Private money lending advice
Canoga Park, CA · Member since 2013 · 19 posts · 7 votes
Hi
I am considering loaning money in a situation where I would be getting 35-40% of the profit and also a preferred interest rate on my money. This would more so be a partner situation so not lending to strictly a borrower.
I would be funding the entire project which would come out to around $175k - $200k including purchase and repairs.
I have never lent private money before and would appreciate some advice from some of you guys out there with experience in this area.
Just want a quick explanation of the basic steps i should take in this process.
Ex.
1 Contracts/documentation to make sure is in place
2 How to be prepared legally
3 Best ways to make sure investment is protected
4 Making sure no one can run away with the money.
5 How ownership of property should be held
6 Dos donts etc
I have heard that securing your money with your name on the deed of trust isnt always good bc of certain risks.
Any advice much appreciated.
Thanks
I think if you are looking to be a passive investor you may want to talk to places like Iplan or Equity Trust or perhaps just deal with tax lien certificates. You have to know the property you are investing your money into. Investing in Real Estate if it from a Capital source or a developer is fine as long as you are prepared to do your due diligence. Read and more importantly understand everything. You are paying the attorney to also explain legal loopholes, in addition to contract verbiage. I would pull a title report on the property to see what is going on. I would run comps/ rental reports to make sure I could offset the investment. I would check to make sure the taxes were up to date, and I certainly would have something that has an acceleration clause.
You need to be the priority lien holder and do not subordinate under any circumstance and run it though a reputable title company to ensure clear title. You can use the title company to foreclose if your terms are not met.
Personally, if I were starting off brand new, I would open an WY LLC (Cheepest and easiest, pay a registered fee to have a local address) to give you an added layer of protection. Set it up with a SEP Ira contribution plan so that I could transfer 25% of whatever earned up to $51k into a Roth Ira, then invest out of there after creating a living trust. Create a joint venture within the trust to fund in the project so that this investor would put up the risk after being directly qualified with the peer to peer funding group so that I could utilize my own funds elsewhere. Take an interest profit as a hard money lender then take the joint profit on the sale without getting taxed.
That's just me...
I could help you more if you were in NC. Regarding your lack of lending experience... and in a foreign country like CA... I'll let the locals help. (I say 'foreign country' only because the laws are quite different there.) You probably need some qualified legal advice/help.
Maybe @Ann Bellamy can point you in a direction. It would seem to me that someone with no experience doing such a transaction would be better served finding a qualified broker to work with, or a real estate attorney. There's just to many things that can wrong, and things to cover. You also want to make sure that the deal can afford what you are charging.
First, find a California attorney well versed in private lending transactions, not just a good real estate attorney, and not an attorney who has represented institutional lenders in conventional residential closings. If you don't know any of these attorneys, call a few CA hard money lenders and find out who they use. Don't use just a real estate attorney, because lending laws can trip you up.
There are many ways to structure the transaction, but it all starts with a good attorney. And don't listen to most of us who are not in CA. CA is a world unto it's own, and like MA and NY, the rules and laws are very different.
If the attorney isn't well versed in the SAFE act, move on to the next one. Then, once that attorney has told you how to protect yourself, then worry about how to structure the deal. Brokers in CA seem to have different abilities and rights than they do in other states, so I'd talk to one of those too, but only one who works with private and hard money lenders, not just a conventional residential broker.
There are a number of private lenders here on the forums who are from CA, @Jeff S. and @Joffrey Long among them (I can't @mention Joffrey, I must not be colleagues, but you can send him a colleague request) Perhaps they can help with an attorney referral.
@Paul Altman I agree with all the posts above find great local legal advise in CA My only other concern is make sure it is a Great deal if it is your first time and if your not familiar with rehabbing then I suggest maybe you invest with a HML.
I think if you are looking to be a passive investor you may want to talk to places like Iplan or Equity Trust or perhaps just deal with tax lien certificates. You have to know the property you are investing your money into. Investing in Real Estate if it from a Capital source or a developer is fine as long as you are prepared to do your due diligence. Read and more importantly understand everything. You are paying the attorney to also explain legal loopholes, in addition to contract verbiage. I would pull a title report on the property to see what is going on. I would run comps/ rental reports to make sure I could offset the investment. I would check to make sure the taxes were up to date, and I certainly would have something that has an acceleration clause.
