Join us in this episode of Property Investory as we discuss the pros and cons of private lending, where you, as the lender, effectively become the bank— but with much less paperwork! Plus, the deal gets done a lot faster! Kulkarni shares how this alternative strategy is more popular in markets such as the US than it is here in Australia, why that is, and if that’s likely to change in our traditional market. It’s a higher risk strategy, and the pros and cons are different for every investor— could private lending be for you?

Timestamps:
01:23 | An Underused Strategy
03:26 | Endless Paperwork? No, Thanks
07:37 | Thinking Outside the Box— and the Banks
09:13 | Banks Can Afford to be Picky
13:12 | Equity Cushioning
15:58 | In Your Positions...
21:32 | Building Life-Changing Wealth
23:08 | Shaking Things Up

Resources and Links:

Transcript:
Salena Kulkarni:

[00:05:46] There is a subtle shift happening in the local markets here, where people, like yourselves as well, who are starting to go, 'Well hang on a sec, there's an opportunity in the market for people to be the bank, and take advantage of opportunities that the bigger banks, that the traditional banks, just are not nimble enough to take advantage of.'

This is Property Investory where we talk to successful property investors to find out more about their stories, mindset and strategies.

 

I’m Tyrone Shum and in this episode we’re speaking with Amazon bestselling author, chartered accountant, and founder of the Freedom Warrior program, Salena Kulkarni. We’ll discuss her passion for private lending and her favourite part of the strategy, and why it may be time to throw out your property investing handbook. 

Tyrone Shum:  

Kulkarni believes there’s a lot to love about private lending, and hopes that the strategy becomes more popular in Australia.

Salena Kulkarni:   

[00:00:27] What I love about private lending is that it's effectively how you become the bank. And anyone who's been around for a long time realises that banks are one of the parties for every property transaction that just don't lose. They have the highest level of control, they put the least amount of time into the deal. And if it all turns to custard they get paid no matter what. 

[00:00:54] So lending deals, which are not as commonplace here in Australia as they are overseas, is one of the most powerful strategies that you can employ. Particularly if you have known methods for transacting those sorts of deals. But it's pretty cool to be the bank, instead of being the person who's running the deal and trying to make the deal work.

Tyrone Shum:   

[00:01:23] I agree with you on that side of things, because we both have experienced firsthand what it's like to be part of that and being a lender to the borrower. But I guess my question to you would be: why do you think not many people and not as many investors actually do this type of deal? Why are there not more of us who are actually lending out money as much as we could, like the banks?

Salena Kulkarni:   

[00:01:46] That's a great question, Tyrone. And I think it probably lends itself to why there's a lot of strategies that the average investor doesn't undertake. And it's because the way that the local property market has evolved over the last 100 or so years, is we've become very rigid around how we transact property. And the reason we've become rigid is because we're concerned about people getting taken advantage of, or titles or deeds not being transferred properly. 

[00:02:14] The way our system has evolved here is there is literally one way to transfer title of ownership. It has to be done properly, it has to be registered. And obviously, the pros of that are that it's very hard to get screwed over or for someone to take advantage of you. But the downside to that is that all of the associated industries, such as banking and lending and so forth, they've almost had to develop their systems and how they work around that method of transacting. 

 

[00:02:45] Whereas if you contrast that to other countries, where the ability to move property ownership around and structure deals and trade debt as an asset— the way that they have evolved means that it's just much more commonplace for people to take advantage of that. So I think it's a double edged sword. On one hand, I think it offers a lot of protection to the average investor, but on the other hand, it makes the system very rigid. And you would have to go out and figure out how to navigate the current system in order to do that effectively over here. And that's probably why there's not much of it.

Tyrone Shum:   

[00:03:26] That's true. I'll talk from say, maybe an investment point of view, as an investor going to the bank and asking to borrow money. The amount of paperwork, the amount of time that's involved in order to be able to get the applications filled in, the back and forth of the checks and so forth, it's a good month's worth of work. And sometimes you don't always get approved as well. 

