Real estate investors spend days, hours, weeks and months finding the next deal. Some get lucky and find their deal within the first few prospects but for others it make months viewing prospect after prospect to finally find The Deal. Now comes the second part of the real estate investment equation:
Deal + Money = Investment
Without money the real estate investment equation is incomplete. Real Estate Investors need to actively work on bringing in private money lenders to both tie up their deal and fund their real estate investment opportunities.
What is a Private Money Lender?
Definition: A private money lender is a non-institutional (non-bank) individual or company that loans money, generally secured by a note and deed of trust, for the purpose of funding a real estate transaction. Private money lenders are generally considered more relationship-based than hard money lenders.
Check out the Web’s Largest Directory of Hard Money Lenders Right Now, For Free! Visit The BiggerPockets Hard Money Lender Directory!
Why Private Money Lenders?
One of the biggest mistakes that new real estate investors make is that they spend an inordinate amount of time learning about finding and typing up deals but a small amount of time on how to raise equity capital from private money lenders. It’s just as important, if not more important, for real estate investors to understand the ins and outs of raising money as finding the deal. Finding a deal is great but if you do not have earnest money to tie up a deal or funds to purchase it, then all that time and effort is for nothing. (Ankit Investing Life Rules: Work Smarter Not Harder). When you make an offer on a piece of property, it is expected, and usually required, that you place a earnest money deposit down with your offer. If you are currently living paycheck-to-paycheck, coming up with even a few hundred dollars can be a big hurdle in launching your real estate investment business, let alone thousands needed for a purchase. Hence if you work on raising capital from private money lenders while locking up deals then you will have a greater chance for investment success.
The goal of this post to help you learn how to raise capital from private money lenders so that you can successfully tie up and invest into real estate projects. The first question that most investors come up against is who should I approach to raise the equity capital? Lets try to answer that question
Private Money Lender Circles
Primary Circle:
The primary investor circle is composed of Friends & Family. Many real estate entrepreneurs/investors (okay lets face it we are all investors whenever we raise capital for a new investment) turn to friends and family for their first funding needs. Friends and family financing is popular because it is easy to get in front of these people who know you best and they are positively inclined to say yes. But there are negative parts of raising money from friends & family as they may not be sophisticated enough to know what is a good deal and what is a bad deal and this can lead to problems when a deal goes sour. Hence when you take funding from friends and family by very clear about the risks and downside.
I would also suggest only taking capital from friends and family members who can afford to lose the investment. That way, if the investment does turn out to be bad, at least you won’t lose valuable relationships. In addition, friends and family often cannot come up with a lot of capital so friends and family can get you into business by providing you initial earnest deposit money so consider this source your angel investment source of funds. The money from friends and family will give you time to create value by locating and locking up deals so that you can either raise additional money from this circle of investors or raise money from secondary and third party circle of investors.
A really good BiggerPockets article that talks about how to raise money from your friends and family is Raising Private Capital: How I Raised $50,000 over Dinner by Arthur Garcia
Secondary Circle:
The best way to explain this circle of investors is to draw an analogy to LinkedIn Connections. When you login into your LinkedIn account and look up a person that is not your network then on the right hand side of the screen you will see how you are linked to that person from other people within your network. When you are linked to a person directly through one of your current network contacts then that is said to be a second connection.
The secondary circle of investors consists of the Friends and Colleagues of your current primary circle (Hint: the bigger your primary circle then the bigger your secondary circle of investors; get out there and make more friends and contacts through the BiggerPockets Forums and other social networking groups). This is the second best source for raising capital compared to the third party circle as this group will be more receptive to listening to you given that you have been provided a nod of approval from your primary circle mutual contact.
In addition, this circle is a bigger capital pool as there are more people in this group than in your primary circle which will allow you raise equity for your investment projects once you have locked up your deal using the primary circle’s capital. There are negative parts of working with this group as it is likely to take more time to raise money from this group as they are less positively inclined to say yes as they do not know you personally. To raise money from this group, you will need prepare to an investment presentation and spend time meeting these investors at luncheons, happy hours, and dinners.