You need to be the priority lien holder and do not subordinate under any circumstance and run it though a reputable title company to ensure clear title. You can use the title company to foreclose if your terms are not met.
Personally, if I were starting off brand new, I would open an WY LLC (Cheepest and easiest, pay a registered fee to have a local address) to give you an added layer of protection. Set it up with a SEP Ira contribution plan so that I could transfer 25% of whatever earned up to $51k into a Roth Ira, then invest out of there after creating a living trust. Create a joint venture within the trust to fund in the project so that this investor would put up the risk after being directly qualified with the peer to peer funding group so that I could utilize my own funds elsewhere. Take an interest profit as a hard money lender then take the joint profit on the sale without getting taxed.
That's just me...
@Faith Brashear @Ann Bellamy @Karen Margrave
Thanks to you all for the advice. I have talked with real estate attorneys but havent gotten to much in the way of detailed advice and how to draw up agreements etc so will take your advice of trying to find one familiar with private lending.
I will definitely make sure I am in first position on the deed but do you see anything wrong with having the deed in my name but placing the property into the other investors LLC that i am not an owner on?
Yes, I would not do this unless you had a partnership agreement between your LLC's.
Simple verbiage - Not an attorney - but something like this to CYA (assets)
Real Estate Partnership Agreement
THIS REAL ESTATE PARTNERSHIP AGREEMENT is made and entered into this___________
day of ___________________, 20 ________, by and between, ______________ whose address is
_____________________________________________(hereinafter referred to as the “First Party”),
and _________________________, whose address is ___________________________________
(hereinafter referred to as the “Second Party”), and hereinafter collectively referred to as the “Parties”.
WITNESSETH:
WHEREAS, the FIRST PARTY has investment capital available for contribution to a business
enterprise; and
WHEREAS, the Second Party has the ability to locate, purchase, renovate, market and sell real
estate; and
WHEREAS, each of the parties desires to own a one-half (1/2) undivided interest in the subject
property described below and the parties have agreed to limitations upon the right and power to
transfer their undivided interests and have also agreed upon the payment of expenses, delegation of
responsibility, and distribution of profits and/or losses incurred with reference to the property;
and
WHEREAS, it is the desire of the Parties to define and set out their relationship in writing and the
circumstances under which they are operating, as of the date of this Agreement.
NOW, THEREFORE, in consideration of the mutual covenants hereinafter contained, the Parties
agree as follows:
1. PRIOR AGREEMENT. It is the intention of the Parties that this Agreement replace all written
and/or oral agreements, understandings, and business ventures, previously, or otherwise, existing
between the Parties.
2. FORMATION. The Parties hereby create a Real Estate Partnership Agreement pursuant to the
laws of the State of ______________. Said “partnership” in any real estate purchased by the parties
shall be defined solely by this Agreement, regardless of the manner in which title to property may be
taken.
3. PURPOSE. The purpose of the partnership is to purchase the house located at________________
_________________________________, for the purpose of repairing, renovating and selling it as
expeditiously as possible, and to carry on any and all such other activities as may be necessary to
accomplish the above described purpose of the partnership. Each partner represents and warrants
that he/she is acquiring interest in the partnership for his/her own account, for investment, and not
with a view to the sale or distribution thereof.
4. TERM. The partnership shall commence as of the date of this Agreement and shall continue
until terminated by an agreement of the Parties, or when monies are distributed per this
Agreement subsequent to closing the sale of the subject property, whichever shall occur first, by
applicable law for the State of ____________________, or by bankruptcy, retirement, or
withdrawal of one of the parties.
5. CONTRIBUTION OF CAPITAL.
(a) First Party. The First Party shall contribute all money needed to purchase, repair, maintain,
advertise, market and any other expenses, as well as any mortgage payments that become due
during the period of ownership of the subject property as well as qualifying for any financing. First
Party’s contribution shall not begin until closing the purchase of the subject property following receipt
by First Party of all supporting and necessary documents as required pursuant to Paragraph 21
herein.
(b) Second Party. The Second Party shall contribute the cost of any earnest money deposit, appraisal
and other expenses, not related to financing, prior to closing the purchase of the subject property.
These expenses will be reimbursed by the First Party at closing.
