timid...looking at a private money lending deal, thoughts?

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timid...looking at a private money lending deal, thoughts?

Adam L.
Member since 2018 · 82 posts · 16 votes

So I'm still poking around and looking for how to invest in RE. I haven't purchased an investment property yet, but am currently offered a private financing deal w/ a neighbor/friend.

So my neighbor a few houses down is a flipper/construction guy. That's his primary thing. He buys properties, flattens them, and builds them up into fancy 2 condos and stuff. He's got a pretty solid track record and makes nice quality houses. He's found a new project and looking to build up two 2000sf SFH's on an old lot.

So he's asking for private lending to meet the 20% down on the bank construction loan on his next project. He needs a total of ~$200k and is asking for 50-70% private financing. His father (who regularly invests w/ him) is putting in $70k and so he's asking me (and others) for $30k-$100k to round it all out. 

He's offering a 25% simple interest return upon sale of the second unit. He's estimating 18-22 months to final sale/close on the second unit.

So questions and input advice here? I am certainly capable of providing this private loan to him. Any advice? I assume I can't get a junior lien on his construction loan. So I ask him to put a lien on his primary house? One of his personal rental houses? his new truck or fancy speed boat? Thoughts on the 25% simple interest? What it would effectively be if stretched out 2 years, compared to just time in the market?

Completed Projects:

  • Aug 2017, purchased small house $420K, 
    • sold 2,400 sqft main home March 2019 $900K and 
    • 1,100 sqft ADU (small house) February 2019 $520K
  • April 2017 purchased lot $420K 
    • built 2 , 2,100 sqft. condos 
    • sold A unit $735K August 2018 
    • and B unit February 2019 $750K
  • March 2016, purchased property $690K
    • sold expanded and renovated Jan 2017 $1,832,000
  • Late 2014, purchased lot mid 2013 $285K 
    • and sold new house late 2014 $932K
  • 2013, purchased lot for $220K 
    • built 2 separate 2000sf units
    • sold each in 2014 just under $600K per side
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Rick Pozos
Wholesaler, Rehabber and Landlord · San Antonio, TX · Member since 2014 · 2k+ posts · 2k+ votes
7y

The last completed project was 2 years ago??

If everyone is throwing in on the down payment, would you even have a lien on the property, probably not. That is how you would secure your money on the project is a lien on the property(even if it is a 2nd or 3rd). 

It seems that he is asking for an unsecured loan. I would loan my sister some non collateralized money or even a close friend(1k or 2k), but a neighbor that I dont really know?? I would probably NOT lend my sister 30k unsecured. 

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  • Jerel Ehlert
    Attorney · Austin, TX · Member since 2014 · 888 posts · 759 votes
    7y

    Run.  You don't know enough to protect your interest.

    What due diligence would you perform?  What secures your money?  What happens if he defaults on the construction loan?

    You should be able to assess when the transaction starts to go off the rails, not after the deal has become a dumpster fire.  If you don't have the knowledge, skills, or experience with the asset class or type of transaction, your risk of loss is much higher.

    Try listening to the Private Lender Podcast.  

    0Reply
  • Julian Buick
    Bluffton SC · Member since 2015 · 199 posts · 55 votes
    7y

    @Adam L. what percentage of your investable capital would this represent? If it is more than 10% then it is probably not worth the risk. If something goes wrong you wouldn't have the knowledge or experience to know how to fix it. If it is less that 10% of your investable capital and you would not be destroyed if you lost your entire investment then it might make sense. I have done deals like this before that have worked out well but I was willing to risk losing the capital because it was a smaller percentage of my total capital. In this case the builder looks like he has a solid track record so the chances of him not performing are probably slim but you always have to protect yourself Incase unforeseen circumstances happen. In a 100k SFR flip if something goes wrong and you have the means you can take over the project and figure out how to finish it yourself to get your money back. It's not hard to figure that out. New construction is a whole lot different and takes a whole lot more money based on the houses you have listed. Also I would be looking at more like 20% annualized interest.

