of the carpet was destroyed. And there was also junk everywhere.

From observing these folks, I knew that they were big fans of Craigslist. I’d see them come home with their pickup truck filled with old TVs, auto parts, appliances, rolls of carpet and junk motorcycles. When the renters fled that evening, they left it all behind. The landlord had to clean up the mess. Guess who wasn’t getting their security deposit back.

The fiasco explains why some folks don’t want to be landlords. It takes a special temperament to successfully manage property. The good news is that you don’t have to own property directly to invest in real estate. Today, I’m going to be tell you about private lending and crowdfunding, two of my favorite strategies of investing in real estate without owning real estate.

Private Lending

I love real estate. I’ve owned rental properties and flipped houses with wild abandon (and wild profit). At the moment though, I own no rental properties and am between flips. The local housing market is red-hot and I shy away from bidding wars. I recently found another way to invest in real estate via private lending.

I issue loans to help investors buy properties. I have lent a total of $255,000 in three separate deals. These loans bring in over $2000/month in interest only payments. My private lending experiences have been only positive and I’m preparing to invest in additional deals.

Private lending allows me to diversify my portfolio into real estate without the hassles of managing a property. I earn a healthy interest rate while helping an investor with short-term money needs.

When I first heard about private lending, my main question was this:

Why would someone want a loan from me at 10% or more when they have good credit? Why don’t they just go to a bank?

There are good reasons why investors turn to private lending:

  • The property must be seasoned: Most traditional lenders require that a property be seasoned for one year before they’ll issue a loan. This simply means that the property needs to have a rental history. Private lending fills the gap.
  • The loan is for a very short term: Flippers often want to get into/out of a home in just a couple months. It’s not worth the hassle of dealing with a bank if the holding period is short.
  • The money is needed quickly: Banks can take weeks or longer to issue money. A private lender may be able to provide the funds in days.

After I knew why investors needed private loans, I was more comfortable with the idea. Here are some important points to consider:

First lien position: The worst case scenario for a private lender is a borrower default. Always make sure you’re in first position on the lien. This allows you to seize the property should the borrower stop making payments.

Mind the loan to value ratio: If a default occurs, you want to be in the best position to get your money back. I require a loan to value ratio of no more than 70%. So, for a property valued at $100,000, I won’t loan more than $70,000. This would allow me to sell the property at below market value to get my money back quickly.

Interest rate: Rates typically start at 10% and go up to 18%. Many lenders also charge between 1 and 10 points. A point is 1% of the borrowed amount.

Credit score: This is not as important as you think. Since you’re in the first lien position, the transaction is collateralized by a property.

Tax friendly: A self-directed solo 401(k) allows you to issue private loans from a tax-sheltered account. If you have income from self-employment, strongly consider this option.

Evaluate the deal:

  • Experience: Has the borrower done at least ten deals or is this his first one? Is the borrower organized and professional? Did he write a business plan? Is there an estimate for repairs?
  • Run the numbers: The property may not be in your neck of the woods and that’s fine. However, you need to make sure the numbers are solid. Ask the borrower to provide pictures of the property and research home sales in the area.
  • What is the Plan? What is the borrower going to do with the property:
    • If this is a flip, does he have contractors lined up? If he is doing the work himself, does he have the experience and do local regulations allow it? Do permits need to be pulled?
    • If the property will be a rental and the owner plans to refinance, what is the timeline? What happens of the borrower can’t refinance the property? Will there be an opportunity for you to continue to finance the home for a longer term?
  • To learn more about private lending from the perspective of the borrower, see this article from BiggerPockets.

Where to Find Deals

Private loans are most often executed between parties who have an existing relationship. The borrower may be a friend, family member or someone who you already have a business relationship with.

I also encourage you to make connections with others outside of your normal network. A great way to do this is by becoming active in the BiggerPockets forums. While you must sign up for an account, membership is free.

Private Lending: Advantages and Disadvantages

Private lending is an awesome way to build wealth. Just remember to do your research. It’s important to thoroughly understand a deal before taking the plunge. Do your homework!