6. LIABILITY OF THE PARTIES. During the existence of the partnership, neither party shall be liable
for any obligations of the other party created without the express approval of both parties. The Parties
shall share equally in any and all profits and losses of the business of the partnership.
7. REPRESENTATIONS AND WARRANTIES OF THE PARTIES. The Parties represent and warrant
that there are no suits, judgments, or liens, of any kind, pending or filed against him/her, whether
individually or in conjunction with any person or entity, in any jurisdiction whatsoever.
8. NATURE OF PERFORMANCE. During the existence of the partnership, the partners shall be
solely responsible for performing the following duties:
(a) First Party shall contribute all money needed to purchase, repair, maintain, advertise, market and
any other expenses, as well as any mortgage payments that become due during the period of
ownership of the subject property as well as qualifying for any necessary financing.
(b) The Second Party shall be solely responsible for the day to day management, maintenance
renovation & marketing of the subject property for resale, thereby protecting the investment of the
parties. The Second Party may, at his sole option and expense, make alterations and improvements
to the property, as in his discretion, are necessary and advisable.
9. PARTNERSHIP DECISIONS. All decisions, including, but not limited to, purchase of assets by the
partnership, any loan or other obligation to be undertaken by the partnership, shall require the
approval of all the Partners. Any decision to sell the subject property shall be made by both parties
upon such price and terms as they may agree.
10. CONFLICT RESOLUTION. At the request of either party, any disputes or conflicts between the
parties may be resolved by arbitration. A mutually agreed upon arbitrator, who is experienced in real
estate, shall be chosen by the parties. Any decision rendered by the arbitrator shall be non-binding on
the parties. The cost of arbitration shall be borne equally by the parties in dispute.
11. MARKETING PLAN. At a time to be determined by the parties, the subject property shall be
marketed for re-sale. The initial asking price shall be $__________. The parties will/will not retain the
services of a real estate broker to market the subject property. The terms of this provision may be
amended by mutual consent of the parties.
12. DISTRIBUTIONS
(a) Subsequent to the sale of the subject property, any proceeds will first be used to reimburse all
cash advances by both parties; second, toward paying off any existing loans on the property; and
lastly towards profits. First Party shall provide to Second Party a closing statement and an accounting
of any and all expenses incurred by First Party and detailing how the new profit figure is obtained and
distributed. After both parties have been repaid for all expenses incurred, and loans repaid, as
described above then any remaining money will be distributed equally (50/50) between the parties.
Any finders fee paid to the Second Party will not be reimbursed to the First Party as closing, but will
be considered as if it were a part of the purchase price of the property.
(b) Any income generated from the subject property prior to sale ( rents [net after mortgage
payment and other expenses are paid], option consideration, unreturned security deposits, etc.)
shall be applied first to reimburse any cash advances made by Both Parties; second, toward paying
off any existing loans on the property; and lastly, towards profits to be distributed pursuant to
the terms of 12 (a) above.
(c) A finders fee of $ __________ may be collected at closing by the second party for locating and
securing the contract to purchase property.
13. DEATH OF PARTNER. Except as provided in this paragraph, each of the parties will not dispose,
i.e., transfer, devise, convey, lease, mortgage, or otherwise encumber his undivided interest in the
subject property without the written consent of the other party.
(a) The death of a Partner shall not act to terminate the Partnership. The estate of the decreased
partner shall continue to be considered a partner hereunder and shall share in any profits and/or
losses, However, notwithstanding any transfer to a related individual, the Transferee shall not have
any rights in and to the property except through the transfer or party. For purposes of this Agreement,
the term “related party” shall mean parents, brothers, sisters, spouses, lineal descendants, spouses
of lineal descendants, trustees for the benefit of any such person or entity, and corporations owned
or controlled by any of the foregoing. Approval of any transfer of interest by a related individual
shall be required to be in writing by the surviving partner.
14. PARTITION. Each of the Parties irrevocably waives any and all right that he may have to maintain
any action for partition with respect to hid undivided interest in the property or to compel any
sale of the property under any law now existing or hereafter enacted.
15. MORTGAGES. The First Party shall, during the term of this Agreement, make all monthly principal
and interest payments due under the promissory note(s) and mortgage(s) described hereinabove.
Any decision to further encumber the property shall be made by both parties, upon such
terms as the parties hereto may agree.