    0Reply
  • Rick Pozos
    Wholesaler, Rehabber and Landlord · San Antonio, TX · Member since 2014 · 2k+ posts · 2k+ votes
    7y

    The last completed project was 2 years ago??

    If everyone is throwing in on the down payment, would you even have a lien on the property, probably not. That is how you would secure your money on the project is a lien on the property(even if it is a 2nd or 3rd). 

    It seems that he is asking for an unsecured loan. I would loan my sister some non collateralized money or even a close friend(1k or 2k), but a neighbor that I dont really know?? I would probably NOT lend my sister 30k unsecured. 

    2Reply
  • Adam L.
    OP
    Member since 2018 · 82 posts · 16 votes
    7y
    Originally posted by @Rick Pozos:

    The last completed project was 2 years ago??

    If everyone is throwing in on the down payment, would you even have a lien on the property, probably not. That is how you would secure your money on the project is a lien on the property(even if it is a 2nd or 3rd). 

    It seems that he is asking for an unsecured loan. I would loan my sister some non collateralized money or even a close friend(1k or 2k), but a neighbor that I dont really know?? I would probably NOT lend my sister 30k unsecured. 

    Very good points about unsecured loans. That's what I'm worried about...this seems like he usually gets funding from family and a few other close friends on a handshake deal. I asked him what we could set up as collateral and waiting for a response.

    no, it looks like he purchased property in 2017 and sold the units spring 2019.

    1Reply
  • Adam L.
    OP
    Member since 2018 · 82 posts · 16 votes
    7y
    Originally posted by @Julian Buick:

    @Adam L. what percentage of your investable capital would this represent? If it is more than 10% then it is probably not worth the risk. If something goes wrong you wouldn't have the knowledge or experience to know how to fix it. If it is less that 10% of your investable capital and you would not be destroyed if you lost your entire investment then it might make sense. I have done deals like this before that have worked out well but I was willing to risk losing the capital because it was a smaller percentage of my total capital. In this case the builder looks like he has a solid track record so the chances of him not performing are probably slim but you always have to protect yourself Incase unforeseen circumstances happen. In a 100k SFR flip if something goes wrong and you have the means you can take over the project and figure out how to finish it yourself to get your money back. It's not hard to figure that out. New construction is a whole lot different and takes a whole lot more money based on the houses you have listed. Also I would be looking at more like 20% annualized interest.

    Yes, it does seem like he has a solid track record and does nice work, not just a cheap flip and run.

    good point about the interest. I'm concerned he is not used to people asking for detailed loan agreements. It seems like he usually just says: "I'll give you your principle + 25% when I finally sell the unit." I looked at his sample agreement and it was shockingly simple and basic. Not sure he's used to signing something about annualized interest rates or monthly payment periods.

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  • Wayne Brooks
    Real Estate Professional · West Palm Beach, FL · Member since 2012 · 23k+ posts · 13k+ votes
    7y

    Assuming you got a second mtg position loan, there’s no reason it couldn’t be done, an 11-12% APRi is still not nearly enough for the risks.  If anything goes wrong, you are pretty much assured of losing your entire investment with an 80% first mtg.

    1Reply
  • Adam L.
    OP
    Member since 2018 · 82 posts · 16 votes
    7y
    Originally posted by @Jerel Ehlert:

    Run.  You don't know enough to protect your interest.

    What due diligence would you perform?  What secures your money?  What happens if he defaults on the construction loan?

    You should be able to assess when the transaction starts to go off the rails, not after the deal has become a dumpster fire.  If you don't have the knowledge, skills, or experience with the asset class or type of transaction, your risk of loss is much higher.

    Try listening to the Private Lender Podcast.  

    Good points. As far as due diligence, not sure what that all would entail. I'm contacting his references and I've seen his previous projects and I know him around the neighborhood/club.

    For collateral, that's the big question. It seems he's generally operated on handshake deals and simple interest loans from family. I asked what we can do about collateral (primary house, rental house, truck, boat, etc) but I think this is more technical than he's used to. TBH, I'm not sure how he's done his funding previously using such a basic, unsecured agreement.

