How do you structure your private lender contracts???

13 Replies

Good Morning,

My company has a couple potential private lenders who are interested in lending to us for the purchase of a distressed residential property. My company will serve as the Gc over the project once complete, we will sell the property retail. We've been doing this for a few yrs but all for out of state investors with no shot at equity.  Although these people are my family or a close acquaintance so for our peace of mind and legal reasons of course I want to have an operating agreement of some sort in place... 

I've worked consistently with an uncle of mine who trusted me enough to do two deals and we just did business with a handshake, he got is original investment as well as the return we discussed... I know that I'd go to hell and back to repay my investors but in business its naive to just give a good word because someone knows you...

Anyhow any words of advice on drafting an operating agreement or an attorney reccomendation would be greatly appreciated! Also one lender is borrowing from his retirement if this adds a level of complication to this please advise.

I like your attitude! And yes, a formal agreement needs to be made, especially with family.

First, you need to speak to your tax adviser, as a member managed and manager managed LLC has different tax consequences.

Voting, liquidation, liability can be based on contributions to capital if not addressed to the contrary in your OA. 

Understand events of withdrawing members, different members can move in or out depending on the deal or business need. You can also have different classes of members, much like preferred and common stock and as to voting rights. 

I like, as the money guy or not, using an LLC rather than being a lender, there are advantages and disadvantages to both, your attorney can guide you.

You need to read your state LLC law and look to the default provisions, things that operate by law unless otherwise stated, it generally better to otherwise state such matters, when and how a member might be treated for tax purposes, liability, creating debt, inheritance and other aspects.

Best advice from me is plan ahead, map out what you might do and cover it in the beginning so you aren't having to revise articles and see your accountant and attorney. :)   

Medium logoscopiccroppedblue2Bill Gulley, General Real Estate Academy | https://generalrealestateacademy.com

Are you planning on doing equity split with the investor, (more complex) or borrow at a fixed interest rate. We do most of our rehabs with private money, in the beginning we did a lot of profit splits, today we don't do that anymore. Fixed interest rates rather than ewuity sharing really simplifies the paperwork. 

Typically the property is titled to us and the private lender holds a mortgage and a promissory note and is added as an aditionial insured (very similar to the documents a bank would require).

We have a couple people that invest via their sdira, we close with a title company, they make sure all the required paperwork is in order. 

Dell Schlabach, BenchMark Properties | 3304326927

Private money is the way to go but I would be careful borrowing money from family. If things go south, hopefully you have other assets to pay them back. In my experience, they still will not be happy even when you pay them back. If working with family is the only option, it might be better to do a partnership structured in an LLC where they know they are actively taking a risk.

Also, make sure you know you are doing. In real estate, what you don't know tends to cost you money.

Originally posted by @Bill Gulley :

I like your attitude! And yes, a formal agreement needs to be made, especially with family.

First, you need to speak to your tax adviser, as a member managed and manager managed LLC has different tax consequences.

Voting, liquidation, liability can be based on contributions to capital if not addressed to the contrary in your OA. 

Understand events of withdrawing members, different members can move in or out depending on the deal or business need. You can also have different classes of members, much like preferred and common stock and as to voting rights. 

I like, as the money guy or not, using an LLC rather than being a lender, there are advantages and disadvantages to both, your attorney can guide you.

You need to read your state LLC law and look to the default provisions, things that operate by law unless otherwise stated, it generally better to otherwise state such matters, when and how a member might be treated for tax purposes, liability, creating debt, inheritance and other aspects.

Best advice from me is plan ahead, map out what you might do and cover it in the beginning so you aren't having to revise articles and see your accountant and attorney. :)   

Thanks and Great response! I think I'll end up filing an LLC, Here in Cleveland Ohio Most of the homes we are purchasing have less than 80k purchase and rehab costs from start to finish so only one investor per deal is typical here. Most likely will be a two member LLC.