16. TAXES. The First Party shall, during the term of this Agreement, pay all real property taxes on
the property. The First Party shall pay all personal property taxes, if any, on property.
17. INSURANCE. The Second Party shall, during the term of this Agreement, obtain and maintain a
policy of insurance on the premises in an amount equal to its Fair Market Value. Any sums made
payable under said policy of insurance shall be used exclusively to replace or repair the damage or
theft for which said sums are paid unless the parties agree otherwise in writing.
18. VACANCY. The subject property shall remain vacant at all times during the term of this
Agreement unless otherwise agreed to by First Party in writing.
19. TITLE TO SUBJECT PROPERTY. As the First Party shall be taking the greater financial risk in
the venture anticipated and to be undertaken as a result of this Agreement, First Party shall hold title
to the subject property in trust. First Party shall be the sole beneficiary of said trust and shall retain
full and absolute control over the legal ownership to the subject property.
Second Party understands and agrees to the terms of the paragraph above in view of the fact that
Second Party has made little or no financial contribution to the venture anticipated and to be
undertaken as a result of this Agreement.
20. CHOICE OF TRUSTEE. The First Party shall have sole responsibility for choosing and
designating a trustee to take title to the subject property. First Party has chosen
_________________________ as Trustee and he shall act on the behalf of First Party at all times
under the terms of this Agreement.
21. SECOND PARTY’S DUTIES AND RESPONSIBILITIES. Subject to the conditions and limitations
but without limitation otherwise set forth herein and to the requirements of any law or administrative
enactment applicable hereto, Second party shall:
A) Prior to Purchase:
(a) Provide First Party with a copy of a purchase contract for the subject property signed by Second
Party. Said purchase contract may include a clause requiring the approval of the First Party within five
(5) days of execution by the Seller.
(b) Obtain an appraisal on the subject property by HUD approved appraiser. In special circumstances
when an appraisal is not possible, the First Party may accept other substitute value confirmations at
his option.
(c) Obtain competing bids, when necessary, to assure a fair price, from contractors and repairmen for
repairs and renovations to be completed on the subject property. Said bids and/or estimates
shall be provided to and approved by the First Party.
(d) Call the Building Department for Code violations on the property.
(e) Obtain termite report.
B) After Purchase:
(f) Review and research the references, credentials and licenses, if applicable, if any contractor
or repairmen which are chosen to perform repairs and renovations on the subject property.
(g) Negotiate and contract, on behalf of the First Party, with contractors and repairmen to provide
services and supervise said contractors and repairmen and their work at subject property. Funds
are to be allocated to the Contractor on a percentage of completion basis as deemed necessary
with any initial percentage payment exceeding 25% to be approved by First Party in writing.
(h) Purchase or cause to be purchased all materials, supplies and equipment as needed for the
proper maintenance, repair, renovation and operation of the subject property in a cost effective
manner.
(i) Endeavor to keep monthly expenditures at a minimum by pursuing effective methods and
procedures of cost reduction and control and advise First Party on cost saving initiatives.
(j) Obtain any and all necessary lien releases from contractors and repairmen for payments made for
work performed on the subject property.
(k) Routinely and regularly inspect the subject property and make recommendations to First Party
regarding the management, repair and marketing of the subject property.
(l) Communicate with the First Party on not less a bi-monthly basis and with reasonable promptness
otherwise to assure that the objectives and purpose of this Agreement are carried out in the
most effective and expeditious manner possible.
(m) Cause to be kept books of account in which shall be entered fully and accurately each and every
transaction of the partnership.
(n) Market the property under terms and conditions agreed upon by both parties. If no bonafide buyer
has been contracted to purchase within 120 days of the date of the property acquisition, a Realtor will
be hired by the Second Party. If a commission is paid to a Realtor it will be deducted from the Second
Parties proceeds at closing since marketing is a responsibility of the Second Party.
22. DEFAULT OF THE SECOND PARTY. In the event litigation results from or arises out of this
Agreement or the performance thereof due to the action, inaction or default of Second party, Second
Party agrees that the First Party’s costs and reasonable attorneys fees may be deducted, at First
Party’s Option, from any profits due to the Second Party hereunder.
23. INCOME TAXES. Each partner shall be liable for any tax consequences created by the sale of
the subject property based on hi/her percentage split of the profits/losses distributed to him/her.