Learn how to raise money from your secondary circle through this great Biggerpocket Blog Post: How to Raise Money Anytime, Anywhere. Even over Chicken Wings by Clay Huber
Third Party Circle:
In your third party circle are investors that are most removed from your network as you don’t know them personally in any manner. This circle is the biggest capital pool that you can access but it takes the longest to convert them into capital partners. The key question that comes into the mind of real estate investors is how do I find these potential capital investor? To help bring clarity to this question, I will provide two ways on how to reach these potential investors:
- Investor Contact Sites: You can utilize websites such as BiggerPockets Marketplace, Lending Club, Prosper, Go Big Network or Lendpost to post your investment opportunity and actively contact potential third party capital investors. A Word of Caution: Please make your contact is within the confines of the Securities and Exchange Commission at both the federal and state level.
- Investor Direct Mail List: This a guerilla approach to getting in touch with potential capital investors wherein you work with a list broker such as Melissa Data and Click2Mail to ascertain a list of potential investors who match your pre-established criteria of Median Household Income, Net Worth, Likelihood to Invest, and Responsiveness to Direct Mail.
Use this article as a guidepost as you work on raising equity dollars. Balance your experience with your capital timeline needs as you consider who you should approach for your equity capital.
I would love to hear your thoughts on how else you can approach private money lenders. Leave a comment, thought or suggestion below.
Photo: John Althouse
{ 31 comments… read them below or add one }
Borrowing from friends and family can be great when things go well. However, If things go bad, or payments are late, it’s a sure way to loose friends and make the holidays uncomfortable around family.
Agree entirely. Hence it is important to make them understand more than anyone the risks associated with the investment. They need to understand that its not a guarantee rather an investment. What is the best method you have found to advise your family and friends of the risks of the project or when things goes bad?
Ankit – this is an Epic post. I’ve probably used circle one, and now circle two – but never the third yet. I’m building my confidence to start working that direction
Thanks for the great article and keep up the great work!
Thanks Brandon. Epic is really kind. You will do great reaching out to third party investors. Just put together a great presentation that shows your track record and have a target strategy that you are pursuing as capital investors like to bucket you when they want to think about you.
Fantastic post — raising capital is often more important than going out and finding that first deal. No money to start with usually means no money to finish with! I’m at the stage where I move more deals coming than I have capital for — not a bad place to be. I also find that showing potential lenders a current flip you’re working — actually meeting them at the property — can go a long way in establishing credibility.
Michael you are absolutely correct. Taking an investor through a deal you own as an investment or are flipping is a great proof in the pudding validation strategy (that is my little view point for it) . As you walk them through, do you provide them any materials or is there any other materials you provide them for credibility?
I’ll direct them to my website early on in the introduction process to establish credibility, but I don’t have anything for them if we’re doing an actual walk-through except for perhaps some ‘before’ photos if it’s near completion.
Great idea. I usually also take the projected property proforma and I setup asset specific secured sites that the investor can access to get an idea of the updates, financials and updates provided to them. So that is a good thing to provide to them
Awesome post, Ankit. One of the best I’ve seen to date on the topic. Thanks for putting it together and to Brandon for the neat little circles.
Thanks Josh. That is huge compliment coming from you but it was Brandon neat little circles that made the post amazing. So thank you Brandon for putting those together and making this post awesome.
Great post. Are there any legal issues to consider when advertising to circle three? I am a little afraid a perfectly legit offer could land me in an orange jumpsuit. Can’t imagine, “rates way better than CDs” would violate any laws, but you never know…
Jared that is an awesome question. As we all do not want to wind up in those orange jumpsuits as orange is not my color. You need to be cognizant of the SEC rules of your state and federal level to make sure that you have the proper disclosure and process & procedures requirements followed. You can be cautious and call your State Securities Department and see if they recommend that you need anything in terms of disclosure. But in the meantime if you want to read more about the subject then read the Reg 504 and Reg 506 within Regulation D.
Ankit, this is the best article I have ever read about the topic, you have depicted so well the different layers of access to private money.