 

[00:03:50] From my recent experience, I had to apply to three separate different mortgage lenders to be able to get a loan, and that was just insanely time consuming. I can tell you, I spent probably a good month or two just to be able to get that paperwork together. And hence the reason why it's frustrating from an investment point of view to be able to go out and get a loan, because there's so much paperwork. 

[00:04:11] And then after that, there's so many lending criterias that they have to meet, they want literally everything behind you, from your serviceability of income, to all your assets and all that. And you think to yourself, 'Wow, they are really trying to protect themselves more than trying to lend out the money to people, but they have so many people wanting to get that.' 

[00:04:31] I can talk from that point of view is that it's not a very easy process. And hence the reason why I think lending isn't so easy to be done from that point of view. But if you actually find the right people and come together, maybe it's from the private lending institution or private lending space, it seems like it's not as regulated. I can definitely tell from that. But at the same time, there's potentially a lot of money to be made from ] the interest in these structure deals correctly, still following the same principles of actually getting a mortgage and alone. What are your thoughts on that?

Salena Kulkarni:   

[00:05:07] I think that's a really interesting thread of thinking. I definitely agree with you, working with the banks is challenging. Even if you have a lot of capital and equity and income, they still make you jump through a lot of hoops before they lend you a cent. And I think, the overarching lesson from all of that is the banks don't lose. So if you want to become a lender, or you want to act as a lender, you want to be thinking like a bank. And that's a difficult transition for a lot of people to make. You want to dot your I's, and you want to cross your T's. And what I would say is there is a subtle shift happening in the local markets here, where people, like yourselves as well, who are starting to go, 'Well hang on a sec, there's an opportunity in the market for people to be the bank, and take advantage of opportunities that the bigger banks, that the traditional banks, just are not nimble enough to take advantage of.'

Tyrone Shum:   

[00:05:14] It's true. And I just had a conversation with a founder of a company, a FinTech company, where they're able to also fund and provide landlords with rents 12 months in advance. And I guess that kind of opportunity came up because him, himself, when he went through to get lending for his investment property, he felt frustrated, because he was not able to access the finance quickly, and not able to access enough to be able to do his future development. Because he actually bought a block of land previously, that he wants to subdivide it, but after all costs, and getting all the loans and fees and everything all paid out, he was left with almost nothing. 

[00:06:53] And that kind of made him think, 'Wow, there's got to be a better way, one, to be able to get finance from somewhere, and two, to be able to get that much quicker and with a less of a hassle.' And I think a lot of new tech companies, I can say are thinking really outside the square to do that to make it easier. And I know, working with so many different investors, and also meeting so many different people, there have been more online, faster ways to get funds. Even though there is still going to be important checks and so forth and you still speak to humans to do that, it's not going to be as hard as to go to like the big four to get the funding and so forth. So what's your experience been like with this space? What have you done?

Salena Kulkarni:   

[00:07:37] I've done lots of different kinds of lending deals. But I guess the thing is, I've not been the one out there finding the deals. What I love about this strategy, probably my number one love of this strategy, is you've got zero obligations to maintain the property. And it's generally a set and forget sort of strategy. You do your due diligence upfront, you put the deal in place, you put the paperwork in place, and then you just collect the repayments and then get your principal back at the end. 

[00:08:06] I've tended to lean more into shorter term deals. But as my confidence in that space has grown, I'm certainly open to longer deals. But I think the reality is that the reason that people seek finance outside of traditional lending is because they don't tick all the boxes that a traditional lender is looking for. So inherently, it doesn't make them a bad person or a bad deal. It just means they fall outside of traditional lending. 