24. WITHDRAWAL OF PARTNER. In the event the Second Party is unable or unwilling to continue
as a partner of the First Party or decides to withdraw from the Partnership for whatever reason, the
following shall apply:
(a) Any substitute partner must be agreed to in writing by the First Party.
(b) Second Party will receive none of the profits upon the sale of the subject property unless
otherwise agreed to the First Party in writing.
(c) Second Party shall be reimbursed for any expenses incurred as a partner hereunder only upon the
sale of the subject property and only if it is determined that a profit has been generated by said sale.
25. MISCELLANEOUS PROVISIONS
(a) This Agreement supersede any and all prior agreements of the Parties, whether oral or written.
(b) The Parties agree to execute any and all documents necessary to carry out the terms and intent of
this Agreement.
(c) Section headings contained in this Agreement are included for convenience only and form no part
of the agreement between the Parties.
(d) If any provision of this Agreement is or becomes invalid, illegal, or unenforceable in any
jurisdiction, such provision shall be deemed amended to conform to applicable laws so as to be
valid and enforceable or, if it cannot be so amended without enforceable or, if it cannot be so
amended without materially altering the intention of the Parties, it shall be stricken and the remainder
of this Agreement shall remain in full force and effect.
(e) Unless specifically disallowed by law, should litigation arise hereunder, service of process
therefore may be obtained through certified mail, return receipt requested, the Parties hereto waiving
any and all rights they may have to object to the method by which service was perfected.
(f) No waiver of any right under this Agreement shall be deemed effective unless contained in a
writing signed by the parties charged with such waiver, and no waiver of any right arising from any
breach or failure to perform shall be deemed to be a waiver of any failure such any right or any other
right arising under this Agreement.
(g) This instrument contains the entire agreement of the Partners with respect to the subject matter
hereof, and the terms and conditions thereof may not be further modified except by a writing signed
by all the Partners. This instrument shall be under no circumstances be recorded.
(h) This agreement, and all transactions contemplated hereby, shall be governed by, construed and
enforced in accordance with the laws of the State of ______. The Parties herein waive trial by jury
and agree to submit to the personal jurisdiction and venue of a court of subject matter jurisdiction
located in____________ County, State of _______. In the event that litigation results from or arises
out of this Agreement or the performance thereof, the Parties agree to reimburse the prevailing
party’s reasonable attorney’s fees, court costs, and all other expenses, whether or not taxable by the
court as costs, in addition to any other relief to which the prevailing party may be entitled.
(i) This Agreement shall be binding upon, and shall inure to the benefit of the Parties hereto, their
respective heirs, successors, and assigns, as the case may be.
IN WITNESS WHEREOF, the Partners have executed this
instrument this ___________________ day of ____________________, 20_______.
Signed, sealed and delivered in the presence of:
___________________________________ _________________________________
Witness “FIRST PARTY”
___________________________________ _________________________________
Witness “SECOND PARTY”
Regarding "I will definitely make sure I am in first position on the deed but do you see anything wrong with having the deed in my name but placing the property into the other investors LLC that i am not an owner on?"
Only in California.... sounds foreign to me.
Please see an attorney, and do not try this on your own.
I have to seconds Karen's advice to find an attorney. California is entirely different from the rest of the country in regards to lending. I have not checked for about two years, but CA has had a 10% usury limit, unless you are a regulated lender under the state DRE.
I think you would be better off forming an LLC (with you having a majority interest to control the property) or a Joint Venture (again with you in control of the property) compared to a Note and Mortgage. Either form can dictate all of the details including rates of return or profit splits and could avoid time consuming and expensive foreclosure action if the deal does not work out. Establish a time frame for either scenario under which you have rights to take over disposition of the property. I am not an attorney or CPA. In either scenario you want an experienced attorney and tell your rehab partner those legal fees are part of the transaction to be paid upfront or repaid upon sale of the property.
Thanks to you all for the advice. I have talked with real estate attorneys but havent gotten to much in the way of detailed advice and how to draw up agreements etc so will take your advice of trying to find one familiar with private lending.
I will definitely make sure I am in first position on the deed but do you see anything wrong with having the deed in my name but placing the property into the other investors LLC that i am not an owner on?