The family layer is certainly the primary and more logical, but I personally don’t feel comfortable with it. Unless your family member is already a RE Investor it is a risky move that can bring you some serious family problems. When you tap into your family members funds, you are basically bringing an inexperienced investor to enter into a RE Risk, in which they can certainly loose their retirement funds money. In my local REI Club, I’m continually listening “success stories” in which a family member made the transaction possible loaning 100% of the acquisition. And this even worst because you are inviting an inexperienced person to the circus pretending that he/she assumes 100% of the risk, when the professionals just take between the 65% and banks up to 80%. To me, this is not good family manners.
Anyway, I’m working hard on the second and third layers and will use your good advice to approach them on a smart way. Thanks for sharing this valuable information with us.
Alex
Alex
Thank you for the kind words. I appreciate the compliment. You also need to thank Brandon as he helped make the article even better with the images and being an awesome editor.
I agree with you that bringing in family money is messy at times so it is best to approach with caution. Keep working hard on raising money and I will try to add a post in the near future on how to draft your fund raising presentation for third party investors.
Help!!!
Im so glad to have run into this post! I have been “stalking” this site for about a year now and have always found awesome information.
My situation: After raising my own cash to cover appraisals/home inspections and binders fees, I also invested 12,000 with a private fund manager to secure funding for the deal. The deal consists of 2 quadplexes in North Florida which would provide a net cash flow of 1200$ per month. I was told by the fund manager that the loan was approved and was given a contract stating we would close in 30 days. Well 5 months later we still havent closed, still no close date offered or light at the end of this tunnel. First I was told they wanted to wait until after the elections. Then it was the fiscal cliff. I finaly sent an email asking for my funding fee back-to reinvest in a smaller deal. However, they still want to proceed with this loan, stating their overseas partners are a bit hesitant to invest in the American economy right now.
Its all just starting to sound like an excuse..
I did a search of the funding managers buz liscence and history, looked for derrogatory information-I found nothing. I even pulled up their primary residence/title/deed/taxes and used google earth to put eyes on the building (the buz is run out of their home)
I beleive if it was a scam, they would have stopped taking my phone calls by now.
Im a fairly new investor, any advice/comments would be greatly appreciated.
Has anyone used Private funding before and how long did it take to secure financing?
Has anyone experienced this before?
The author mentioned “Please make your contact is within the confines of the Securities and Exchange Commission at both the federal and state level” can someone explain/go into detail on this. Is this some sort of list I can review.
Jennifer
Let me see if I can provide some feedback to your issue. Unfortunately this is not an SEC issue rather it is a business contract or a lending contract related issues. Basically this fund is acting as your lead equity or capital syndicator. I have used private funding in the form of hard asset financing/bridge loans and it took about 30 to 60 days to come together. I have never heard of something like this before. Why dont you just request your $12k back and go to another lender. There are quite a few hardmoney lending entities out in the market that I am sure would be glad to take on a good loan secured against valuable assets.
Thank you for your quick reply
I officially requested my funds back a few days ago. They replied as usual, “we are still proceeding on this loan in a positive manner”
All in the same email Im being told that they are in a “holding pattern” and that they are trying to shed a positive light on the American economy to their overseas partners. Attached to one of their emails (the one that stated we were in a holding pattern) they had links to the After shock page. Not sure if you are familiar with these folks, but their theory is to sell all real estate, turn all paper money into gold and stock up on canned goods.
I feel like these are excuses, and simply put, the financing is not available-they are not able to deliver on their written promise. Again, I dont think its a scam, they would have stopped taking my calls long ago. I’ll check out the web site you mentioned and see about securing other funding.
That was an awesome explanation Ankit!
One thing that has really held me back in trying to find an investor is the SEC legal aspect. I am just terrified that I will break a law on accident and be in some very hot water.
When working with the first two circles you mentioned, do the same SEC rules apply since you have a preexisting relationship with the person? Does this mean that they don’t have to fall into the “accredited investor” bracket? Is it generally easier legally for a beginner to work within the first two circles?
If you could offer any insight into this I would greatly appreciate it!
Thanks
Nick
Thanks for the kind words. Here is my understanding on the SEC rules. If you are raising less than $5.0 million per year then you can use the 504 Reg D exemption wherein you can raise money from 45 unaccredited investors. Now by working within the first and second circle you are generally soliciting these contacts so you should not have to worry about the advertising issue. Now my only recommendation with the second circle contact is have three forms of contact with them over a 90 day period prior to having them invest alongside you. So consider that a cooling off period so that they can vet you properly as an operator.