 

[00:08:35] And so if you can find a way to vet and do good due diligence on those sorts of people, often they're prepared to pay a premium. And with the right security and the right support they can be just as lucrative, if not more lucrative, than some of the deals that... the banks are hamstrung to a degree, because they're regulated by the central banking system, and they can't raise their rates above a certain level, as we've seen with inquiries that have happened in recent times. 

[00:09:13] What the banks do is because they know it's a competitive market, and they can't be more than a couple of points above the central bank. What they do is they try and make make money off us otherwise, like charging us fees and penalties and things like that. Whereas I feel that in the private lending space, it's much more transparent in that I know, as a lender, that I'm not going to do this for nothing. It's certainly not a loan that you would be trying to make at commercial lending rates. You want a premium because frankly, it's a riskier proposition. The banks can afford to be picky and conservative about who and how they lend because they're not charging as much, whereas we're taking potentially more risk on in some of these lending deals depending on how they structured. And you want to be compensated for that.

Tyrone Shum:   

[00:10:11] And because also, too, looking at from a point of view that it could be more of a short term, and also the amount that you get back from it is probably contributing towards a larger type of deal, then it's actually a small amount. So maybe I'll give you an example. If you're getting maybe, say, $1 million from the bank, and you're getting charged at, say, 5% interest rate, compared to say, maybe loaning, say $200,000 on top of the $1 million at a higher rate, say, like 20%, or something like that, when you actually add those two interest rates together, or those interest amounts together, and you average it out, it actually comes maybe to seven or 8%, which is only a small percentage above. 

[00:10:55] And for them, when they look at a deal like that, as a developer, or maybe as a borrower to be able to get those funds, it helps them to be able to move forward into their deal further down the track. Because otherwise they might be stuck, and then they're stuck with $1 million, which they're paying, and they have to wait 12 [or] 18 months before they can get funding elsewhere. Whereas to them, that 12 months of time is a cost. And that cost could potentially be sped up if you actually be able to find private lenders to be able to support that shortfall, say $200,000 they need to be able to help them move through the project. 

 

[00:11:25] Because that 12 months is profit for them. If they don't get moving, that time loss is a huge, huge potential problem for them, for the development that they're doing. And that's what we've discovered is that they're looking for a faster and easier way, still meeting all the requirements that the first tier bank or the larger bank is being able to because obviously, the banks might lend it to them. But they're only limited because the banks, maybe my only lender, not to say 50% or 60%, because of the commercial loan. And they're just short for to complete the rest of the stuff that they need. So there's that kind of little gap that we're kind of looking at from that point of view. 

Coming up after the break, we’ll dive into the possible risks that come along with private lending...

[00:13:29] Whether you're talking about a $100,000 property or a $2 million property, one of the first things that I'm looking at is if things turn to custard, am I going to get paid? 

The most important things you need to consider, and why, when going into a deal...

[00:18:00] Knowing what state you're investing in, whether the legal system is landlord friendly, whether it is easy to go in and take possession, those sorts of things become really important considerations. 

The other market she learnt in and why you need to be a certain type of person to run private lending as a full-time business.

[00:23:15] My experience and where I really learnt the fundamentals was in another market. And I've always been aware that it does exist here in Australia, but friends of mine that have been professional mezzanine fund lenders, I've watched how they've done it.

And that’s next. I’m Tyrone Shum and you’re listening to Property Investory.

Kulkarni shares her thoughts on lending much larger amounts in Australia than in other markets she’s worked in, and how that larger amount doesn’t translate to a larger percentage of the property’s value.

Salena Kulkarni:    

[00:12:01] I think in the local market is the price of real estate in Australia is very, very high. So the numbers are going to be bigger. So if you're looking at a $1 million property or a $2 million property, and you're looking at trying to lend $100,000 to $400,000, it's a small percentage of the value of the property. The sorts of deals that I've tended to do in the lending space have been much, much smaller than that, deals starting from as little as $20,000, up to on average, typically $80,000 to $100,000. So, much smaller. But I think the mechanics and the principles are very similar. 