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  • Jay HinrichsBusiness Member
    Real Estate Consultant · Summerlin, NV · Member since 2014 · 45k+ posts · 66k+ votes
    7y
    Originally posted by @Adam L.:
    Originally posted by @Julian Buick:

    @Adam L. what percentage of your investable capital would this represent? If it is more than 10% then it is probably not worth the risk. If something goes wrong you wouldn't have the knowledge or experience to know how to fix it. If it is less that 10% of your investable capital and you would not be destroyed if you lost your entire investment then it might make sense. I have done deals like this before that have worked out well but I was willing to risk losing the capital because it was a smaller percentage of my total capital. In this case the builder looks like he has a solid track record so the chances of him not performing are probably slim but you always have to protect yourself Incase unforeseen circumstances happen. In a 100k SFR flip if something goes wrong and you have the means you can take over the project and figure out how to finish it yourself to get your money back. It's not hard to figure that out. New construction is a whole lot different and takes a whole lot more money based on the houses you have listed. Also I would be looking at more like 20% annualized interest.

    Yes, it does seem like he has a solid track record and does nice work, not just a cheap flip and run.

    good point about the interest. I'm concerned he is not used to people asking for detailed loan agreements. It seems like he usually just says: "I'll give you your principle + 25% when I finally sell the unit." I looked at his sample agreement and it was shockingly simple and basic. Not sure he's used to signing something about annualized interest rates or monthly payment periods.

    Unsecured Prom notes ARE shockingly simple  can be as little as one page with 2 or 3 paragraphs.. that's very common and acceptable and enforceable.. 

    GAp funding is risk funding no double its relationship funding..  we do a lot of it but with folks we have known for years and in most instances we are in a position to step in.. most lenders who do this are the opposite .. at least the ones that get in trouble.. no experience and no ability to step in if needed to protect their interest.. granted the return is good.. that's the bottom end of what we would expect..  

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  • Adam L.
    OP
    Member since 2018 · 82 posts · 16 votes
    7y
    Originally posted by @Wayne Brooks:

    Assuming you got a second mtg position loan, there’s no reason it couldn’t be done, an 11-12% APRi is still not nearly enough for the risks.  If anything goes wrong, you are pretty much assured of losing your entire investment with an 80% first mtg.

    Agreed about the APRi discussion. It seems he's usually operated on a simple interest agreement: "I'll pay you back your principle + 25% at the end of the project" I'm not sure he's familiar with doing a more complicated loan structure and not sure how he'll respond if I say a flat 25% at the end is too low.

    What's the equation or term to convert this into an equivalent annual yield or interest rate? 

    If I loan him $100k and after 2 years (no monthly payments), I get back $125k.

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  • Adam L.
    OP
    Member since 2018 · 82 posts · 16 votes
    7y
    Originally posted by @Jay Hinrichs:

    Unsecured Prom notes ARE shockingly simple  can be as little as one page with 2 or 3 paragraphs.. that's very common and acceptable and enforceable.. 

    GAp funding is risk funding no double its relationship funding..  we do a lot of it but with folks we have known for years and in most instances we are in a position to step in.. most lenders who do this are the opposite .. at least the ones that get in trouble.. no experience and no ability to step in if needed to protect their interest.. granted the return is good.. that's the bottom end of what we would expect..  

    Yes, it seems he usually operates on unsecured Promise Notes (he sent me a sample agreement).

    I'm not sure I understand your first sentence about GAP funding. 

    Can you comment more about the interest return? I agree, 25% flat interest after 2 years seems quite low, but one a 1 year return seems great. What returns do you usually look for? How are you calculating an equivalent annual interest rate?

    0Reply
  • Jay HinrichsBusiness Member
    Real Estate Consultant · Summerlin, NV · Member since 2014 · 45k+ posts · 66k+ votes
    7y
    Originally posted by @Adam L.:
    Originally posted by @Jay Hinrichs:

    Unsecured Prom notes ARE shockingly simple  can be as little as one page with 2 or 3 paragraphs.. that's very common and acceptable and enforceable.. 