Paul, first, if you are trying to get attorneys to give you advice about drawing up agreements on your own, you won't get very far. That's like asking a real estate agent how to sell your house without using a real estate agent.
Second, we can't say this often enough or strongly enough. Don't do this on your own. Find an attorney who really knows about private lending and don't try to save a buck by doing it yourself. You could cost yourself way more than you save.
Third, your second paragraph above doesn't quite make sense:
"I will definitely make sure I am in first position on the deed but do you see anything wrong with having the deed in my name but placing the property into the other investors LLC that i am not an owner on?"
Perhaps you mean first position on the deed of trust, as opposed to first position on the deed. Also, if the deed is in your name, you are not placing the property into another investor's LLC, you own it in your name. If you place the property into the other investor's LLC, you are not on the deed, unless you are one of the owners of the LLC.
Given the complexity of CA lending laws, I suggest you discuss this with a lending attorney before deciding how to structure, since usury laws will play into your decision. It sounds like the simplest would be to form a new LLC with you having a percentage ownership equivalent to the percent of profits you are getting, and also recording a deed of trust for the amount of the funds you are investing and getting a preferred interest rate on. But don't listen to me, find a good attorney and discuss with him, because I know nothing about CA law.
@Paul Altman Ann is right, do not do this on your own. We have 30 years experience in real estate development, and have used conventional, private and hard money many times over the years. We are licensed real estate brokers. However; we would never attempt to draw up a financing agreement on our own. In fact, we use a mortgage broker. If we didn't do that, we most certainly would use an attorney. Though we are very experienced and have read many lending documents, it's not our area of expertise, and missing something can mean losing big money. Why risk it?
In your case, it's not borrowing, but lending money. Disbursing the funds for rehab, etc. How would money be paid out? What inspections would be required? Do you know whether or not he numbers being given for rehab are actually enough to do the work necessary? What is the experience of the borrower? What are you basing the value of the property on? There's just so many things you need to look at.
Paul, You are getting great advice.
My 2 cents is that in the future, I would ask for more % of the profit. I would never accept less than 60% and have gotten 75% for putting up 100% of the cash. IMO you are accepting too much risk for the return. I wonder if your partner has possibly exaggerated the potential profits of the deal to make you comfortable with less %. Unless your partner is very experienced at this business, he more than likely has underestimated the costs and underestimated holding time. I don't know anything about your deal but it sounds like a fix and flip. Margins on those (esp in California) have tended to get quite tight in the past year.
Think in terms of other types of investments. The active manager never gets more than about 25% in any hedge fund or REIT or mutual fund or oil and gas partnership. The passive investor gets 75%-95%.
If you hired a licensed general contractor to manage the entire rehab process it would only cost you approx 15% of the construction cost. Why is your guy worth 60% of the profits, cause he found the property?
Why should REI be different than other types of investments? And those are professional managers, I would bet since you are putting up all the cash your partner is relatively a newbie.
I never understood why JV deals discussed on BP are commonly expected to be 50/50 deals. That is not what I have found to be "the market" in my experience.
@Eric M. - your comments make a lot of sense, and the analogies are reasonable to a point. However, there are hard money lenders in my area that will lend up to 100%, and the interest/points on a well-executed rehab typically amount to 30-40% of the profits, so well-skewed in favor of the rehabber. Now I know that the lender gets paid first, and is in a stronger position than an equity partner.
But still, why would a rehabber want to work with a money partner taking 60-70% of profits if they can get essentially the same financing from a HML that will only cost them 30-40%? I'm working on a deal as the lender right now that is basically a 50/50 deal, using a profit-sharing mortgage, with no guaranty of anything to myself. However, I would only work with an experienced rehabber on such a deal. This seems to be what the market will bear in my area.
I think you’re over-complicating things, Paul, and you appear way over your head. If you’re funding the entire project, 100% including the repairs, why don’t you just buy it in your name, or that of an entity you control, and have a partnership agreement with your rehabber? You’d maintain control and could bring in someone else if the relationship soured. At no time would you give up your equity.
Instead of a convoluted 35-40% profit spilt with a preferred return (c’mon Paul, do you even know what that is? Yikes!!!) you could just split the profits 50/50 and keep it simple. There would be no loan here, since you would control all the funds -- just a partnership agreement a good RE attorney could help you with as well as a CPA.