[00:13:12] It's important to mention to people, there are two ways to kind of address a lending deal. One is that you're the primary lender, you hold the title of the property and you're in first lien position. And if something goes wrong, you can swoop in and you take that property. And then the other type of lending is where you're in second position. So there might be a bank or another lender ahead of you. And you are basically in second in line if something goes wrong. You need to step in and understand whether or not you're going to get your money. 

[00:13:18] So one of the things that is crucial to consider if you're thinking about being a lender is what kind of equity cushion is there in the deal? Whether you're talking about a $100,000 property or a $2 million property, one of the first things that I'm looking at is if things turn to custard, am I going to get paid? And so I'm constantly looking at, yes, there's the due diligence on the deal sponsor and the environment and the geography and the industries that run in that community. But I think the first thing is like, okay, how leveraged is this deal if the market collapsed tomorrow, or if this particular developer or sponsor fell over? Am I going to get my money? And so I think sometimes people don't understand what being in second position means. Sometimes when they do understand they don't like it. So I think it's about making sure you're comfortable with where you sit in the pecking order. I think that's crucial.

Tyrone Shum:   

[00:14:29] I actually just want to add to that as well. Typically, the first lender would usually be lending a larger amount, just depending on the deal and also, too, at a lower rate, which is the reason why for them, it's because it's sort of lower risk. I guess that's why they're able to get a better rate than that. And I think at the same time, they're aware that if something does go wrong, there's plenty of equity in there. But usually, as you mentioned, with the second lenders that do come in, they would be expecting because they are taking a slightly a little bit more risk, that they are coming in second position, and therefore, to them, they will be looking at ensuring that the equity is enough to be able to cover the first and also the second, if anything that's go on. Plus also the interest costs and legal fees and whatever they need to pay out as well. So in my personal experience, I usually look for most deals a maximum of say, 75%, LVR, giving us about a 25% equity position. 

[00:15:28] If the value is too small, and there's not enough, and I actually had recently had a discussion with some of our legal team here, and they said, 'Look, most times, if they got to go to litigation, you would factor in at most between $70,000 to $100,000 for litigation, if it needs to go all the way to the Supreme Court for whatever reason. So we're always factoring that in now for any of our deals that we're looking at for any private lending. But yeah, I'd be curious, Salena, what kind of examples have you invested into what kind of deals?

Salena Kulkarni:   

[00:15:58] I think the point you make is a really good one. And this whole thing of if something goes wrong on an Australian deal, you have to go through the court system, and it's expensive. Whereas the deals that I do in the environments, say, for example, in the States, because it's a more commonly understood kind of arena, you don't need to go to court. You just take the property. I mean, the paperwork is pretty black and white, it's almost the equivalent of evicting a tenant sort of thing. It's not a high cost, time consuming kind of thing. 

[00:16:33] So the sorts of deals that I've tended to go into, if I've got small amounts of capital, I'll happily go into a lending deal for... let's say, a $20,000 one would be kind of bottom of the ladder. $20,000 and I'm in second position. But the overall loan to value ratio might be 60%. And 60% today, not 60% on completion, or 60%, at the end of the reno. 60% today, so that's important. 

  

[00:17:05] One of the things I've seen some people do is bring me deals where they're showing me when it's finished, that the equity cushion will be there, but there's no equity cushion now. So you just want to be really careful of that. The other kind of lending deals that I like are still sub-five years. And I still call that a longer term lending deal. So the shorter term ones are anything under two years, and then two to five years, I call long, but it could be longer than that. And that's where you're in first position. 

[00:17:39] Effectively, with those sorts of deals, you're getting well above the legislative rate of whatever. If the rate's 3% [or] 4%, you're getting 8% to 15% per annum. And in those sorts of deals, if something goes wrong, I know I can just walk in, take the property. And so knowing what state you're investing in, whether the legal system is landlord friendly, whether it is easy to go in and take possession, those sorts of things become really important considerations. 