    GAp funding is risk funding no double its relationship funding..  we do a lot of it but with folks we have known for years and in most instances we are in a position to step in.. most lenders who do this are the opposite .. at least the ones that get in trouble.. no experience and no ability to step in if needed to protect their interest.. granted the return is good.. that's the bottom end of what we would expect..  

    Yes, it seems he usually operates on unsecured Promise Notes (he sent me a sample agreement).

    I'm not sure I understand your first sentence about GAP funding. 

    Can you comment more about the interest return? I agree, 25% flat interest after 2 years seems quite low, but one a 1 year return seems great. What returns do you usually look for? How are you calculating an equivalent annual interest rate?

    your filling the GAP between the first lender and purchase price  ergo slang for equity loans is gap funding.

    25% apr is what yo need not 25% total return other wise yes time erodes your return..  I do a lot of it but at much higher returns than your talking about you need big returns to off set the risks.. also since its on such a small amount the return does not affect the operator that much .. and if they want OPM they need a partner of some sort.. most money partners want 50% of the total profit. 

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  • Robert S.
    Contractor · Milltown, NJ · Member since 2016 · 297 posts · 213 votes
    7y

    @Adam L. Good day, as a contractor who gets approached quite frequently to participate in these type of loans by my own clients, please take into consideration that you need to pay taxes on your return. So the IRS’s take should get factored into your required return.

    1Reply
  • Natalie Schanne
    Real Estate Agent · Princeton, NJ · Member since 2016 · 1k+ posts · 1k+ votes
    7y

    @Adam L. - my concern is... if he’s so successful with these projects, why doesn’t he have or why isn’t he willing to pay his own $100-200k downpayment or at least half of it? Like on a $1m cost property, if things go south he loses his 100k first then his investors lose 100k then the bank loses on its 800k. He also doesn’t seem to have a team to do multiple rehab projects at once unless he’s doing construction jobs and only allocating his people to his own jobs when they’re not busy. Will that slow down progress? What was his reason for taking so long between projects? You have to ask a lot more questions. I’d also try to get 12-15% interest with MONTHLY interest PAYMENTS DUE. You’re more likely to get your money back faster and/or know if things are going south if you’re getting payments. Also, see if he will let you background and credit check him.

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  • Adam L.
    OP
    Member since 2018 · 82 posts · 16 votes
    7y
    Originally posted by @Natalie Schanne:

    @Adam L. - my concern is... if he’s so successful with these projects, why doesn’t he have or why isn’t he willing to pay his own $100-200k downpayment or at least half of it? Like on a $1m cost property, if things go south he loses his 100k first then his investors lose 100k then the bank loses on its 800k. He also doesn’t seem to have a team to do multiple rehab projects at once unless he’s doing construction jobs and only allocating his people to his own jobs when they’re not busy. Will that slow down progress? What was his reason for taking so long between projects? You have to ask a lot more questions. I’d also try to get 12-15% interest with MONTHLY interest PAYMENTS DUE. You’re more likely to get your money back faster and/or know if things are going south if you’re getting payments. Also, see if he will let you background and credit check him.

    Hey!  Good questions. I'm not sure why he's not putting down his own cash, I just assumed that's how flippers operated with OPM.

    For timelines, it looks like this is his general schedule 15+ months to do a full construction and build out, then time to sell them, then time to find the next property. It appears he's happy chugging along at this pace so that he can enjoy time with his family and just do the amount of work he needs to sustain his family.

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  • Jay HinrichsBusiness Member
    Real Estate Consultant · Summerlin, NV · Member since 2014 · 45k+ posts · 66k+ votes
    7y
    Originally posted by @Natalie Schanne:

    @Adam L. - my concern is... if he’s so successful with these projects, why doesn’t he have or why isn’t he willing to pay his own $100-200k downpayment or at least half of it? Like on a $1m cost property, if things go south he loses his 100k first then his investors lose 100k then the bank loses on its 800k. He also doesn’t seem to have a team to do multiple rehab projects at once unless he’s doing construction jobs and only allocating his people to his own jobs when they’re not busy. Will that slow down progress? What was his reason for taking so long between projects? You have to ask a lot more questions. I’d also try to get 12-15% interest with MONTHLY interest PAYMENTS DUE. You’re more likely to get your money back faster and/or know if things are going south if you’re getting payments. Also, see if he will let you background and credit check him.

     you would be surprised.. builders have over head they have a home they have kiddos etc..  its hard for most builders to amass enough equity .. many end up doing it but it takes volume and years if your just doing a few at a time I flat will guarantee all profits go to life style and his personal over head.. not to savings.. 

    some builders do not need outside capital others do..   

