How to pay back my investors while still profiting myself?

Question

Hi all,

I'm ready to start buying my first investment properties. I have the properties and my investors lined up and ready to go. The numbers pan out for a 10-15% return. Everything is ready to roll.

The problem I'm struggling with is how to pay my investors back.

The main thing all my investors want to know is when will they receive their principal back. Most are requesting to recoup their initial investment in 2-3 years and don't want to park their money in the property long term. I am willing to move and self-manage but I am struggling to answer this question.

How do I pay back my investors and still turn this into a profitable business in a market that barely appreciates? Part of my dilemma is how to orchestrate the returns for my investors. I was thinking of two options

1. To offer them 8% guaranteed return. And take the money as a loan. The problem is how to get the principal out of the property? (I was thinking to offer to swap out their investment with new investors when the time comes and they want their principal back.)

2. To offer equity in the deals. To be completely candid, I am unsure how to make this work.

In essence what I'm asking is - how can I start a real estate business without supplying all the capital and still make room for myself?

For a point, of reference here are the numbers on one of the deals I am looking into now:

- Purchase price $150,000 - 8-units

- AGI $48,300 (currently fully occupied)

- Total expenses $20,317 (including 10% for vacancy, Managment, and R&M)  = $33,174

- NOI: $15,126 =10.1% CAP

- Annual Debt costs: $7,892 (my mortgage lender offered 75% financing at 5% rate, amortized over 25 years)

- I assumed $20,000 for construction (we walked through the property, it needs much less than that)

- 6% closing costs ($9,000).

-Total out of pocket expense: 25% down = 37,500. 20k construction and 9k closing = $66,500

- Leaves me with a very conservative $7,234 NOI  ($15,126-$7,892 = $7,234) and a 12% Cash-on-cash return. ($7,234 / $66,500 = 11.8%)

Any leads or assistance will be greatly appreciated! I would love to chat with someone personally for some guidance.

Thanks

Christopher Phillips · Answer

@Boruch Leivi Bartfield

Ignoring the finer details of the numbers, my gut reaction is to get the place up and running, make interest only payments to your investors, complete the rehab process over 2-3 years, then when the place is ready refinance the property at the after repair value so you can pull principle out to pay back your investors.

I agree with @Anthony Dooley. Don't dump rehab into a fully rented out place. Rehab the units as you get turn over and only if you think you can get more rent from the next applicant.

You have to work out the numbers. There is the possibility that after all the debt servicing and expenses you won't initially have anything substantial in your pocket, but once you rehab the place and refinance it to pay your initial investors you'll be able to to enjoy the proceeds.

Boruch Leivi Bartfield · Answer

@Christopher Phillips I agree as well when you say.

"You have to work out the numbers. There is the possibility that after all the debt servicing and expenses you won't initially have anything substantial in your pocket, but once you rehab the place and refinance it to pay your initial investors you'll be able to to enjoy the proceeds"

I'd need to figure out how to survive those 2-3 years before I profit.  Perhaps, I will do a mix of both larger units while not profiting initially and smaller duplexes that I can use my own capital for to survive on till I pay off my investors.

Thanks for the advice!

Boruch Leivi Bartfield · Answer

Hey Anthony,

I apprecaite your advice and insight. I especially agree with your advice to not improve the property all at once. Instead, I should try to improve the property slowly ultimately with the goal of doing a refi and paying them off.

I have found difficulty finding 20% COC deals on larger units, I have seen 20% on duplexes. I did not want to build my portfolio on a bunch of duplexes because the fixed costs are the same no matter how small or large the units are. Also, any small mistake or capital expense makes a HUGE differences when you're netting only 6-7k a year.

However,  I made need to rethink my goals and game plan in order to pay off my investors while cash flowing.

Thanks Anthony!

Anthony Dooley · Answer

You need to factor the closing costs and repairs into your acquisition costs. The $150K would actually be $179,000. This throws all of your calculations off.  This is not a high end property, so your cash on cash should be more like 20%. This allows you to pay your investors 8%. Your goal should be to improve the property over 2-3 years, not $20K all at once. By improving the property and raising rents, you increase the NOI.  This would allow you to do a cash out refinance in 2 or 3 years and repay your investors in cash. You would then own the property without having any money in the deal.