BiggerPockets

"Personal Guarantees are STUPID!"

Friday, October 28

Wow.

I just received another screeching email from a self-proclaimed guru bragging about how he just did another risky deal with private money from a new private lender in a crap-hole neighborhood that he would never buy in with his own money, and that he didn't even have to offer a personal guarantee because the lender didn't know enough to ask for it.

Bravo Sparky. Bravo.

You took advantage of someone that didn't know any better. I'll bet your mother is SO proud.

And the crime of it is, he's far from the only one that does this. I personally know several real estate investors that HAVE walked away from risky deals and left private lenders holding the bag.

And that wouldn't hesitate to do it again this afternoon if it suited them. Some of them even brag about doing it.

The amazing thing is that they continue to find new people that will lend to them.

Personally I have never understood that. Sure it's nice to offload risk. That makes good business sense when done properly. But to stick it to someone unsophisticated like a neighbor or acquaintance that doesn't know any better?

C'mon. That's just plain dishonest.

In my book there are really only five basic rules for using private money in real estate deals. I know that if I abide by them I'll significantly increase both the likelihood that we'll have a profitable deal, and the likelihood that we'll do more deals together.

My five rules are:

1. Don't use someone else's money to buy in areas where I wouldn't spend my own money

2. Don't use someone else's money to buy properties that I wouldn't buy with my own money

3. Don't use private money to practice if I've never done that type of deal before

4. Don't take private money from someone that can't afford to lose it

5. Give a personal guarantee

Pretty simple, isn't it?

It really isn't all that difficult to do things the right way.

As you might expect, I get a lot of grief about #5 - the personal guarantee part.

Other more "seasoned" investors are always telling me that I don't have to give one, and one of them even told me that I was "stupid" for giving them when we recently got into a heated back and forth argument about it.

Stupid. Really? Hmmm.

That's not how I see it. It's more like putting my money where my mouth is Sparky. Thankfully there's still a bunch of us left that consider that to be important.

This post was originally published on my blog at the Cash Flow Mercenary Academy.

Comments

1. 

   Joshua Dorkin Reply
   7 months ago

   Fantastic post, Dennis. I've blasted this one out there for everyone to hopefully read!

2. 

   Dennis Fassett Reply
   7 months ago

   Wow thanks Joshua!

3. 

   Mike Morrison Reply
   7 months ago

   Great post Dennis. This kind of crap screws the pooch for all of us.One of the downsides of our business is it draws in some slimeballs.

4. 

   Bryan Hancock Reply
   7 months ago

   If the lender is KNOWINGLY being compensated for the additional risk and/or has additional margin via a lower LTV to protect their investment than I think a personal guarantee isn't necessary. The trouble that is described above is taking advantage of people that don't know any better. That is always wrong.

   If, however, someone is a romping, stomping investor and they place the loan knowing about the risk I don't see any reason to require a personal guarantee.

5. 

   Dennis Fassett Reply
   7 months ago

   I agree with you on that Bryan, because in your scenario it's two equals doing a business deal together.

6. 

   Chris Clothier Reply
   7 months ago

   Great post Dennis and I'm surprised so far no one has commented on the opening few lines.

   It is amazing that there are actually people on mailing lists who would open an email such as that and say "yeah, that's the kind of guy I want to model myself after"! To make it worse, there will probably be a cheap, quicky course on how you too can find gullible, easy people to lend you money with no guarantee so you can invest in crappy neighborhoods you would never risk your own money in and find an unsuspecting buyer to off-load your high cash flow property to.

   I wonder what the name of that course would be?

   Thanks for sharing Dennis.

7. 

   Bill Walston Reply
   7 months ago

   EXCELLENT post Dennis. I couldn't agree more. Integrity is key when dealing with your private lenders.