On the other hand, you could loan the money, but I strongly suggest you keep it a straight interest only loan, forget about all the complicated financing and profit sharing, and don't loan 100%. You could loan using a 1st trust deed for the purchase and a 2nd TD for the rehab. You would disburse the 2nd as work progressed using funds control. A broker like @Joffrey Long (I must not be a colleague either) could help but you would need a lending attorney if you complicated his standard paperwork. Either way, you’ll likely need a broker to originate the loan and work with title and escrow for you (welcome to CA).
Many options here, but if the previous paragraph reads like Latin, then just buy the property on your own and partner with a rehabber to do the work 50/50, after you arranged this with an attorney and a CPA.
Jeff
I know lenders that do a deed in lieu ahead of the deal as a back up to avoid having to take the property via the courts or trustees. Also if the property is bought by an LLC, you can be named on that or they can transfer the LLC to you to also avoid a foreclosure and you can take the property that way.
@David Beard I agree with you. When lenders/partners get so greedy and demand such a high return, they make it impossible to have a project executed successfully. @Paul Altman not only wanted a percentage of the project, but interest on the loan too. Why would a rehabber, builder, or anyone else agree to such terms? Those little deals don't have enough profits in them for the return that Paul and Eric want to extract.
I agree with @Jeff S. you are overcomplicating things. Simple is better in this case. I can't give you legal advice but I can steer you in the right direction.
Don't be a solo investor, get out there and meet good folks & compare notes.
On line info here in BP is a great start but it has it's limits. I see too many newbies trying to get free advice here that will hit a wall. This is serious money & serious business folks.
I am thinking I should have private lending as a topic at one of the FIBI groups. I had to rescue a newbie lender last month who really made some huge errors in documentation.
I agree with comments above.
The only thing I might add is to take a look at the expected profit margins on the deal. Many times the interest and fees generated from a simple 1st position loan at 100% of the purchase price will amount to roughly 50% of the profits anyway, with no need for partnerships and complicated agreements.
@Ellis San Jose - that would be a terrific topic. Just in the past couple of days on this forum, highly experienced people have advocated different approaches to a 50/50 profit sharing deal, one sayin that the 100% money partner should be on title, the other other saying absolutely not, you don't want the liability for the property during the deal, just use a profit-sharing mortgage.
I was just talking with a pair of investors who did a 50/50 deal with a 100% financial backer to buy a distressed 24-unit apartment property. They worked their tails off for months rehabbing, throwing out druggy tenants, and filling it with upstanding citizens. They are splitting profits and equity 50/50 in an LLC with the money guy. Then the money guy gets a mortgage on the property, with him acting as sole guarantor, recovering all of his investment. Well, they are splitting profits computed after the mortgage interest is paid, as stated in the operating agreement. They feel like they'd working their tails off for a modest amount of monthly cash flow (though they do own half of the equity that was created, which totaled $350k or so), while he gets $2,500/mth or so with a zero net investment (now I know his credit and finances are on the line for the note, but this is their perspective).
So these deals where there is a multi-year (or indefinite) time horizon, particularly when a lot of equity is created and no defined end game, are just rife for unhappy participants.
@David Beard great points.
Private Lending & Deal Structuring.
I am putting on the calendar for 2014 FIBI meeting topics. I will invite legal & tax professionals as well.
I expect it will be a well attended.
Learning about proper deal structuring has been an expensive lesson for me. I wish I was aware of all the tools available to structure a deal back then. I suspect it will be an expensive lesson for others if they don't take the time to get educated & consult with legal & tax professionals.
Agreed, investors seem to take a very casual approach to partnerships and lending arrangements. I'm not real familiar with Cali, but the difference mentioned seem to be more to who can do what rather than what can be agreed to as that is usually a very well defined arena nationally as in keeping with interstate commerce.
The agreement posted is nice showing what may be included, there are many more issues, off hand 14. was not something I'd ever agree to unless I was married to her (LOL). There are procedures for the disposal of contested sales.
While partners can be jointly liable for debts, it should take agreement to create an obligation not just any obligation created by one party, at least to a limited amount.
Profit sharing mortgage arrangements, I'd just guess are 90% of the time will have significant issues, you're either a lender or a partner and you should avoid trying to cross over. Most small operator lenders are probably stepping all over it. Just one issue, is profits paid as a condition of a loan is a cost and if yuou have usury laws, the probably sailed way over the limitations.
