Family member financing down payment. Appropriate return?

Question

I'm looking into buying a student rental property.  I have a family member offering to front me the $25,000 down payment.  I have the money in savings, but also have a young family and this feels like a good opportunity to leverage.  I'm curious how you guys would structure this transaction.  My initial thought is:

7-10% annual dividend plus lump sum repayment of principal in 3 years.

Obviously the property won't cash flow enough to cover this principal repayment in 3 years, but it does give me a chance to extend the savings window to get into the REI game while taking advantage of a generous offer while it's in front of me.  To reiterate, I do have the money saved up and worse case scenario could pull it out to repay him.

Is there any reason to not do this?  Is 7-10% too generous of an offer? I'm open to all options!

Thanks!

John Thedford · Answer

You cannot borrow over 10K interest free. IRS will impute interest.

Austin Jones · Answer

Yes @John Thedford I will be 100% liable for this $25K loan.  My partner in the investment will bring his own $25K to table for a total of $50K.

Austin Jones · Answer

Thanks @Scott England.  I understand what you're saying.  From a pure investment standpoint I know it's lower than what the market would demand.  A few other things of note:

- This family member is my Grandfather, who also owns the company that I run.  He knows that I can pay him back even if I take a loss for the entirety of the 3 years because he signs my paycheck!  Our main business is very successful and growing, but I'd like to also build some income separate from the company, hence REI!

- I could easily pay the principal off in three payments if you think that would be a more attractive option.

- My underlying driving force is to provide a decent return for a family member who was generous enough to offer.  Honestly I don't think he even expects interest, but I'd prefer to provide him a return as a gesture.

John Thedford · Answer

If a 50/50 partnership, and you plan to split profits evenly, then 7% seem very fair. I borrow from privates and pay 6-7% but they get 1st lien and LTV's are usually around 30%. Are you going to be 100% liable for the funds?

Austin Jones · Answer

Can do.

Investment is a 50/50 partnership with a friend, hence why my down payment (which will include $ towards closing costs, etc)  is only $25K:

- List Price - $175,000

- 4BR/1BA student rental in area where rents will be between $1900-$2400 for a 4BR.

- Taxes - $2789/yr

- Insurance - $1200/yr

- Property Manager - 7% of rent, plus $100 tenant placement fee.

- Property doesn't need any major work done(new roof, flooring, appliances), though a second bathroom would put it at the top end of the rent range.  This is on our radar.

Anything other details that might help?

Scott England · Answer

@Austin Jones

I think you are on the right track and if you are looking for something that is fair, yet still a family deal, I think anywhere in that range is good.

However, if you are looking for a true market comparison (which is impossible because this product doesn't exist anymore on the open market), you will be closer to the 15% mark.

Consider that your more aggressive private or HML rates will be around 10% for the term you indicated... 3 years, interest only.  However, that is on a first mortgage position with 20-25% equity.  Your family member is looking at a 2nd mortgage (if that) with 0% equity behind it as a cushion and with 0 principal reduction until payoff.

From strictly a risk-based perspective (which you may not be looking for) that position demands a much higher rate.

Jeremy Pace · Answer

@Austin Jones

Honestly, I feel like I need more details to be helpful.

Is the down-payment 25% ? what are the numbers like on the property (rents/taxes/etc.)