I'll Let my CPA make the final call on whats best as far as the tax implications for my company, although I believe any net profits would just be considered a capital gain taxed at 35-40% or so unless I reinvest the profits into Real Estate...

Originally posted by @Charlie Fitzgerald :

I'd spend the money to have a RE Attorney set this up for you correctly to protect all parties.

 Exactly what Ive decided to do! Its not expensive but could be very expensive without it...  Thanks for your reply!

Originally posted by @Ryland Taniguchi :

Private money is the way to go but I would be careful borrowing money from family. If things go south, hopefully you have other assets to pay them back. In my experience, they still will not be happy even when you pay them back. If working with family is the only option, it might be better to do a partnership structured in an LLC where they know they are actively taking a risk.

Also, make sure you know you are doing. In real estate, what you don't know tends to cost you money.

 Thanks for your response... Using a private money lender with an actual operating agreement in place is the only uncharted territory thus far, hence my inquiry into how other bp members have gone about this in their businesses. We've been actively rehabbing homes in my area for the past  years and we have our costs under control better than the average company here. There inst much that can surprise me with homes in my area.

Originally posted by @Dell Schlabach :

Are you planning on doing equity split with the investor, (more complex) or borrow at a fixed interest rate. We do most of our rehabs with private money, in the beginning we did a lot of profit splits, today we don't do that anymore. Fixed interest rates rather than ewuity sharing really simplifies the paperwork. 

Typically the property is titled to us and the private lender holds a mortgage and a promissory note and is added as an aditionial insured (very similar to the documents a bank would require).

We have a couple people that invest via their sdira, we close with a title company, they make sure all the required paperwork is in order. 

 Great and accurate response!!  No equity splits here, these properties dont have huge margins where equity splits are attractive, which Im sure you're aware of being from ne ohio as well lol . So yes a fixed rate, borrowed from an ira, what title company do you use if you dont mind sharing?

Dionte G. - glad to hear you are heading the way of an operating agreement (OA) with an atty. while it will cost some money on the front end think of it as educational money. This document will become part of your business library of intellectual property that you will own.

Ben Franklin once said that "good fences make good neighbors" and I have adapted that to say "good agreements make good partners". Agreements are usually only needed if people can't work things out and then the agreement guides everyone on exactly was originally agreed upon. If you do business in the future with family again I would suggest that you use a written agreement such as an OA to memorialize the agreement - it will likely save your relationship if there is hiccup as the terms of the agreement will guide both parties.

Originally posted by @Dionte Graves :
Originally posted by @Dell Schlabach:

Are you planning on doing equity split with the investor, (more complex) or borrow at a fixed interest rate. We do most of our rehabs with private money, in the beginning we did a lot of profit splits, today we don't do that anymore. Fixed interest rates rather than ewuity sharing really simplifies the paperwork. 

Typically the property is titled to us and the private lender holds a mortgage and a promissory note and is added as an aditionial insured (very similar to the documents a bank would require).

We have a couple people that invest via their sdira, we close with a title company, they make sure all the required paperwork is in order. 

 Great and accurate response!!  No equity splits here, these properties dont have huge margins where equity splits are attractive, which Im sure you're aware of being from ne ohio as well lol . So yes a fixed rate, borrowed from an ira, what title company do you use if you dont mind sharing?

 We use Colonial Title in Canton, investor friendly title co.

Don't know where you are located, but Firelands Title out of Hudson would be a good choice as well, very investor friendly and involved in the NE Ohio Investor groups

Dell Schlabach, BenchMark Properties | 3304326927

Originally posted by @Brian Gibbons :

@Dionte Graves

See www.trustetc.com

They are in the Cleveland area and they are custodian for self-directed IRA

Make an appointment to physically see them

These guys don't have the best reputation. I have not personally used them, but I have heard from people that they are incredibly slow to fund. Do some research, there are not a lot of good things said about them aside from being local for Clevelanders. 

Medium img 0298 2Matt Motil, The Marie Paul Company | (216) 930‑4227 | http://www.drmattmotil.com