Have you ever wanted to be the bank?
If you think about it, it’s not a bad position to be in. You loan capital and receive interest payments. If the payments are late, the amount you’re owed increases. What about high-risk loans? Those either come with huge interest rates to make up for potential losses, or they’re secured. That means if the borrower can’t pay, there are assets the bank can seize to protect their interests.
Investments within the private credit space are alternatives that can produce passive income.
Ways To Invest In Private Credit
To get started, you could go out and look for your own deals. You’d have to make sure to draw up a good contract, make sure payments are coming in on time, and take care of various accounting tasks, among others.
That’s not going to appeal to most people. Thankfully, there are a variety of other options that are a bit more passive.
The most accessible path in terms of the options available to you would be buying bonds through a traditional brokerage account. Effectively, bonds are like tradable lending agreements. There’s corporate bonds, municipal bonds, government bonds, and even some special government savings bonds. Some of these even come with some tax advantages. Typically you’ll have information available like the credit worthiness of the borrower, remaining term, and the yield, among others, to help you size up opportunities.
Publicly traded bonds are just a part of the overall debt markets. There are plenty of other options as well. In the alternatives space, there are a variety of companies that have built fractional investment platforms for various types of private credit opportunities. Things vary greatly from platform-to-platform and there are a lot of options in alternatives in general.
It might be helpful to go through a few examples to get a sense of the breadth of opportunities available:
- Groundfloor has a debt security they call “LROs” that fractionalize loans to small real estate developers. Those loans are secured by a first lien position on the property (they can foreclose on it if the borrower doesn’t pay back the loan). Loans are given grades, similar to bonds, with riskier loans yielding more.
- LexShares connects accredited investors to plaintiffs and law firms that need funding to support their legal cases. These are niche, high-risk lending opportunities where payback hinges on the verdict of the case. A loss in court also means a loss of all investment principal, but a victory can bring in a meaningful return from investors’ share of damages.
- A platform like Mainvest, on the other hand, allows you to invest in small and local businesses and get paid back (principal and interest) in the form of a revenue sharing agreement.
Key Characteristics of Private Credit Investments
What, exactly, to expect varies tremendously between platforms and the underlying asset and industry the lending is based around. That having been said, there are some principles that will generally hold true.
First, if the investment platform doesn’t have a secondary market and allow for trading of private credit assets, you won’t ever have a chance to earn a return through appreciation (selling for a higher price than you paid).
Second, even if the assets are traded, in general the value is likely to trend down over time. That’s because the amount of potential future interest earnings will decrease over time as payments are made. That makes the asset less valuable to acquire.
Third, losses are possible and, in some cases, even likely. The structure and level of risk on individual loans can vary tremendously. In the high risk areas, and where loans are unsecured, losses will be fairly common. The hope is that the yields/returns from the loans that repay successfully still allow the overall portfolio to earn a healthy return.
Lastly, diversification is very important. Any individual loan, or even a corporate bond from a publicly traded company, could result in the full loss of principal invested. Even major banks like JP Morgan Chase, that have vast resources and data to inform their decisions on who to extend credit to, sees some result in charge-offs. This is why diversification is very important to earning a good return.Show more +
Private Credit Investment Platforms
Investment Platforms With Accreditation Requirements
Fund That Flip
LexShares provides accredited investors with litigation financing investment opportunities. The minimum investment varies based on the offering, but can be as low as $2500. Litigation financing will only provide a return if the case is won. If lost, the entire principal investment is lost and no return is received.