Private Money Deal Structuring?

11 Replies

I'm finally almost done with the updates that I wanted to do on the duplex I bought last fall, which means that it's about time for me to start shopping for new deals. I'd prefer not to move and take another FHA loan; rather, I'd like to try giving private money a try. Keep in mind that I'm not interested in flipping. I'd really like to do buy and holds instead.

I seem to have stumbled upon a pretty great pool of contacts with a decent amount of cash to invest if I get my elevator pitch down right. A lot of the write-ups I’ve read on biggerpockets and elsewhere focus on how people cleverly find deals, and how they cleverly coax large sums of money from various sources. What they're usually fuzzy about is what they did to turn that money into a property. In other words, I’m not worried about getting the money; I’m more concerned with what to do with it. Well, I’d buy a house or two or ten with it…but how do I structure the deal?

The most obvious way that I’ve thought of is the structure the investment as a note. I.e., they give me $50,000, I pay them back at ~7% apr, like a regular loan. The pros/cons are:

Pros:

-Simple. It’s a loan, I just make payments back, and it’s easy to explain.

Cons:

-Can’t combine that with bank financing because most banks don’t want another lien on the property and I don’t think I could get anyone to invest without me putting the property as collateral. This means that I need to get several people in together, and that’s never easy.

-I don’t think it’s the most profitable way to do it--I’d pay a bunch in interest to these guys

The second idea I had was to have them invest in my company (yet to be created). They would invest in "Matt Rothwell Holdings LLC", and then my LLC would buy the property(ies) and distribute funds according to how much they invested.

Pros:

-Seems more scalable, I could see this working better in the long run.

-Matt Rothwell Holdings LLC could potentially get bank financing to go along with investor funding.

Cons:

-Matt Rothwell Holdings LLC does not exist yet. I'm thinking there's a good amount of money required to set up that company and then more money to file taxes every year.

-Complicated

-I have no idea how to structure this.

-Not sure, but I’m pretty sure the SEC gets involved here.

So these are just a couple ideas that I’ve brainstormed, but I’d love to hear examples of how others have setup private money deals. What did you get out of the deal, and what did your investors get?

Keep it simple and secure for your investors. First lien position with money arriving in their mail box every month. That'll make them willingly and happy to stay involved. They loan you $50K for 12 months on a balloon note @ 7%. 

What am I missing?

P.S. Charles Schwab says the stock market returns are expected to be 6.3% annually for the next 10 years, so 7% is e-z money for them. 

Do you have an idea of how long they're willing to commit capital for?

I would set up a special purpose LLC either way you go.

The fees to incorporate vary by state, but they're not too costly - here in Florida it's $100 to file and $25 for the registered agent. What can be expensive is the cost for an attorney to draft an operating agreement and likely placement memorandum for potential investors. They're also going to make sure the offering of securities falls within a federal exemption from registration. That way, the SEC doesn't get involved because you followed the regulations.

There are a few common structures you could potentially use. You can do some quick research by checking out some of the crowdfunding sites and look at the equity investments. You can be real simple and distribute a flat preferred rate of return or be detailed with the waterfall and include a hurdle, catch-up and split.

Originally posted by @Steve McCondichie :

Keep it simple and secure for your investors. First lien position with money arriving in their mail box every month. That'll make them willingly and happy to stay involved. They loan you $50K for 12 months on a balloon note @ 7%. 

What am I missing?

P.S. Charles Schwab says the stock market returns are expected to be 6.3% annually for the next 10 years, so 7% is e-z money for them. 

If I gave everyone a first position on a lien, I'm thinking that certain government agencies might not be to happy with me.  The properties I'm interested in are $200,000-$300,000, so I'd need more than one investor.  Otherwise I'd just do a bank loan, I could easily do better than 7% for 50k with a first position lien.  

I got it. This sounds like a crowdfunding project.

Originally posted by @Steve McCondichie :

I got it. This sounds like a crowdfunding project.