8. Jeff Rabinowitz Reply
   7 months ago

   Part of the advantages of social networks is that you can easily reach many people that you never would have before their advent. If you choose to be dishonest or reckless and put unsuspecting people at risk you can be quite successful at it for a while. However, if you can stomach following that path you will leave a trail. Part of the beauty of social networks is that you will not be able to completely erase that trail and you will be exposed. You can be just as if not more successful following an ethical path and when you do you can proudly share your reputation instead of spending so much of your efforts in a futile attempt to hide it.

9. 

   Jim Ingersoll Reply
   7 months ago

   Good points on 1-4. However, I don't think a personal guarantee is necessary if you are credible and obey rules 1-4. Dealing with banks you always sign a personal guarantee, however, one when getting seller financing or using private money a big advantage is not needing personal guarantee's.

   I do lend and borrow and I do follow rules 1-4, but don't think it is necessary to sign personal guarantee's nor make my borrowers sign them when I am a private lender. I do however, do my own due diligence and know the risks and returns that are being generated.

   Jim Ingersoll

10. 

    Luis A. Reply
    7 months ago

    I could add one more to your rules. I have never rented or sold a house that I would not let my family live in...

11. 

    Dennis Fassett Reply
    7 months ago

    Chris - the crazy thing is, there are two high profile people in my market doing this exact thing. Nobody has come out with a course yet that I know of, but you KNOW it can be far behind.

    Thanks for stopping by my blog.

12. 

    Dennis Fassett Reply
    7 months ago

    Bill - integrity and transparency both. Most adults are smart enough to evaluate the risks associated with a particular action. The key, though, is that they need to know what those risks are and have time to do their own evaluation.

    Thanks for reading my blog!

13. 

    Dennis Fassett Reply
    7 months ago

    Very true Jeff regarding social networks. What I have found, though, is that less than 20% of my private investors use any type of social media at all, because they're considerably older than we are. So even if these folks were exposed for the clowns that they are, there would still be a segment of the population that would never know.

14. 

    Dennis Fassett Reply
    7 months ago

    Jim -

    All of my private investors are individuals. None of them I'd consider "rich" or even "well off". They're all comfortable, have worked a long time and developed sizable retirement savings accounts that aren't earning any sort of return whatsoever. They may or may not be accredited investors. Only one has any experience with real estate beyond buying their personal residence.

    Some of them I'd consider sophisticated investors in terms of equities and bonds, others not.

    But in each case, every one of my investors gave me money because they believed in me. They trusted me implicitly with their money.

    Part of that is because of the reputation I have developed.

    Part of it is my rules 1-4, where I treat other people's money the same as my own.

    And part of it is the personal guarantee.

    The great thing is that, when you think about it, since I'm careful in following rules 1-4, there's very little chance that a personal guarantee will ever come into play, because if something does go wrong with a deal, the property itself should completely satisfy the lien. And even if it doesn't, the difference will be small.

    That's a good deal for me and my investor.

    But when it comes down to it, aside from putting my own money into a deal, what better way is there to put my money where my mouth is than to give a personal guarantee which lets them know there's no downside risk on their investment?

    I don't think there is one.

15. 

    Dennis Fassett Reply
    7 months ago

    Great point Luis. By following the rules I have for myself I do the same.

16. Michael Costa Reply
    7 months ago

    Great article Dennis.

    On your last post you mentions hat with a personal guarantee that there is no downside risk which isnt necessarily accurate. Depending on ltv and purpose of loan (purchase money, purchase money + rehab) there can still be considerable risk. Additionally the personal guarantee is only as good as the guarantor - a highly leveraged guarantor or one that would declare bankruptcy makes the guarantee worthless. With all this being said, this situation probably wouldn't happen if one follows the previous steps since someone who follows those steps probably is pretty ethical. My last point is that if your personal guarantee truly gives your lenders no downside risk I hope they price that in and are giving you a low borrowing cost.

17. Barry Reply
    7 months ago

    Rule number 5 Makes one wonder how many owner/managers would let renters live in a house without paying a damage deposit? That is the same as a personal guarantee, just backed by real dollars instead of your word!

18. 

    Dennis Fassett Reply
    7 months ago

    Barry - nobody that wants to stay in business very long, that's for sure.

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