Should I loan someone $100k for 10% return?

25 Replies

I connected with someone that I don't know personally who was looking for an investment partner.  He is a broker but can't get qualify to cover the purchase of a property he wants to fix and flip.  First we thought we'd be 50/50 partners, but then it seemed too complicated and we don't have the same risk tolerance (he doesn't want to get it inspected).   So... he wants to borrow 100k for a 10% return.  I'd get 10% no matter how long the turn is up to a year.  Yes, we'd draw up legal documents and the house would be used as collateral.  Here are my questions.  How much do I get charged in taxes?  Is it the same as ordinary income?  Has anyone done similar?  Is this a good use of my money?  I've been trying to find a better real estate investment but can't find any deals anyway.  Any guidance would be appreciated

@Joe Mazur you should ask your CPA how the income would be taxed. I think if you are going to do this then you need to think about what happens if he can't repay at the end of the year. Will you have a first position MTG that you can foreclose? What will it cost you to foreclose? What is the ARV of the property? If he got it almost all the way done and you had to come in and spend another 20k to finish or whatever would it still make sense? I mean in a perfect world it all goes good and you get that oh so good mailbox money but think about if it all goes wrong what is your exit strategy or how can you protect yourself.

@Joe Mazur @Tyler Gibson made some very good points. Proceed with caution. Big red flag "he doesn't want to get it inspected". Does that mean he won't pull permits to do the work either? My biggest problem with lending money like this is if the fix and flip fails you end up with a property that can't be sold for what you have already invested in it. Not my kind of investment. Especially dealing with someone you don't really know. 

tax's would be treated just like you were making interest in the bank.

Passing on an inspection is sometimes good for negotiating. 

What I would do is vet this person before signing any contracts. 

If someone came to me and wanted me to invest 100k on a fix & flip, I would need to know every detail about this person, which contractor they will be using, their track record and previous experience, etc. 

Originally posted by @Frank Wong :

Whats the LTV of the property? I would want to be in first position lien on the property no exceptions.

If he is borrowing some on his end from the bank would it even be possible for me to be in 1st position? 

 

Originally posted by @Tyler Gibson :

@Joe Mazur you should ask your CPA how the income would be taxed. I think if you are going to do this then you need to think about what happens if he can't repay at the end of the year. Will you have a first position MTG that you can foreclose? What will it cost you to foreclose? What is the ARV of the property? If he got it almost all the way done and you had to come in and spend another 20k to finish or whatever would it still make sense? I mean in a perfect world it all goes good and you get that oh so good mailbox money but think about if it all goes wrong what is your exit strategy or how can you protect yourself.

Great points, Tyler.  Lots of things could go wrong that I hadn't thought of.  Thanks for the reply 

 

Originally posted by @Joe Mazur :
Originally posted by @Frank Wong:

Whats the LTV of the property? I would want to be in first position lien on the property no exceptions.

If he is borrowing some on his end from the bank would it even be possible for me to be in 1st position? 

 

If he's also getting a bank loan, then you should pass on this because you will end up being in second position.  Not a position you want to be in, especially as a new/inexperienced lender.  

 

10% is not enough return.  I am going to assume it will take virtually the entire year because there is nothing for the borrower to gain paying earlier than at the end of the term.

Apartment syndicators with long track records offer higher return.  The S&P with a much longer track record returns virtually the same return.

If not for the return then why?  

Add in the risk.   Here are some red flags: 1) he cannot qualify for the loan via traditional means.  2) He does not want to do an inspection.  Is this because he believes it is necessary to close the deal.  Does he have the skills to forego an inspection without significant risk?  3) No mention of his experience level so I assume it is not great.  4) if he is willing to forego the inspection, what other risks is he willing to take?

>Is this a good use of my money? 

On the return versus risk, I would think not.  Are you expecting to learn something in this exchange?   If you can learn something useful then go for it.  If you want RE and something passive that is likely to produce better return maybe consider an established syndicator (do your research).  If you want something passive and easy then maybe an index fund (again do your research).