Advantages

  • Healthy interest rate: Short term loans (1 year or less) start at 10% and go up from there. I’ll never complain about earning 10%.
  • Control: Investments are in your direct control. You pick and choose who you lend money to.
  • Collateral: If the borrower stops making payments, he loses the home and his equity. This is a strong incentive for the borrower to not default.

Disadvantages

  • Upfront research: Private lending requires work. You need to evaluate the deal and the person.
  • Are your eggs in one basket?: Diversity is important in any portfolio. Make sure that one loan doesn’t consume a significant portion of your investments.
  • Illiquid: While private loans are short-term, your money is tied up for the duration of the loan.

If private lending sounds like too much work, crowdfunding is another way to diversify into real estate without actually owning property.

Crowdfunding

The JOBS (Jumpstart Our Business Startups) Act which went into effect in 2015 opened the door to a new class of real estate investments. JOBS allows the use of crowdfunding to issue securities, something that had been previously forbidden.

You’re probably thinking this right now:

Please translate? What does this mean for me?

There are innovative new ways for you to invest in real estate without owning property. RealtyMogul, Fundrise, RealtyShares and PeerStreet are four crowdfunding platforms that you need to know about.

RealtyMogul

RealtyMogul is one of the largest players in the real estate crowdfunding business. As of June of 2017, the company has deployed 270 million dollars.

RealtyMogul offers two types of investments, a REIT (MogulREIT) and private placements. Because the MogulREIT is open to all investors (no accredited investor requirement), I’ll focus on it.

First, a REIT is defined as:

A REIT, or Real Estate Investment Trust, is a company that owns or finances income-producing real estate. Modeled after mutual funds, REITs provide investors of all types regular income streams, diversification and long-term capital appreciation. REITs typically pay out all of their taxable income as dividends to shareholders. In turn, shareholders pay the income taxes on those dividends.

RealtyMogul’s MogulREIT allows you to invest in a diverse commercial real estate portfolio with minimal hassle. Through MogulREIT, you have exposure to investments that would not be available to retail investors:

MogulREIT can invest in a variety of property types, including but not limited to, multi-family, office, industrial, self-storage, retail, medical office, and hospitality. The fund can invest in various commercial real estate-related equity and debt securities across these different property types.

Because of lower fees and the focused nature of MogulREIT, your returns may be higher than that of a conventional REIT. The MogulREIT is currently returning 8% to investors.

MogulREIT numbers:

  • Minimum investment: $1,000
  • Payouts: Monthly
  • Redemption: Quarterly
  • Must be accredited?: No

You can start investing with RealtyMogul here.

Fundrise

Fundrise is a platform that I invest with. I opened my account in March of 2016 with an initial investment of $1,000 (Income eREIT) and then added another $2,000 (Growth eREIT) to bring my account to $3,000. I’ve earned almost $300:

Fundrise has created a portfolio of eREITs and eFunds that invest in commercial and residential properties respectively. Fundrise believes that its strategy will outperform conventional REITs:

By pursuing a private market, direct investment strategy, Fundrise portfolios earn higher annual current income than public income-focused investments.

While my initial investments were in the Income and Growth eREITs, Fundrise also allows you to invest in specific geographic areas:

Fundrise also has an option that allows you to specify investment goals and your money is deployed accordingly across the REITs/ eFunds:

Fundrise eREITs and eFunds numbers:

  • Minimum investment: $1,000
  • Payouts: Quarterly
  • Redemption: Quarterly
  • Must be accredited?: No

Start investing with Fundrise here.

RealtyShares (accredited investors only)

RealtyShares offers investments in debt (mostly residential), preferred equity and equity (mostly commercial). Unlike a REIT, RealtyShares allows you to invest in a specific property or a pool of pre-determined properties. The platform has done about 650 deals and prides itself on being very picky (less than 5% of deals are accepted).

