When we share our model with other real estate investors they are always intrigued by the idea of “Recycling our Capital”. They get excited about the idea of passive or private investors investing in their business to super charge growth.
However, something happens when we tell them that we pay our passive or private investors double-digit returns on repaired and rented units. They say things like:
“I would never pay that much!”
“Why would I pay that much when I could offer 6% or 8% and be way above market?”
“You are crazy and a stupid business person!”
Truth be told, no one has actually said the last one but I know most of them are thinking something very close to it. I hear it in their voice.
This article was actually sparked by a conversation I had with my accountant while preparing my taxes for the year. We were reviewing the year and highlighting what we are doing and when I told him what we are paying for private money, he asked, “Why pay 10%, why not 8%?”
I trust this guy and I consider him a good friend, so I had to sit back and think about it.
So this is why we do it:
By offering above average returns on repaired and rented units, it enables us to work with a select client list. We have our pick of investors and can chose to pass on investors that are too much work. Some people are great to work with and some will chew up endless hours of your day and not be worth the headache.
In addition we are happy to pay an extra 2%-4% over what some people say they would pay as we want our investors to profit for working with us. I think grinding the interest rate down is short sighted and does not show mutual benefits. In our business model, we want to ensure both parties feel extremely happy about working together.
Another reason we pay above average returns is we are not looking to do skinny deals. If we need to lower the interest rate 2% to make a deal profitable then we need to pass on the deal. In our model, we insist the investors understand the margin of safety we are building into the deal. If I need to lower the interest rate 2% to pencil a profit, the deal does not fit our investing criteria. The higher interest rate means we only go after the most profitable deals.
Do you know the difference in an interest only mortgage payment when the interest rate difference is 2% on a 40K loan? The answer is $66.66 a month or $800 a year. On deal by deal basis, this amount should not be your focus. Instead, focusing on building a portfolio of assets bought at distressed prices. If you can help people earn an above average returns on their cash or IRA you should be happy to pay it.
To conclude, a double-digit return gives us a marketing advantage over other investment options. It allows us to work with investors we want to instead of investors we have to work with (Big Difference). It ensures we only close on the most profitable deals. Lastly, we get to help people earn above average returns on their cash or IRA.
Good InvestingWhy do we Pay Double Digit Returns to our Passive Investors? by Michael Zuber