Using other peoples money
Northern Virginia · Member since 2017 · 16 posts · 15 votes
I am sure this is dependent on a lot of variables and how the deal is... But I am curious to learn.
I see all over the place saying to raise funds for deal from other people. They're talking about friends, family, investors, etc. When going that route, how are you making the deal appealing to them? Are you promising a certain amount of money per month then a lump sum to cover the rest in a few years? Are you using their money in conjunction with a loan/mortgage (from bank)? Will you only take the money if it covers the entire cost of the property or will you take what ever they're willing to give you? Are you required to file with the SEC or something? I've seen a ton of information online and on here, but really it's just too much information. It's hard to decipher what would work and what wouldn't. So examples would be cool to see.
Thanks!
Hi Jonnathan,
Generally, the majority of the project costs are covered by financing. The money that is raised is used to fund the loan down payment, renovation costs (sometimes these are included in the loan), and all other costs associated with closing the deal.
In return for investing, the passive investor is usually offered a preferred return. Preferred return isn't a guarantee (you never guarantee a return to passive investors!). Instead, it is paid out of the cash flow (income - expense - debt service). Any profit remaining after the preferred return (including the proceeds at sale) is paid out is usually split between the passive investors and the sponsor.
The preferred return and profit split are all negotiable.
This first option is for equity investors. You can also bring on debt investors. In which case, you offer a fixed interest rate for a set number of years and then return all of the capital.
@Account Closed All of the above.
There are many ways to structure a deal. Usually private money is used in combination with a more traditional lender. If the private money is a lender they are in a safer position. If they become a partner and have an ownership stake there is more risk but hopefully more profit potential.
You need to find out what your lenders would be happy with. A lot of it is negotiating a deal that works for both of you.
@Account Closed position, that a PML is in a safer position, there are benefits to being a PML. They are only in a safer position if they are in first lien position (first loan on the property). A second lien is unsecured, and is not safe (the RE crash of 2009 was not too long ago). A private money loan offers your investor a rate of return - typically a lower rate of return because the assumption is they get paid first or second. That is the benefit, they get a "rate of return" over a defined period of time.
An equity position (owner, partner, member in LLC - these are all the same terms), shares in the risk as well as the reward with you. Typically, there is a bank loan, and then the equity position fills the balance of the cash requirements. Typically, the investor gets a % of the profits or a guaranteed minimum follow by a % split. You can structure it any way you feel is best to appeal to your investor.
I believe your larger question is how does one fill the Sources stack. Uses are how you spend the money. Sources are where you get the money to spend. Most use debt for a large portion of the Sources stack because it costs less, and they can increase the rate of return on the equity or cash position. Most real estate transactions with bank debt require equity/cash from an investor. One can use friends, family, investors to fill this portion of the capital stack. Either way, the deal is typically attractive to an investor based upon level of confidence, experience, length of time, level of risk, amount of money at risk, and rate of return. Most presenters of deals focus too much on the last item and not enough on the others. Generally speaking, a 30 year old investor (higher level of risk for growth) has dramatically different goals and level of risk compared to a 70 year old investor (lower level of risk for asset protection and cash flow). You need to get to know and most importantly understand what your potential investors are seeking in order to know what they want. Propose a structure that makes sense to both of you.
Either way, I would suggest you contact an attorney to properly guide you as to how to structure your project - either with PML or equity. There are rules and guidelines one needs to follow.
@Scott Krone the reason I say being a lender is safer, even in second position, is that lenders get paid before equity holders at sale time. Let me use an example. If a property is brake even, that means all bills are being paid but no money is left over for the owners. In other words the lenders get paid and the owners do not. If there is a loss the owners take a hit on their equity before the lenders.
Of course there are exceptions especially if they are doing 100% financing. You are also correct that being in second position is significantly riskier than first position. It is very very risky if the owners have no equity.
Thanks for the great information!
Hi Jonnathan,
Generally, the majority of the project costs are covered by financing. The money that is raised is used to fund the loan down payment, renovation costs (sometimes these are included in the loan), and all other costs associated with closing the deal.
In return for investing, the passive investor is usually offered a preferred return. Preferred return isn't a guarantee (you never guarantee a return to passive investors!). Instead, it is paid out of the cash flow (income - expense - debt service). Any profit remaining after the preferred return (including the proceeds at sale) is paid out is usually split between the passive investors and the sponsor.
The preferred return and profit split are all negotiable.
This first option is for equity investors. You can also bring on debt investors. In which case, you offer a fixed interest rate for a set number of years and then return all of the capital.
Great posts !
We use hard money / private money to fund 1st TD at up to 90% Purchase + 100% Rehab Costs...
Then we fill the 10% gap with a 2nd TD held within a Land Trust. Then we well partial beneficial interest of that land trust to smaller private money investors.
And here is a sample of an "Assignment of Beneficial Interest" in a Land Trust:
http://www.ctlandtrust.com/files/AssignmentoftheBe...
Here is a good resource on Land Trust by Jack Shea, where he also talks about Assignment of Beneficial Interest