We’ve all borrowed money at some point. We’ve either taken out student loans, used credit cards, or purchased a home with a mortgage. Borrowing money is almost an unavoidable part of life.
The problem with borrowing is, of course, having to pay it back – with interest.
Have you ever wondered how nice it would be to be the bank on the other side of the transaction? You could just lend your money out, sit back, and watch those interest payments roll in.
Well, as it turns out, the idea may not be too far-fetched. In fact, one of the best ways to create passive income is by being the bank.
Are You Already the Bank?
To take it a step further: if you currently have a diversified portfolio and it contains bonds, well then, you already are “the bank.” After all, a bond is simply an I.O.U. or a promise to pay, where money is lent out on the basis it be paid back over a certain term with interest.
Bonds are considered “safer” instruments (less risky) because they’re known to be less volatile than stocks. Debt holders receive interest payments before companies distribute profits. This is why having a portion of your portfolio in bonds, increasing as you age, is widely accepted as the standard allocation strategy and necessary for diversification.
When it comes to real estate, investing in debt (that is, lending money out and receiving interest in return) is also considered an important investment vehicle and a great way to build diversification into your portfolio.
One of the best ways to invest in debt is through “first lien mortgages” or “first trust deeds.” The word “first” is extremely important because it means that in the event of a default or foreclosure, the holder of this lien or deed (the investor) has the first priority to be paid back during a foreclosure action.
This is why people often refer to investing in debt as “safer” than investing in equity real estate investments; because in case something doesn’t go quite as planned, you’re simply the first to be paid back.
To clarify, investing in equity investments mean that you own a share of the investment and participate in the profits. You’re actually on the side that borrows money for the investment if there’s leverage involved.
Who’s Actually Doing the Borrowing?
Typically, the borrowers in this type of real estate transaction are professionals who are looking to purchase a property, renovate it, and sell it off for profit. In essence, it’s the fix-and-flippers, like the ones you see on TV, but they’re not doing it for a show. They’re truly doing it for a living.
Well, one of the most difficult parts of a real estate investor’s business is securing funding and there are multiple reasons why a borrower would avoid traditional banks:
- Qualification – The majority of the time, considering the nature of the purchase (an investment rather than a home mortgage), they may not qualify for traditional loans
- Amount – The professionals typically need money for the purchase and for additional renovations. Traditional banks typically will lend up to 75% of the property.
- Speed – Traditional mortgage loans takes quite a bit of time to complete. Typically these fix and flip investing professionals need the money quickly to get the project going. Days instead of months.
So private mortgage lending, like investing in first liens, was created to fill the needs of these professionals.
What makes these first lien loans special is the fact that they are collateralized by real, hard assets (a physical property). This distinguishes it from peer-to-peer lending or credit card lending, which does not have collateral backing.
This is important because in the case of default, the lender can take the property and sell it to recoup their funds. In those other cases, the only recourse often is to file a mark on the borrower’s credit history.
Pros to Investing in Debt
- Considered safer
- Easy investment to understand
- Steady Cash Flow
- Collateralized protection
- Recognized as lowering portfolio volatility / Diversification
- In a poor housing market, it’s a much safer position to be in as compared to owning the property
Cons to Investing in Debt
- Relatively illiquid, typically held for term of the loan
- Does not get favorable tax treatment as is the case with some other real estate investments, no depreciation, income is taxed as ordinary income
- Returns are relatively fixed since they’re loans, without the upside of equity investments
- Risk – if the borrower defaults, the property must be sold to recoup costs
How Can You Invest in Debt Opportunities
- Personally get connected to real estate investors and lend them your money directly
- Purchase loans backed by real estate from brokers
- Crowdfunding – certain sites will crowdfund to raise the capital for a certain deal
- Invest in a fund that invests in debt and first lien mortgages
Challenges I’ve Faced in Debt Investing and a Solution
So I’ve invested in many first lien mortgages mainly through crowdfunding platforms in the past. What I’ve found is that vetting the deal and sponsor can be quite a task. Every single deal takes time although I’ve gotten much better at it through experience.
I’ve found that investing in debt, though, is one of the most passive ways to invest in real estate because almost all of the work is done up front. However, I’ve also found it time-consuming to vet each individual deal and sponsor when I’m trying to create a diversified portfolio.
So I found that the solution to this “time problem” is to invest in debt funds. Investing in a professionally-managed fund can be far less time-consuming because they vet the deals on your behalf.
For someone looking for a more passive investment or someone without a good amount of experience vetting these deals, this is often the preferred method.
A good fund manager will have the experience, expertise, and system in place to perform the proper due diligence required and make sure the investor’s funds are being utilized optimally.
DLP Lending Fund
DLP (Direct Lending Partners) Lending Fund is a debt fund that holds $150 million in assets. It has a 14.3% historical net return (IRR). They’ve also funded 1000+ loans and over $400 million dollars with zero principal loss or missed returns. So I feel pretty comfortable saying that they have a tremendous track record.
