Should I Invest With A Friend?

Question

Hey guys, first post TIA :)

So one of my friends from HS who I've kept in touch with but am not great friends with invests in real estate (flips, rentals, etc) and he is looking for investors.  To get started with him, I would loan him $25k and get a 7.5% return.  Looks like I'd get interest payments monthly and principal returned after one year.  So basically I'd be just personally loaning him money that he would use it to invest/work his real estate magic.  What's the term for this (me loaning money to someone in this manner)?

He's had some success over the past couple years but is just starting out and I would be one of his first investors.  I own a property in northern CA that I'm renting out but he is investing out of state.  So what do you guys think?  Good idea/bad idea?

My thoughts:

1.  I want to get more involved in real estate investing (not sure how active/passive though) so 25k seems like a reasonable starting point.  Not chump change but also not really something I would kill myself over if things went awry.

2.  He is personally guaranteeing the loan - whatever that means.  Should I ask for any proof of net worth or what?

3.  Gut instinct = good investment.

Arlen Chou · Answer

As John D Rockerfeller had once said:

"A friendship founded on business is better than a business founded on friendship".

Take it for what it is worth, but I NEVER do business with friends or family, even if it looks like a killer deal, unless I am willing to write off the money as a 100% loss.

Good luck,

-Arlen

Peter MacKercher · Answer

My point is that you don't have anything securing the loan. And 7.5 % is not great. If he has great credit and net worth why doesn't he just get a loan from the bank at about the same interest rate.

If i were you i would not do it.

Account Closed · Answer

sorry I got distracted and missed the 1 year return of principaL.  And I forgot to say...Welcome to BP!

Account Closed · Answer

Well....I think following your gut is a wise idea....however, 7.5% seems very low.  That's about 15yrs to double your money.   And there isn't any equity building, other than the friendship.  I would avoid any situation where a business decision becomes a personal decision.  If you do invest with him I think you will be better off considering it a gift.  Investment real estate can produce 7.5% plus 10 or even 20% more while simultaneously providing an appreciating asset!  The game of investment real estate is to make money along the way to the big return you get when you sell the asset.  Maybe he already knows this?

Account Closed · Answer

@Jerry George  If you want to just give 25k to someone that is not even a close friend, for a non-specific purpose...go ahead.  I wouldn't do it.

There are better ways to invest...

Jerry George · Answer

I'm not buying anything though, I'm really just investing in his company (him really) and he will go out and use the cash as he sees fit.  I have no say in what gets bought, what he does with the money, etc.  I think you may be referring to a situation in which someone is directly investing with you in a specific property.

I definitely understand the type of return RE can generate but that would be on more specific equity tie-in type deals right?  For ex, if he had a property at 100k and needed two investors to chip in 50k, then I would expect more than if I were to just loan him 50k and he buys whatever prop. he chooses.  I'm new to this obviously so correct me if I'm wrong (although I do own a rental property here in CA that is providing a nice COC return - bought at a great time/great deal).

What exactly is the risk though?  He is willing to show me his bank statements/Net worth and I've seen his credit score (very high) so if all his properties go bust, wouldn't I have a recourse to sue him and get my money back?  I don't see a scenario in which he could go absolutely bankrupt but obviously there's some risk of that.

I'm basically just trying to assess the risk and determine if the reward is worth it or not.  I know that the risk free ROR is around 1% on a similar timed investment so I'm going from there.  7.5-10% seems pretty reasonable for the risk, maybe I'm missing something?

Peter MacKercher · Answer

You can buy out of state and get 15+%  I'm doing a few deals for a client right now with him getting 18% COC rate of return after all expenses.

Bill Wallace · Answer

Personally, there's no way I'd do that. Too much risk with a newer investor on both your parts. He doesn't have a track record and you don't have experience with this kind of transaction.

If you do want to move ahead anyway I'd want documents showing past deal successes and something showing how he's guaranteeing the loan.

Should I Invest With A Friend?

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