Unlike the RealtyMogul and Fundrise REIT offerings, investing with RealtyShares requires work. You must vet deals. RealtyShares provides a dashboard to search for potential investments, and you can click on a deal to learn more about it:

While RealtyShares professionals have already approved the deal, it’s up to you to analyze it before jumping in.

RealtyShares’ numbers:

  • Minimum investment: Variable
  • Payouts: Variable
  • Redemption: Variable
  • Must be accredited?: Yes

Start investing with RealtyShares here.

PeerStreet (accredited investors only)

PeerStreet was co-founded by Brett Crosby who famously sold his previous company (Urchin) to Google. PeerStreet is similar to private lending in that you’re investing in individual deals. Just like private lending, PeerStreet is in first position on the lien.

After setting up an account, you can start researching deals on the PeerStreet dashboard:

 

Clicking on a deal reveals a detailed view:

 

PeerStreet has some advantages over private lending:

  • Low minimum investment: The minimum investment is $1,000. Because of the low minimums, you can diversify across more deals.
  • Vetted deals: Experts on PeerStreet carefully review every deal. This is the most difficult part of private lending and with PeerStreet, you have an expert doing all of the hard work.
  • Automated investing: PeerStreet allows you to define investment criteria. Money is then automatically invested for you.

PeerStreet numbers:

  • Minimum investment: $1,000
  • Payouts: Monthly
  • Redemption: Variable
  • Must be accredited?: Yes

Start investing with PeerStreet here.

Crowdfunding: Advantages and Disadvantages

Crowdfunding platforms offer an innovative way to invest in real estate without the hassles of property ownership. Just remember to do your research.

Advantages

  • Experts have your back: The deals offered on crowdfunding platforms are vetted by experts.
  • Their REITs may outperform traditional offerings: Because of the focused nature of the Fundrise and RealtyMogul REITs, they may have better returns than a traditional REIT.
  • Diversification: I’m a big believer in index funds and the diversity that they bring. Crowdfunding platforms, especially the REIT offerings, offer diversity in real estate.
  • Access to real estate that’s not normally accessible: Commercial real estate is difficult for a retail investor to purchase.

Disadvantages

  • Risk: The crowdfunding platforms are all very new. None have been tested by a recession.
  • Higher fees: The management fees are higher than a low-fee index fund or a traditional REIT.
  • Illiquid: The REITs have quarterly redemption options while the private placements are longer term.

I Love Real Estate

My long term goal has always been to acquire additional investment properties. Over the past four years, I’ve made offers on three different properties, only to get outbid every time.

I’m second guessing my real estate dreams now. Why deal with bidding wars, the hassle of tenants and leaky faucets when you don’t have to?

And if you have any doubt about the performance of real estate, listen to Josh Brown:

In the next month, I’ll be investing in two additional private loans and also investing my first $10,000 in PeerStreet. Perhaps I’ll never own an investment property again? From the experience of my landlord friend across the street, this may not be a bad thing.

Mr. 1500 loves to write about personal finance, early retirement and anything else that has to do with money. When not thinking about numbers and dollar signs, you can find him with his family playing in the beautiful outdoors of Colorado.

13 Comments

  1. Lance @ My Strategic Dollar

    July 12, 2017 at 8:27 am

    Awesome roundup of potential REIT investments. I’ve been considering jumping as well, but just haven’t. Looks like you’ve enjoyed the process and getting solid returns. I’ll have to look further into it! Thanks for sharing!

  2. Church

    July 12, 2017 at 8:39 am

    I, personally, am with PeerStreet right now for all the same reasons as Mr. 1500. I did the landlord thing and now I am done with all of that. Being a more “passive” landlord is much better this time around.

    I can say that my returns are much better than any savings account. I love being first lien holder, how many investments do you own that come with a first lien? I believe real estate should be in everyone’s portfolio in some shape or form and this is a great way to own it without getting your hands dirty (literally).

    Great summary, Mr. 1500.

    • Mr. 1500

      July 12, 2017 at 9:54 am

      I love the passivity too! No late night phone calls. No checks “lost” in the mail. I may never own another rental!

