Small Investors Can Compete for Secure, High Returns Starting Right Now

I had a recent comment on my blog and the reader wanted to know why I am writing "all this negative stuff" about lending. To me it is perfectly clear why I am writing this, but let me repeat the obvious. 

There is an enormous and growing investment opportunity that few small investors have yet to recognize.  Simply put, except for what money the government prints and lends, there is no liquid money (and not much desire) to make unleveraged loans without recourse to the assets of the borrower in the traditional banking system or the shadow banking system.

The opportunity is being created because there is no longer liquidity in the private commercial market for Single Family Residential (SFR) real estate, except for the newly socialized programs from "Government Sponsored Entities", Fannie Mae and Freddie Mac and a few portfolio lenders (many of whom are in real financial trouble, see http://ml-implode.com/).

According to a 2008 article at  www.moneyandmarkets.com, as of that date Fannie and Freddie would have to face the same music as the private lenders sooner or later as the sub-prime problem was rapidly spreading to Alt-A and A loans they originated and they had more than $6 Billion in REOS on the books at that time.  The federal government bailed them out financially despite their poor management history and now more than 70% of new loans are through GSE's.

In 2008, 8500 Banks and Thrifts had another $8.56 Billion in foreclosed properties on the books.  Clearly in April of 2009, these numbers are much larger. No one is going to buy these properties as investment rentals unless the price they sell at will allow the net profits from renting them to generate high enough risk adjusted returns to offset the vagaries of Toilets, Tenants and Taxes and compete with more passive investments like Trust Deeds or Tax Liens. 

Because of this fact, small private investors are going to have an unprecedented opportunity for stable, consistent returns of 12% or better on their personal investable assets and even better tax deferred or tax free returns from investing in Private Money Loans with Self Directed Retirement Plan Dollars in investments secured by a hard asset, namely real estate . There is a great resource for analyzing returns on potential real estate investments from the CCIM Insititute (www.ccim.com) which you can download at http://www.box.net/shared/bx654vz239 . This spreadsheet can be used for commercial or SFR properties and the analysis is much more thorough than you are likely to get from any would be real estate agent or real estate investment club vendor.

With the death of Securitization eliminating leverage for big investors, most are looking elsewhere for leveraged returns, but it is leverage in large part that has created the mess we are in and deleveraging is something we are all dealing with. 

There is a New Reality

The Investment Company Institute (ICI) has reportedly said that 50% of current retirees want to take more control of their assets at retirement.  Self Direction of Retirement plans is growing at 40% per year, but the people who educate themselves enough to do this do not want to pay fat fees to anyone and expect high returns on their self directed investments with the security of a hard asset (real estate).  Self Direction of Retirement Plans has been legal since 1974, but not common and represents about 4% of the IRA market.

We are talking about $4 Trillion dollars in IRA assets that is increasing at $200 Billion dollars per year as Baby Boomers retire and move their Qualified Plan Assets (401k, 403b, Defined Benefit Plans, etc.) into IRA's. The company that connects willing individual small lenders of individual retirement plan assets (secured by real estate) to borrowers whether directly or by creating pools of some type will be able to tap into an asset base of $4 Trillion Dollars!!! 

In order to do this effectively, this type of company will have to have a new outlook that includes very little  or no leverage in loan portfolios, with a serious look at Non-Recourse, Portfolio Lending from individual pension assets. This means a complete change in mindset from the “originate and sell to the secondary market”, which is dead commercially to a mindset that must accept a lower profit model.

These new companies will need a high level of automation to process and service loans, minimal overhead, a method of viral, low cost marketing enabled by the internet and word of mouth and will need to  recognize that the pass through of returns to smaller investors will be at higher rates/percentages than they have ever seen before, meaning much slimmer margins than they have ever seen or contemplated.  If this sounds ridiculous as a business model, compare it to closing your doors, having the value of your company go to 0 and going out to look for a job. All while scheduling time to testify in your own defense against pending lawsuits from outraged borrowers and willing law firms.

There is Good News

The good news is that the loans we are talking about can be made at current market valuations, with a 30% or more layer of protective equity for the originator, who will have to be a portfolio lender.

I have been able to pack rooms with would be Pension investors, but they want 12% or more in cash on cash returns secured by real estate (similar to what they can get on first trust deeds or tax liens right now).  Others in the room want to buy real estate at prices that will generate the same kinds of returns after expenses.  As various SFR markets capitulate (some already have like areas in Indiana, Detroit and Michigan, with many more markets to follow) those with cash to buy will get the returns they want and everybody else will have to pay, one way or the other.
 
The Rich Get Richer, so what is new about that?

Traditionally, the big, liquid money has swooped in to buy when real estate markets capitulate and many wealthy individuals are doing this selectively now.  Many more are waiting on the sidelines, expecting rates of returns in the high teens each year or better before they buy with huge gains possible by adding value and holding for the long term.  This is just history repeating itself. 

International Sovereign Wealth Funds and Domestic Hedge funds (also looking for near term returns in the high teens or big capital gains) are making or looking at stupendous purchases of mortgage pools at unprecedented discounts or buying blocks of new properties from builders or foreclosed properties from private lenders and servicers that can no longer carry them on the books.  As the FDIC takes over more banks, large portfolios including real estate will hit the market in liquidation.  If you have cash, the deals will be unprecedented in our lifetime.

New News

What is new is the $4 Trillion dollars in aggregate value of assets held by small investors who no longer trust the traditional venues for investment.  This trend is likely to accelerate as boomers prepare to retire and realize they will need to play "catch up" by earning compounded returns between 12-15% annually if they expect to reach even minimal retirement goals.

When reality sets in, the safety and security of Private Money Lending on secured real estate will be a big part of the solution.