[00:18:13] And so, lending deals are super powerful, because they give you a level of leverage and control that is hard to match. I think the downside that's worth mentioning is if you're going into a long term lending deal, so you could potentially structure a 30 year mortgage with someone who for whatever reason, doesn't want to, or can't get lending through conventional means. And you might structure a loan with them. 

[00:18:45] Let's say for example, you do a 30 year loan at 8%. Now, the problem with that is that obviously they are paying a premium and you're helping that person get into a home, they probably bring a sizable deposit to the table, so they've got skin in the game. But the problem with it is if we run into an environment with high inflation, your repayments don't change. You're still going to only get that 8%. 

 

[00:19:14] So one of the things to bear in mind is that lending deals are great and can be lucrative. But I don't know that you would necessarily, as an investor, put all your eggs in that basket because it's not really a hedge against inflation. If inflation kicks in, you still get paid whatever the negotiated amount is, whereas on the other side of the table when you hold real property, if we have a period of prices going up and inflation going up, then theoretically rents should go up too. So that is a hedge against inflation. So it's an interesting... It's probably a minor point, but it's something to understand.

Tyrone Shum:   

[00:19:55] It's definitely very interesting that you mentioned that as well, too. And I guess I'm also looking at this from a strategic point of view. Because ultimately, as you said, you wouldn't be putting all your eggs into this basket to do it, it's more to help you potentially depending on what you want to do with your portfolio, but to sort of help maybe use this to generate some additional capital, additional income, which will help eventually pay down your portfolio or use it for other means as well. Because I like what we've had these previous discussions as well. There's a lot of episodes we've already done as well with Selena and myself talking about the different strategies, but in the different strategies we do, it's ultimately got to look at your end goal, what is it that you want to achieve out of having a property portfolio. 

 

[00:20:38] And if the current market to buy a property, and then just to wait 10 years has been your strategy, you might have to be waiting for a very long, long time. But if you have some additional equity or capital that you can deploy and use the strategy of, e.g., private lending, and generate maybe an extra 10% or 15% extra on top every year just from this, and use those funds that you generate from that interest and pay down your your portfolio and build that asset base up further, this might be a faster way to accelerate and pay down. 

[00:21:09] And it's something I've really been enjoying learning from Selena, because she's showing me other ways that you can do it. I never thought that was possible to do it that way, because I've only been learning about doing developments and buying property and all that. But these alternate strategies are actually a very smart way. If you structure it well and do it correctly, you can actually reap a lot of benefits from it, too.

Salena Kulkarni:  

[00:21:32] I think it's all really, all this education that you share, Tyrone, is so great. And my thinking around alternative is that it's not intended to replace traditional investing, it's a bolt on. And I think the reality for investors, if they want to really build meaningful wealth, life changing wealth, where they have the freedom to choose what they do with their lives, then what alternative investing does is it speeds things up. So instead of needing to create a plan, which might take you... objectively, most of the people that I work with, who are higher net worth, who are business owners who are doing really well, a lot of them are still 25 to 35 years away from hitting their goals, even if they're doing all the right things by the property investing playbook. 

  

[00:22:25] And what alternative does is it just allows you to access a more liquid lucrative sector of the market that's not well understood, that's not well known. But exactly what you said, it just speeds things up, allows you to increase the velocity of your money, and get it back and reuse it, whether it's lifestyle or paying down debt. So that you've got that choice to do what you want with your time sooner.

Tyrone Shum:   

[00:22:55] I'd love to be able to jump into maybe an example that you've done. You mentioned that you've invested some in the past in the US. Have you also done any in the local market within Australia as well, too?

