Although using private money is a smart way to invest in real estate without using your own cash, it’s not a perfect solution. Let’s explore some of the risks of using private money, so you’ll get the full picture and decide if this is an avenue you want to pursue.
4 Risks and Drawbacks to Using Private Money
1. Legality
The legality of raising money is not easy to understand, and it differs largely depending on your location. Because of this, we advise using a lawyer, and as we all know, lawyers are not cheap. However, hiring a lawyer to set up your business correctly at the start is much better than not doing a deal at all or sitting in a federal jail cell for doing it incorrectly.
2. Networking Required
Networking is neither easy nor quick. As I have noted, networking is a lifestyle, and if you don’t like that lifestyle, you may find the process of raising private money cumbersome and difficult.
3. Higher Interest Rates
Although the rates you and your private lender agree on may not be as high as those you’d pay with a hard money lender, chances are the rates will be significantly higher than you’d see with a conventional bank. Typical private money interest rates I see are between 6% and 12%, depending on term length and other circumstances. If these rates fit your business model, great!
4. Personalities Are Involved
When borrowing from a bank, you are typically dealing with a system that has no emotion involved. However, borrowing from real people always involves the potential for drama, emotion, and problems. What if your lender suddenly needs his money back? What if they get into legal trouble? These scenarios are further evidence that you need strong written legal paperwork with any lending arrangement.
Private money is not for everyone, but if it’s an avenue you want to pursue, it can be a terrific way to raise enough capital to really scale your business to new heights. Be sure you understand the risks involved and take the necessary steps up front (ahem, lawyer) so you don’t get into trouble at the end.
Finally, just remember that raising private money is about having great deals, building relationships, and ultimately delivering on the promises you’ve made. If you can do those three things, you’ll have a successful future as a private money–funded real estate investor.
[This article is an excerpt from Brandon Turner’s The Book on Investing with No (and Low) Money Down.]