  3. pia

    July 12, 2017 at 8:47 am

    I have been reading up with interest about real estate crowdfunding. It is still very much in its infancy state in Australia so I’m still hesitant whether or not to take the plunge!

    • Mr. 1500

      July 12, 2017 at 9:53 am

      “It is still very much in its infancy state in Australia so I’m still hesitant whether or not to take the plunge!”

      Here too! It will be interesting to see what happens when a major recession hits. As Buffett likes to say, we’ll see who is swimming naked when the tide goes out!

  4. Jason

    July 13, 2017 at 7:11 am

    I have looked at the REITS from Fundrise and Realtyshares (also looked at investing, but I am not an accredited investor quite yet) and the only thing that turned me off slightly was the high fees that went with them. I know that they are about normal for an actively managed fund, but after going to passive investing it is hard for me to go “back” to paying higher than normal fees for REITs, even though I also love the idea of real estate. Thoughts?

  5. Dividend Growth Investor

    July 13, 2017 at 1:58 pm

    This is a good review Mr 1500. I really am enjoying your writing at IZ.

    However, I agree with you that they are still relatively untested. And probably giving those platforms a try could be worth it with what many refer to as “play money”.

    Perhaps I do not understand these well enough and need to do more research. However, why would individual investors like you and me get a cut out of lucrative Fundrise/Mogul real estate deals, when other REITs (like the ones in VNQ) could be easily taking on those projects? I keep wondering whether those private placement real estate platforms just include mostly higher risk projects that more established players have passed up on, and may not deliver the total returns we want. The real test would be how these platforms would perform during the next recession. It would be interesting to check these out in a decade, and compare notes on how things progressed.

    A decade ago, P2P loans were a new thing. Many people invested in them through Prosper & Lending Club, and the forward results were not good.

    Best Regards,

    DGI

    • Mr. 1500

      July 13, 2017 at 2:35 pm

      “Perhaps I do not understand these well enough and need to do more research. However, why would individual investors like you and me get a cut out of lucrative Fundrise/Mogul real estate deals, when other REITs (like the ones in VNQ) could be easily taking on those projects?”

      That’s a perfectly valid point. The deals that these new companies take on seem to be smaller in nature. Peer Street is all residential. I suspect that these deals are just too small for a massive REIT like Vanguard’s to bother with.

      My investments in these new platforms are experiments for now. I do like some of the safety nets though like first lien holder on Peer Street deals. It seem much safer than the uncollateralized debt on Lending Club and Prosper.

  6. Investment Hunting

    July 13, 2017 at 4:53 pm

    Great info here. Thanks for the post. I’m really interested in getting started with one of these companies. I’m an accredited investor so all options are open to me. If you were to start with one company, which would it be and why?

    • Mr. 1500

      July 13, 2017 at 11:34 pm

      Don’t make me pick one! Ha!

      Peer Street has some very smart people behind it. I’ll be starting to invest with them very soon. I love that investors are first on the lien, so risk is minimized.

      Please research all of these before taking the plunge though! Lend Academy is a great place to research these investments too.

  7. Dom @ Gen Y Finance Guy

    July 13, 2017 at 6:40 pm

    I currently have about $80,000 invested through the PeerStreet platform. But as you briefly mentioned, it is best to do this in a pre-tax account, due to the fact that the gains are taxed at ordinary income.

    This is especially important for those with high incomes. As an example, our household is on track to earn between $360,000 to $400,000 this year, which puts our marginal tax rate at 45.65%.

    I am currently earning about 8% across my portfolio of loans with an average LTV of 69%.

    Thanks for the write up Mr. 1500.

    • Mr. 1500

      July 18, 2017 at 5:50 pm

      You’re killing it Dom! Nice work on the huge income and nice return on the PeerStreet platform. I’ll be throwing some of my own money at PeerStreet very soon.

  8. Todd Weitzman

    July 22, 2017 at 2:05 pm

    This certainly seems like a great way to invest money. Real estate is widely regarded as a safe source of investment cash. Now you don’t have to utilize too much money to get involved! Thanks for the post

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