For my non-passive RE investments, I expect a return so much greater than 10% annual (otherwise I would just have the money in an index fund).  Your offer seems to be passive so the expected return should be less but there are options that likely are less risk and produce better returns.

Good luck

10% is great IMO. Just make sure you have the property appraised and your legal documents are airtight. Not many folks can get 10% return without doing much work.

Originally posted by @Joe Mazur :
Originally posted by @Frank Wong:

Whats the LTV of the property? I would want to be in first position lien on the property no exceptions.

If he is borrowing some on his end from the bank would it even be possible for me to be in 1st position? 

No, the bank will want to be in first position.  So if he is borrowing from the bank and then you other than his credit and his time. What financial commitment does he have in on this deal?  Gotta play out the worst case scenario to evaluate your risk.

 

I think 10% is too shy for a $100k loan but that's my opinion. 

I would put the deal under an LLC and put a provision under the contract that he not allow anyone else to borrow $ against the property without your consent. You do not want him to over leverage the property. Vet the project and his track record, how are you so sure the resale will be as such? How long would it take and what's the penalty if it goes over?

@Joe Mazur . If he defaults and you get the house it still won’t be inspected and it may not be completed either. This to me is a monster risk with a very mediocre return. My rentals return 20-25% when you consider the back end. My retirement (some of it) is at 27%. 10% minus 3% time loss of money is pretty poor use of 100k. RR

@Joe Mazur

I would be very leery. Getting permits is the legal way to go and the norm. I would not want work done without permits. If a fire broke out after selling it would having non permitted work be a liability? Though very rare someone getting caught for non permitted work can cost big $ Also permitted work is a selling point.

"All work done with permits.

Permits are signed off."

What about liability insurance? Does he have an existing policy?

I was part of a deal with two homes on one lot. About 140k below market.

Turns out back home was built without permit. Lost $ on the deal.

Without permits that project could have moved forward. Got renovated and then been told to tear it down or open her up for inspections.

I'd pass without inspections.

Id

@Joe Mazur Private lending is a great use of your money as long as you can 

1. know you will get the initial investment back (ideally with interest) and

2. you can still sleep at night if the money is lost and

3. its in alignment with where you want to be (financially, etc)

I have been doing private lending for about 4 yrs now, and wish I knew about it long ago. It doesn't generate as much ROI as actually owning, but private lending is another stream. Where Iam, I am taxed on the income/interest/profit as if it is income.

If you don't know this person, then I would suggest you take the time to know them. Go for a coffee, dinner, etc. Is this someone you want to work with? There are many people out there who will take your money! so find the right person to team up with. You can also ask them for their past portfolio, referrals, etc. You can do a search on their past properties to see their success rate on flips. You can also do a FB/linkedin/etc search on people. With everyone I lend $ to, I do a search on them. If I get any negative feeling from it, then I don't do it.  

The inspection (appraisal) thing is another matter. As part of your lending requirements, you can put that as a condition. 

Also treatment of 2nd MTGG in default differs depending on where you are. I would suggest you contact a lawyer in the state/province where the property is located and ask them. 

A few thoughts to consider, some already posted...

- a point (or 2) up front for the deal, in the deal

- 10-12.5% for 6 mo, 1/2 point for more time, say 60 days additional, plus the interest accrued

- stay below 65% ARV, with a complete, detailed estimate going in

- stay 5% below area comparables when determining a realistic ARV that WILL SELL!

- know your guy's track record, credit status, etc well before getting involved

- always be in first position on the title- have a title search done prior for liens, clouds; use a RE attorney to draw up the paperwork- heed his advice!

- make sure your guy has ample skin in the game, meaning, lots of his own cash to lose...

