Real estate investors often 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 may take months of viewing prospect after prospect to finally find the deal.
But what happens after finding the elusive good 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 deals and fund their real estate investment opportunities.
What is a Private Money Lender?
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.
Why Use 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, if not more, important as finding deals for investors to understand the ins and outs of raising money. Finding a deal is great, but if you don’t have earnest money to tie up a deal or funds to purchase it, then all that time and effort is for nothing.
When you make an offer on a piece of property, it is expected (and usually required) that you place an earnest money deposit down with your offer. If you are currently living paycheck to paycheck, coming up with even a few hundred dollars, let alone the thousands needed for a purchase, can be a big hurdle in launching your real estate investing business. Therefore, if you work on raising capital from private money lenders while locking up deals, you will have a greater chance for investment success.
The goal of this post is to help you learn how to raise capital from private money lenders so you can successfully tie up and invest in real estate projects. The first question that most investors ask is, “Who should I approach to raise the equity capital?”
Let’s try to answer that question.
The 3 Private Money Lender Circles
1. Primary Circle: Family & Friends
The primary investor circle is composed of friends and family. Many real estate investors turn to friends and family for their first funding needs. This is because it is easy to get in front of people who know you best—they are the most inclined to say yes. But there are negative parts of raising money from friends and family. For instance, they may not be sophisticated enough to know what a good deal and what is a bad deal is, and this can lead to problems when a deal goes sour. So when you take funding from friends and family, be 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 you may want to view this more as simply an initial source of funds to get you going, providing you earnest deposit money. 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.
2. Secondary Circle: Friends and Colleagues of Friends
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 not your network, on the righthand 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 “secondary connection.”
The secondary circle of investors consists of the friends and colleagues of your current primary circle. (Hint: The bigger your primary circle, the bigger your secondary circle of investors—so 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, 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 aspects to working with your secondary circle, as it is likely to take more time to raise money since this group 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.
3. Third Party Circle:
Your third party circle is made up of investors who are most removed from your network. You don’t know these individuals 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 when they think of a third party circle is, “How do I find these potential capital investors?”
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 Meet, 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 creative approach to getting in touch with potential capital investors, where 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 you approach private money lenders.
Leave a comment, thought, or suggestion below.