Investors ‘Flocking In’ to Real Estate Lending

By Brian O'Connell

The stock market is off to a roaring start in 2018, but there’s no shortage of investment gurus who warn that continued equities growth is far from guaranteed.

The dreaded market correction could be coming sooner, rather than later, some say.

That gives some money managers pause about what asset tools to steer in and out of a client’s retirement portfolio. But there’s an emerging school of thought that one specific alternative investment could be good protection against a stock market correction.

“We’re seeing financial experts weigh in with their 2018 investing recommendations, citing everything from mutual funds to value stocks,” said Bobby Montagne, chief executive officer at Walnut Street Finance, a private lender.

But one prime retirement savings vehicle often gets overlooked -- real estate lending, Montagne said.

Real estate lending means investing in a private loan fund managed by a private lender. Walnut Street is one such lender in the $56 billion home-flipping market.

“Your money helps finance individuals who purchase distressed properties, renovate them, and then quickly resell at a profit,” Montagne explained. “Investments are first-lien position and secured by real assets.”

With real estate lending, investors can put small percentages of their 401(k)s or IRAs in a larger pool of funds, which lenders then match with budding entrepreneurs working on home flipping projects, he said.

“It allows investors to diversify their portfolios without having to collect rent or renovate homes, as they would in hands-on real estate investing,” Montagne added.

'Investors are Flocking In'

Real estate lending is quickly becoming a mainstream option.

“With Silicon Valley and Wall Street bringing added security to the private money market, investors are flocking in -- drawn by returns as high as eight percent,” Montagne said.

A key component with real estate lending investments is a higher, more effective level of diversification.

“A private real estate fund helps retirement investors diversify their portfolio to include real estate without having to invest in real estate directly, by doing a flip themselves or purchasing and managing a rental property,” Montagne said.

A private loan fund investment also helps balance a retiree’s portfolio to include real estate, while avoiding the high cost and the liquidity risks of actually buying real estate, he added.

“It also pays immediate earnings, as opposed to direct real estate investment where investors typically look for gains from slow, steady appreciation over many years,” Montagne said.

The two most common risks in all real estate lending are defaults and real estate market downturns.

“But by making loans to experienced flippers and by monitoring project progress, private loan funds offset the risk that borrowers will stop paying their loans,” he said. “Some lenders use loan agreements that allow the lender’s renovation experts to take over the project if the borrower falls behind schedule or fails to pay the loan on time.”

Despite those annual 8 percent returns, which Montagne describes as “normal,” advisors should be careful when addressing potential real estate lending investments.

“Real estate investing is a good investment vehicle to diversify your asset allocation with a product that has good risk and return relationship,” said Paul Koger, head trader at New York-based Foxy Trades. “The inherent risk involved with doing just one of those projects is bigger than an average retirement investor could take. However, pooling of the projects gives the investors an attractive investment opportunity.”

An Aggressive Investment

Some investment experts deem any investment associated with real estate flipping as a higher-risk play.

“Investing a percentage of a retirees funds in real estate flipping would be considered an aggressive investment,” said Sid Miramontes, founder and CEO of Irvine, Calif.-based Miramontes Capital, which has more than $250 million in assets under management.

Even though the investor would not directly manage the real estate project, he or she has to understand the risks involved in funding the project, material costs, project completion time, the current interest rate environment, where the properties are located geographically and the state of the economy, he said.

“I have had pre-retirees invest in these projects with significant returns, as well as clients that did not have experience and results were very poor,” he added. “The investor needs to realize the risks involved.”

A 1 percent to 5 percent allocation is appropriate, only if the investor met the aggressive investment criteria and understood the real estate market, Miramontes said.

Investment advisors and their clients should also be careful about grouping all real estate lending into one basket.

“You could invest in a mortgage REIT, which would be a more traditional vehicle to get exposure to real estate lending,” said David Reiss, professor of law at Brooklyn Law School in Brooklyn, N.Y. “If you’re doing something less traditional, research the fund’s track record, volatility, management, performance and expenses.

“You should be very careful about buying into a fund that does not check out on those fronts.”

Brian O'Connell is a former Wall Street bond trader, and author of the best-selling books, The 401k Millionaire and CNBC's Guide to Creating Wealth. He's a regular contributor to major media business platforms. Brian may be contacted at [email protected].