 I'm not sure crowdfunding is the right word for it, but I guess the principle is similar.  "Crowdfunding" conjures up images in my head of jorts, beards, nano-breweries and fixed gear bikes--not the approach I'm going for.  I was more thinking that by piecing together 2-3 investors worth of funds, I could get enough to buy a cashflowing property or two.

I guess what I'm struggling with is: I know whats in it for me, but how do I structure the deal so that the investors see enough reward that its worth it for them?

Two words:

1. Security (if I don't perform you get this asset back)

2. Guaranteed Returns. (you'll get a dividend/interest/distribution paid every...)

If this is going to be a ongoing long-term enterprise, the idea of forming a limited partnership might make the best sense. 

A 7% return for the investor with the first position note might make sense if it were for a suitable period of time for them since it would be well secured. Maybe you could find someone to take second position on a $200K property. Third or fourth position at that rate--fuhgetaboutit.

Originally posted by @Matt Rothwell :
Originally posted by @Steve McCondichie:

Keep it simple and secure for your investors. First lien position with money arriving in their mail box every month. That'll make them willingly and happy to stay involved. They loan you $50K for 12 months on a balloon note @ 7%. 

What am I missing?

P.S. Charles Schwab says the stock market returns are expected to be 6.3% annually for the next 10 years, so 7% is e-z money for them. 

If I gave everyone a first position on a lien, I'm thinking that certain government agencies might not be to happy with me.  The properties I'm interested in are $200,000-$300,000, so I'd need more than one investor.  Otherwise I'd just do a bank loan, I could easily do better than 7% for 50k with a first position lien.  

 Typically in real estate borrowing/lending there is a promissory note that is secured by a lien on the property. There's only one lien created to secure the note (loan).

 In the note your investors would own x% of the note that is secured by the lien. Say two investors would own 50% each, four 25%, etc., where they're individual interest (either personally or through their entity) in the note is secured by the lien that is recorded at the time of the loan.

My 2$- if reducing complexity and legal costs is your goal, I don't think that would be accomplished by syndicating a first mortgage note.  A syndicated first mortgage can be more complex because the investors want to know who controls the workout scenario if things go wrong, and that's after you go through a length description of how to define "going wrong".  An operating agreement isn't much more complicated than a loan agreement, and you can still leverage the property if you want a bank loan.

I know most people are doing hard money loans on these fix and flips, but to me the returns and risks are the same as equity.  I'd rather invest in the equity, especially if there are other people involved.

The idea of forming a parent LLC is a good one if you want this done on a programmatic basis but you'll have to work out with your investors a typical profile of what you're going to buy because I doubt they want to just write you a check and hope for the best.

Wow, thanks for the responses guys, you've given me a lot to think about.  It seems like I've got a couple options here for taking investor money and turning it into property.  

Option 1 - Syndicated mortgage:

-I take money, add it to a pot then have a contract written up that details everyone's stake in the investment.  That is the "note" that buys the house.  

Pros:

-Less setup costs

Cons:

-Each time I do this, the same setup is required, so if I want to do a bunch of this stuff, then I'll rack up a sizable amount of legal costs

Option 2 - Make an LLC that buys property, people buy in to get a share of the company

Pros:

-Easier to buy additional properties beyond the first one

-Turns RE investing into a full-time gig that I'd basically have to quit my job for.  (Maybe a pro?  Maybe a Con) 

Cons:

-Setup costs/Legal expenses. Once I create the LLC, I'm then basically required to buy additional properties beyond the first one to amortize the setup costs across several properties.

-I'd have to come up with an operating agreement that is agreeable to all parties

-It doesn't really sound as rock solid to investors, it'd probably be a tougher pitch.  

It sounds like if I was flipping houses, option 2 would be a no-brainer. However, the returns for a buy and hold business would be substantially leaner. I'm not sure I could sustain an LLC without asking for more money for every new property. Or is that the point?

@Matt Rothwell  Thanks for starting this thread.  I have been wondering the same thing.  Have you move forward with the plan you outlined?  Also, say you were offering 7% to your investors and they financed the whole property, what type of "cut" would you take on that (assuming there is margin to take a cut) or would it just be on the back end sale/

Great feedback from everyone... that's why I love BP!

Chris

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