    The risk though is for non experienced investors going into second position with no clue how to fix it if it has a water landing.. 

    Most people that have these business usually have a partner.. one partner provides capital the other the expertise to get it done.. and then they usually split 50 50 .. this is far less than 50 50.. this is why returns on this type of funding should BE FAR higher than a simple 10 to 15% interest rate.. FAR higher.. and there should be some equity participation with a pref.. that's how I do mine.. 

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  • Adam L.
    OP
    Member since 2018 · 82 posts · 16 votes
    7y

    good advice all. So I asked the guy more specific questions, here's the responses and after talking w/ references.

    • Bank will not allow a 2nd, junior lien on the construction loan.
    • He's clear that he's asking for an unsecured loan w/ personal guarantee (quote "which is why the rate is much higher than a standard loan")
    • he does purchase title, builder, fire insurance.
    • he does NOT plan to refi mid-way through. His standard practice is to pay down bank lien at sale of first unit, then investors at sale of 2nd unit.
    • He plans to pay out investors in one lump sum at sale of 2nd unit. He does not do monthly payments.
    • His references from past projects said similar. It was a smooth easy loan, personal guarantee that was just a handshake.

    So....it seems to me that this guy is trustworthy and excels in building these nice 2 unit properties, but he is not savvy or experienced the specific details of a private loan like this. He's operated his past deals with more or less a single page contract saying a simple interest loan lump payment at the end of the project.

    He does not seem like he intends to write a lien against other real property (his truck, boat, other rental unit) nor does he seem to do monthly payments, nor does he seem to consider the time vs % factor. 25% in one year is great, but over 2 years is crap.

    Any more thoughts on this? Has anyone else interacted or experienced a builder/flipper person that doesn't really 'get' the specific details of asking for a loan?

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    • Jay HinrichsBusiness Member
      Real Estate Consultant · Summerlin, NV · Member since 2014 · 45k+ posts · 66k+ votes
      7y
      Originally posted by @Adam L.:

      good advice all. So I asked the guy more specific questions, here's the responses and after talking w/ references.

      • Bank will not allow a 2nd, junior lien on the construction loan.
      • He's clear that he's asking for an unsecured loan w/ personal guarantee (quote "which is why the rate is much higher than a standard loan")
      • he does purchase title, builder, fire insurance.
      • he does NOT plan to refi mid-way through. His standard practice is to pay down bank lien at sale of first unit, then investors at sale of 2nd unit.
      • He plans to pay out investors in one lump sum at sale of 2nd unit. He does not do monthly payments.
      • His references from past projects said similar. It was a smooth easy loan, personal guarantee that was just a handshake.

      So....it seems to me that this guy is trustworthy and excels in building these nice 2 unit properties, but he is not savvy or experienced the specific details of a private loan like this. He's operated his past deals with more or less a single page contract saying a simple interest loan lump payment at the end of the project.

      He does not seem like he intends to write a lien against other real property (his truck, boat, other rental unit) nor does he seem to do monthly payments, nor does he seem to consider the time vs % factor. 25% in one year is great, but over 2 years is crap.

      Any more thoughts on this? Has anyone else interacted or experienced a builder/flipper person that doesn't really 'get' the specific details of asking for a loan?

       this is a friends and family deal..  you either trust him or you don't.. bottom line.. and if market is not kind your probably going to lose some if not all your money..  but most likely it will be fine.. 12 % interest for this risk.. in my mind is only being done by very naïve investors or friends and family wanting to do a solid for this guy.. that's my thoughts.

      The reason most lenders do not allow seconds behind their firsts is it precludes the ability to take a deed in Lui it forces senior lender to full blown foreclosure if the second wont just go away unpaid..

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