The comment of lending with a pre arranged quit claim deed is a big no-no, that deed is worthless and ineffective. Deeds are effective when executed not filed and it also circumvents foreclosure statutes.
I'd say if you have the opportunity to attend a good seminar on entities given by attorneys and accountants it would be a good thing to listen to, they usually are not guru promotions (usually). :)
@Ann Bellamy : Thanks for your response. I am definitely not attempting to draw up my own agreements, I will be getting an attorney to do that. I have just been talking to a couple different attorney to see who seems to be the most qualified on private lending matters and havent gotten detailed responses from them so am still searching for one that I'm convinced is the right one to do so.
@Eric Michaels : One thing I have been confused about in lending on the real estate projects is that I know that many passive investors will simply lend money to rehabbers for smaller 10%-12% interest rate (which isnt small at all when compared to what you make on your money from many other investments). I know in a lot of these cases they arent funding 100% of the deal but they are still most of the time risking a considerable amount of money so I dont understand why those investments exist and then in other situations its not acceptable to not get at least 50% profit on the entire deal.
I dont really see a fair comparison between a one time real estate deal against hedge fund managers making no more than 25%, they are making 25% of a substantially larger amount of money when compared to the profit of lets say $50K from a one time deal with a lender on a rehab. I dont think a lot of rehabbers would find it even worth their time for such small profit ownership especially to the maximum of a 95% cut to the lender that you mentioned. If we are comparing a small real estate lending deal to larger scale real life investments then why dont conventional banks charge more to borrowers than what they do (4%-7%).
Im my case the other party in the deal finds the deals, manages and markets the project.
@Jeff S I figured that having an interest rate that the other party is responsible for paying over time as long as the money is still out there will keep them motivated to complete the job as fast as possible knowing they have that financial obligation and money they lose out on the longer they take to complete the project. That would be my reasoning for not just doing a straight up profit split bc there isnt as much of a sense of urgency.
@Karen Margrave Actually my numbers agree with what you are saying and side more so with @David Beard . Yes I am asking for a rate and profit split but it would still most likely work out to be at or less than 50%. You are right I dont think I would ever agree to a %25 profit split as a rehabber unless the potential profit was very large considering that your profit on a smaller deal could easily be eaten up by unforeseen surprise fixes.
Thanks for all your advice. Good to hear your feedback.
"@Eric Michaels : One thing I have been confused about … is that I know that many passive investors will simply lend money to rehabbers for smaller 10%-12% interest rate…. I dont understand why those investments exist and then in other situations its not acceptable to not get at least 50% profit on the entire deal."
I don’t think you understand the risks involved, Paul, nor the time.
Assuming you loan using sensible numbers (low LTV, high ARV relative to the project cost, etc.), are secured by a first trust deed, and your rehabber knows what he or she is doing, your likelihood of earning all points and interest (i.e. getting paid back) is extremely high. If things go bad, the chance of at least getting your principal back in a foreclosure is also very high. In sum, these are relatively safe investments.
If it’s important to you, your time investment per loan will likely be measured in a handful of hours; like much less than 10. That is, these are very efficient investments.
You don’t have to loan at 10-12% “smaller money.” Prevailing rates in L.A. are substantially higher. With all due respect, Paul, it appears you're greedy.
Once you become an equity partner, you risk not making anything or even losing; as happens to some deals. You also have to tighten your controls to ensure you always know where the money is going. In addition, you will spend a lot more time on each project, following-up on construction and reviewing accounting. Your liability is also greater. I’d only do this with someone who started as a borrower and only after many successful deals with him. Yes, you will make more money here.
"@Jeff S I figured that having an interest rate that the other party is responsible for paying over time as long as the money is still out there will keep them motivated to complete the job as fast as possible knowing they have that financial obligation and money they lose out on the longer they take to complete the project."
The more you contribute, which means the less your partner borrows, the less will be his urgency to complete and the more will be his resentment toward the payments. Taking a large cut of the profits, and charging your partner a nominal amount each month on top, is not the same as him being on the hook for a 100% loan with the opportunity to earn all the profit. I’m not suggesting a 100% loan. Nor am I suggesting you try to figure out what motivates anyone.
Jeff