Salena Kulkarni:  

[00:23:08] Well, I've certainly been looking at your deals Tyrone, and I find those super, super interesting. My experience and where I really learnt the fundamentals was in another market. And I've always been aware that it does exist here in Australia, but friends of mine that have been professional mezzanine fund lenders, I've watched how they've done it. And you definitely have to be a certain kind of person to really run it as a full-time business. But I think what I appreciate about what you're trying to do is you're really trying to facilitate the deals, which I think is a— in what I've seen— new sector of the market for Australians.

Tyrone Shum:   

[00:24:01] Thank you for sharing that as well, Salena. It's interesting, because with the last year, with 2020, a lot of things have happened. The market has changed, the banks have also changed as well in their lending criterias, which has opened up a gap in the market. And this is where the opportunities have lied. And that's the reason why it came across to us within Property Investory to be able to offer these opportunities, because we have seen so many developers have come through and said, 'We've been successfully developing', they've got a good track record, and you can see that just based on what they've done, but the banks won't lend them up to, say, maybe, 50% or 60% LVR because they're on a commercial loan.

[00:24:42] Different story if it's residential, if you've just got a home and you need to just borrow against that, you can still get up to 80%. But when it comes to, say, development, it's a different ballgame here. And a lot of times when they do come to us, it's usually in an amount that is needed for a very short period of time. Maybe to finish off some engineering work or maybe just start on some part of the construction. And it's only for like usually six months or so. 

 

[00:25:06] And that's where, I guess, investors like myself are happy to become private lenders. Because we can see that as long as there's equity in there— not at the end, but at the point where we get into the deal and then we see there's an uplift in value— that gives us more assurance by the end of it, that there's plenty of equity to be able to either get refinanced out from the first tier lender, or get paid out through the sales depending on what stage it is at. 

[00:25:37] I could talk about an example that just recently came across the table, and we're still working through this deal at the moment. But it is something that has a very interesting part. We were actually provided this deal in Orange, and the developers have purchased the land at $2.9 million, just rough figures. And the valuation that came back, just recently, as of today's market was around that $5 million mark. And this was only about 12 months ago that they purchased this property. 

[00:26:08] Now, this property can be subdivided into quite a number of blocks. And I guess at the end of this value of this particular block, they're able to get a final completion value, once it's subdivided and sold all lots, an evaluation of about $22 million. So for us, for something like this, even if he's got about $2.9 million at the moment with an equity position of say an additional $2.1 million of the $5 million value. Even if we were just lent them, say, $1 million, there's still so much equity in there that for us, it just seemed like it was a no brainer. 

[00:26:39] And then on top of that, even if he's got the DA approved, the valuer has come back and said, 'Look, it'll be worth even more than the $5 million', and I think he quoted something like $10 million. So apparently there is already a DA on there. And if we actually gone into this particular deal, the property would be worth about $10 million based on a $2.9 million purchase. 

[00:26:59] So those kind of deals do exist. And it's just mind boggling. I'm thinking, why am I not aware of this one to buy ourselves? That'd be great to do a deal like that. So it's fascinating just to be able to see that it is out there, it's just a matter of finding them and be able to work with those developers, because this was brought to us by a broker who's actually been working closely with him for many years, and they've got good history with them. So because of that, we've got all the due diligence behind that. 

[00:27:28] And something like that can return anywhere between, say, 20% to 30% per annum, if you invest in that, knowing that there's so much equity. So if everything goes to custard as you said, or things just go south, we can literally take the property as is right now, with a DEA approval and sell it down for $10 million and still get our money back with interest on top.

Salena Kulkarni:   

[00:27:47] That's so awesome. I mean, the deals that I do aren't quite that sexy. But the thing is, I think what you're saying it illustrates a point that there are diamonds out there to be found. The challenge that most Australians and New Zealanders have is you've got to work so hard to find those kinds of deals. So the advantage of sitting on the lending side of the fence is you're not scrambling and fighting amongst other people to get those deals. You can kind of sit back and wait for the diamonds to come to you.

Thank you to Salena Kulkarni, our guest on this special episode of Property Investory.