They use very strict criteria to partner with good real estate investing professionals which ensures a high margin of safety in case something goes wrong. Their system must work because to date they have never lost investor capital. That doesn’t mean they never will, but they have the infrastructure in place to handle the downsides.
The target returns for the DLP fund is 11%+, although historically they’ve achieved returns of 14.3% since inception. When you look at the returns in relation to risk, or risk-adjusted returns, it makes it look even more attractive.
The Waterfall Structure (or how everyone gets paid is quite simple.) The Fund has something called a preferred return of 10% meaning that investors get paid 10% before DLP participates in further profits. Here is the order that the money gets paid out:
- First, you get paid your capital back
- Investors receive returns of 10%
- Investors and DLP split further profits 80%/20%
So How Can You Invest in This Opportunity?
Well, you can go directly to them, and the minimum investment is $250,000. It is mainly geared for institutional investors. Unfortunately, that may be a bit more than you’re willing to invest and normally you’d be out of luck and would have to move on.
However, there’s a solution for you….
CityVest was created by Alan Donenfeld to try to solve the problem of access to these major institutional funds. He was trying to help his brother, also an anesthesiologist like me, to invest in high quality, professionally managed funds. He decided to create a way to aggregate investors and together they would be able to meet the minimum subscription amounts and invest in these funds. In this particular case, he created an access fund called “DLP Access Fund.”
Think of CityVest as the driver of the bus (DLP Access Fund) that gives you access to the DLP Lending Fund. Where it’s normally $250,000 to invest, people can now collectively invest at lower amounts. It’s up to CityVest to make sure the bus gets filled up enough to provide that access.
What Does CityVest Get Out of This? What Are Their Fees?
For creating the entity to invest, managing all the investors, and taking care of all the administrative and legal matters, they charge the fund a one-time $50,000 administrative fee. They also charge the fund a .75% annual management fee. They receive from the fund $500 per year per investor for arranging for the audit, tax prep, income distributions, and other expenses.
If they meet their $10 million raise for this access fund, the fees come out to about 1.75% the first year and 1.25% every subsequent year per investor.
In addition, a special benefit for PIMD readers is that the .75% annual fee is reduced by half for the first year.
Well, again, you could go directly to DLP. The only requirement is that you invest a minimum of $250,000. So the benefit of going through CityVest is access at a lower required minimum.
If you go to CityVest directly, the minimum is $50,000 but by being a PIMD reader and using our link, the minimum is $25,000.
Of note though, due to legal restrictions, they have a finite number of spots in the Access Fund for investors. Am I going to take up one of them? Read until the end to find out…
What Does Passive Income MD Get Out of This?
In full disclosure, I am an affiliate for CityVest which means that I receive a commission for connecting investors like you and opportunities like CityVest / DLP Access Fund. As you can imagine, I get tons of requests from operators to partner with them since this site is so real estate focused, but I turn most of them down because frankly, I wouldn’t invest in them myself. In fact, I can say that with almost every opportunity that has made it on the site, I have invested alongside readers.
So I get the chance to feel good about presenting good opportunities to readers and negotiate bonuses on their behalf. Investors get access to institutional-grade funds through lowered minimums and exclusive bonuses like the reduction of certain fees.
With the income generated, we’re able to keep the site up and running while continuing to support our employees. We like to see it as a win all around and those are the only types of opportunities that make it onto the site.
What Do You Get Out of The Investment?
- Expected returns of 11%+ from investing in collateralized debt
- Cash flow paid quarterly
- A truly passive income source
Are There Better Investments out There?
This depends on what you’re looking for. Certainly, debt deals and funds get less consideration than equity opportunities because the returns are less on paper.
However, I’m always looking to diversify and looking for solid risk-adjusted returns. Debt is typically a safer play than equity investments and considering where we are in the real estate market and cycle, I think diversification is a good idea. Plus 11%+ sounds pretty solid to me.
Am I Personally Investing?
Yes, to cut right to it, I am investing and unfortunately, that means one less spot for someone else out there. The SEC limits the size for this type of fund to include 100 investors total.
How many spots are left? It’s sure to change as the word gets out but it’s definitely in the double digits. The fundraising will remain open until all spots are filled and then that’s it, the fund will close to new investors.
- Investing in secured debt is a good way to build diversification into your portfolio, with good risk-adjusted returns
- Investing with CityVest in the DLP Access Fund give you access to invest in DLP’s Lending Fund, normally a $250,000 minimum, but for PIMD readers, it’s a $25,000 minimum
- Targeted 11%+ returns
- Limited positions but open to PIMD readers first, through our link.
If you’re interested in investing in the DLP Access Fund, find out more here.
Have you invested in debt before? Through single deals or funds? What’s your experience been? Have specific questions about this opportunity? Ask below….