Easy to understand article Ankit. thx
Regarding Nick’s question about which circles to stay within, I teach investors how to make double-digit secured returns by loaning out their own funds, and funds of their relationships within the first two circles. I don’t teach multilevel marketing but it works that way because everyone knows someone. As a private lender myself, I have found that once my partner and I start making money together by making small private loans to RE investors, they want to bring more principle to the table AND they tell their friends. Once you foster the new relationship, you have just gained a new source of funds whereby you can go make more private loans.
I don’t like the third circle because you need to have a large amount of deals if you start advertising for funds. Speaking from experience, I have been overrun by money and not enough deals to fund. I teach my guys to build their private lending business one loan/borrower at a time and make safe, consistent, double digit returns doing it.
Lee Carney
Question Lee, how does this plan sound. Borrow 120K, max 5 year plan. Interest only payments of 1,000.K monthly. Total 60K return plus 10% bonus on initial investment. Secured by deed and life insurance.
Hello Jeff,
Although the devil is in the details, at inital glance, looks like a solid deal – profitable and secured(if you are the lender). I am kind of a deal junkie, so the more info you give me the more I will review.
Be aware of too long of a term because that subjects your collateral to valuation considerations.
Lee Carney
Lee, I would be the borrower here. I plan to occupy this foreclosed home and that is one of the securities. As to terms, just looking to take time to do repairs and let the market stabilize to get the most return on my investment. Home now selling at 119K, taxed at 282K last year. Agent says offer less, bank is desperate to sell. Thoughts. Jeff
Let me ask this I am fairly new at Private money and HM because I have been using my self directed IRA to purchase.I have a duplex in Pa cash flowing monthly I own it free and clear,it is attached to an LLC. Could use this as leverage to get a private lender or HML to loan against this property to go out and purchase another? If yes how would I structure it ithe the lender?
Jim
First question back to you: The duplex that is owned by the LLC; is that LLC owned by your LLC?
Depending on that response back I can give you a better idea on how to structure the purchase transaction.
Ankit
Hi Ankit The property is attached to an LLC that I purchased with my IRA
hence- I own the LLC being held by my self directed IRA
The LLC with the property is an entity that sits alone.
The LLC is owned by your self directed IRA and the property is owned by that LLC. If that is correct then you need to find a non-recourse lender to give you a cash refinance but that money would have to go back into your IRA and then you would have to use your IRA and another non-recourse grade loan to buy a new investment property. There are lenders out there doing non-recourse lending to IRA. Just be cautious of a UBT tax that may apply to your rental cash flow stream.
To consider making yourself more attractive to potential investors consider that they should be concerned as to what happens to the funds they invest with you if you are not around to complete the project….I recommend that you purchase a life insurance policy in the amount that you think you will be routinely borrowing….name your investors as beneficiaries of that policy…
For example…let’s say you know that you will be needing to borrow a total of $300,000 to fund your project and that you are targeting 3 private individuals to loan you $100K a piece….You should have a $300,000 life insurance policy and you will name each of these individuals as beneficiaries in the amount of $100,000. When the project is complete, you have sold the property and returned the capital along with agreed upon interest to your investors you remove them as beneficiaries of your policy, make your firm beneficiary…and than when you are ready to begin another project repeat the process…
I think this is a very nice touch that demonstrates your thoroughness and professionalism….I think it would provide the potential investor with a high degree of confidence in your abilities as a business person…which in turn should translate into them having a high degree of confidence in your ability to deliver what you are promising….
Rick’s idea is also known as Key Man Risk Insurance as the capital investors are depending on you as the key man to finish the investment. So having that insurance policy is a great idea. Thank you Rick. How much do policies such as these cost? What are the key shortcomings?
I’m looking to purchase a foreclosed home, but due to it’s earthquake damage a normal lender wont do a loan so looking for private investor. My profession in construction is the key to my success. Home selling for 137K, tax assessed at 282K. Like Rick’s idea of using life insurance as collateral.