Advice on Private Lending and how to plan for the worst

6 Replies

Hi guys

So I am hoping to see if I can get some advice or differing opinions on my current situation. As a person that travels for work a lot, my time in my city is limited to a few days each week, which means I need to stay very organised if I ever want to successfully build a team and flip houses on the side. 

I have a friend who is going to be purchasing a fix and flip from a wholesaler and use hard money to finance the loan, and am looking to provide funds for the construction costs, instead of her taking out a second construction loan, in order for to make a small return on my capital, but more so to be able to be apart of the flip project and learn as much as I can along the way.  

I have heard that getting a lien on the property is one way to have the money secured, but then this is dependent on the hard money lender which may or may not allow a second lien on the property? 

Also I want to be able to go onto the property and see work done and be apart of the project, but does this mean that I could be liable for any issues that go down on the work site because I was physically there? Do any of you private money lenders lend through an LLC? The other thing with creating an LLC is that as this is my personal savings, I want to be able to take out my money if I later on want to buy a house or do my own flip, and not necessarily have my money tied in an LLC as such.

I know there are a number of ways to structure this, but basically the two things I want to know is what are the best ways to mitigate risk whilst lending out for the first time and what levels of protection can you have if you plan on providing PM but still want to be able to be on site of the project and learn along the way. 

Thanks in advance!

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@Anthony Patel - Your best option, in my opinion, is to form an LLC with your friend doing the flip. You are the equity partner and he is the "work". This way you can lend your money and have it secured to the property, because you'll own it, and the hard money lender wont have any issues with a second lien position. If after this one deal you want to stop partnering with this individual...no problem just close down the LLC and distribute the funds to the owners in accordance with the operating agreement.

Based on your situation this sounds like your best option. You can then also say you were part of a flip when you go to talk to banks, wholesalers, etc. and actually mean it because you'll have been a part owner in the company rather than just a lender. 

you can lend as an llc or private person just make sure you record the 2nd mortgage. As far as being at the property to inspect the work, as a private lender you can do that without having any liability of being considered a partner However if you start picking up color of the tiles or choosing the colors for the house that maybe construed that you are a partner in the deal (long shot but possible ). 

It's normal when private money lenders want to see the progress of the work when they fund construction. They want to make sure that they money is going into the project and not in just someone else pocket.

@Anthony Patel

I see 4 ways to do this:

1.  JV Agreement - Your friend takes title to the property in their (personal or LLC's) name. You then have a JV agreement on the side stating the terms of your JV, but your name isn't ever on title (there are pros and cons to this). This route might be the cheapest if your friend also has a JV contract to use.

2.  Create an LLC with both of your names on it and state the JV terms in the Operating Agreement. Creating an LLC costs $200 in our state, but attorney fees to create the operating agreement can range. If you want to count this project on your flipping resume, then this is the best way since you actually take title.

3.  2nd Lien - You'd get a Promissory Note and Deed of Trust.  Unlike the other two options, this route gives you in a "better" position because the investor is required to pay you off first before collecting their profits because you're the lender.  A lot of people don't realize that as the flipper/investor, you're always the last to get paid (after your contractors, your agent, your lender, etc).

4.  Company Loan - Instead of loaning to your friend for this specific project, you can just lend directly to their company (or to their name) with a Promissory Note.  Maybe add a personal guarantee for extra protection.

What did you mean by "taking out a second construction loan"?  A lot of hard money lenders provide rehab financing too.  Are you sure you're not providing gap funding (i.e. the down payment)?

You're right that a lot of hard money lenders don't allow 2nds. If your friend's HML doesn't, I have some that do.

You can always visit the property, whether you're a lender or partner.

You don't need an LLC to lend money.

If you're lending money, you should be in a position where you don't need to use that money in that timeframe. Usually on your lending terms you state when the money is due back. In a JV, your money is stuck in there until the project is done.

Account Closed

Can't make a blanket statement to say that 2nd is not a safe position. Depends more on CLTV (cumulative loan-to-value). At 50% CLTV, I'd say that the 2nd position is pretty safe. With our flips, we tend to stay below 75% CLTV.

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Account Closed

The only reason why I can think of a 2nd lienholder paying the 1st and keeping the 1st current is if the 2nd is planning on foreclosing themselves. Otherwise, if the property has a low CLTV, just let the 1st handle the foreclosure process so you can get paid out. It's never a guarantee, but it's a pretty safe bet if you did your due diligence correctly up front and validated the numbers, especially the as-is and ARV values. If you are working behind a good hard money lender as the 1st, then they would have vetted the deal property.

I've borrowed money from a dozen hard money lenders (half of them local here in Seattle), and talked to a hundred more over the past year.  Most of the national lenders do not allow 2nds, and half of the local ones don't.  They want to see the borrower have skin in the game (so that they're less likely to walk away).  It is their business because it protects their loan interest.  The demand has nothing to do with enforcement in court; they simply wouldn't do the loan because it's part of their underwriting criteria.

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