Suggest you do a few dry runs, get to know the process, develop a legal team (and mind-set if you have to foreclose), define potential pitfalls better before compromising on a nice chunk of six figure $$$. Consider a better rate of return for the risks involved

Full disclosure: I am a risk taker myself, but have learned (mostly) from my mistakes...

You shouldn’t just partner with someone just because “you can’t find” anywhere else for your money. It’s better to not be part of a bad deal and miss a few deals than to try and take everything that comes your way.

Without more backstory or how long you two known each other, it’s hard to say but my gut tells me to stay away from those kind of deals.

@Joe Mazur

Im seeing red flags off the bat. Having had experiences with flipping partners myself in the past.... a lot can go wrong. Doesn’t sound like your partner has much experience... and neither do you (i assume).

If it were me... I would not do this deal... PERIOD!

@Joe Mazur if you are unsure about the deal to the point that you are soliciting advice on an online forum, I think your gut is saying it’s a bad move, and you should trust your gut. At some point there will be a deal that will feel good and get you 15% on your money..hold out for that one



Hey Joe - a couple of great resources and people to ask on this topic would be Joe Fairless @Joe Fairless and Matt Faircloth @Matt Faircloth. They are experts on syndications. Both have books, podcasts and youtube videos on lending as a syndicator. As the others are saying, there seems to be too many red flags:

1. Why can't he qualify on his own?

2. The small cost of inspection will out way any potential major costs discovered

3. Your IRR seems really low - I've been reading and hearing 15 to 18% is more reasonable

4. What was the vetting results of this guy?

5. First position is vital

6. Contact some pros who are gracious to offer advice

All The Best!

@Joe Mazur if you are concerned about him not getting the property inspected, that same concern exists if your money is used to fund the project. It is honestly probably worse, because at least if you are partners, you can monitor the finances. You are in second position, which means if the project isn't finished, you are the one who loses your money. 

The 10% is an annual percentage rate, so if he borrows your money for one year, you get roughly $10,000. If he borrows your money for six months, you get $5000. You could invest that money in the stock market and probably get similar return with lower risk. Obviously depends on what you invest in, but if you pick stable companies at least you won't run the risk of loosing everything. If you like real estate I would consider REITS or even crowd funding options that probably go through better vetting.

For reference you can get over 2% in an FDIC insured savings account currently, so you have to consider how much the risk is really worth.

Without seeing the details on the deal and knowing the track record of the individual, it is hard to say if the deal itself is good. The fact that they want to skip a $300 inspection seems strange for sure. At least the inspection gives a third party opinion of the condition. Most flips fail because of major expenses that were overlooked (foundation, sewer, HVAC, electrical, etc).

@Joe Mazur we have worked with people in the same capacity as you are inquiring about here.  We use "private money" to fund our deals and pay 6-12% depending on the deal and the amount of the loan.  You as the lender would have what we call the core 3:

1.  Deed of Trust in your name - this is similar to a bank when they lend, it states that you must be paid off at sale of property.

2.  Promissory Note - We personally guarantee the loan in our names, and sometimes collateralize other property we own.

3.  Added to the Hazard Insurance Policy - this way if the property does burn down or something similar, we cannot take the insurance check and run.  


With these core 3 you are in a great position, mostly because we normally have a 30-65% equity position in the property.   Meaning that if the property is worth 100k, we would only ask for a loan of 50-70k depending on what we have it under contract for.  

If you are having trouble sourcing deals, this is a great avenue to have your money work for you and we believe is a solid hedge due to the fact it is a tangible investment, you can literally drive by and see where your money is parked.  


If you have any other questions, please feel free to reach out to me.

@Joe Mazur

Does he have a background in general contracting?
A home inspection is cheap for what it does and normally worth every penny.
The fact that he does not want to get a home inspection is a red flag.

yes, he may be able to save a couple of dollars by making an offer without a home inspection contingency...but hes doing the risk on your dollar.

Regarding the tax implications.
It would be considered interest income and subject to your marginal federal and state income tax rate.

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