What does Private Money want?

20 Replies

Hi Everyone.  I've been actively investing in single family residential properties for about five years.  I've bought long term rentals and short term rentals.  I've bought a freshly renovated property and I've bought an original property to renovate and refinance.  I have learned a lot and thankfully have a nice little portfolio today.

As I dive further into the real estate business, it is really what I want to do, but I see how much money it truly takes to grow.  I'm even contemplating starting a property management company to keep me close to real estate all the time, instead of for my "side hustle".  At this point, I'm considering pursuing private equity for the next portion of my portfolio.

My question is this, what does private equity expect in return?  As I understand the model, the general incentive to private money lenders is to put money in a relatively safe investment with a multiple better return than say, T-Bills.  I realize this can vary widely, as private money can be anyone from my Uncle to an unaffiliated wealthy investor.  However, is there a typical expectation of the total return of capital, or a long term position in the property?  It is hard to model properties without this basic understanding, of course.

I am a buy and hold investor, so the position I take is with the intent of keeping the property.  I don't understand the process to refinance out the private money if it is expected to be returned in five years for example.  The property's monthly net cash flow would have to generate the investor's return, which doesn't seem problematic.  But then what, are we partners in the property long term, or do I pay down the private debt long term with my net cash flow from the deal, etc.?  Also, what are some expected down payments for an arrangement like this?  Finally, if there is something obvious I am missing, please feel free to let me know (nicely, please).

Thank you for your input, it is much appreciated!!

@David M.

For me, I don’t want to be partnered or in any way tied to a private or hard money lender long term. I view them only as a short term solution for a short term need. By short term I mean 6 months or less.

So the model I’ve been using is: find a smoking deal that needs a major rehab. Buy it and rehab it using any means necessary - HELOCs, unsecured business lines of credit, private loans from friends and family, 401k loans, or money you had stuffed under your mattress. Then either flip it or refinance.

Either way - flip or refi - you use those proceeds to pay back your short term money, or, in some cases, roll that short term money right into another deal.

@Kyle M. Thanks for your feedback.  I've thought about plastiq.com or something similar to get cash from my credit cards for 2.5%.  If I were to take an even $100,000, that would cost $2,500.  I'm sure my average interest rate is around 18%, or maybe a little less, around 1.5% per month.  If I hold for a six month seasoning, that would be $9,000 in monthly interest and $2,500 in initial fees for a total cost of $11,500 or 11.5%.  That is fairly comparable to private money  / hard money.

The only questions is, what happens if there is a crash in month five?!

@David M.

Most private lenders does not report the loan balance to a credit agency.  The credit card companies report your debt and affects your debt-income-ratio (DIR); may be credit score too.

Based on the situation; private funds may be favorable than credit card debts

@David M.

In the 1% chance the market drops 10-20% in the next 6 months, you will break even.

In the .1% chance the market drops 20-50%, you will figure it out when it happens. This is what cash reserves are for.

In the .000001% chance there is a catastrophic drop in the next 6 months, you will have more important things to worry about such as fighting off the zombie apocalypse.

@Saravanan Saravanan thank you for your reply.  That brings me back to the original question, is Private money there for the 30 year term, or are there different expectations on repayment than a traditional mortgage lender?  If Private money expects repayment in say 5 to 10 years, what does the buyer typically do?  Does an investor find a second private lender to pay off the first at that time, or how would the exit work aside from selling the asset?  Thank you!

@David M.
We have funded rental properties with 2 to 3 year balloon; structured using 6 to 10 year amortized schedule.  Some were funded for 4 to 6 year ballon with 15 to 20 year amortization.

In many situations the owner on records would refinance back with cheaper commerical loan from bank or credit union.  Could be single family rental refinance or blanket / portfolio loan refinance.  Some portfolio lenders who work from $100K and above and some $1Million and above.

Some clients resell to turnkey landlords for a profit to get long term capital gain; and distribute their sale over period of time.

If you are a buy and hold investor, consider using private money by giving them an equity position. In my syndications I give away 70% of the equity in order to raise the funds needed for the down payment, reserves, closing fees, etc. This allows me to provide my investors with a strong return, yet you are not obligated to a debt payment to your private money. 

As for return expectations, it really depends on your money. I think a 6-10% cash on cash and 14+IRR is attractive to most investors on multifamily or commercial. For flips/short term you will be looking at 10-15% annualized return.

There also should be a separation of say an individual private lender and a more institutional one who has to file with the SEC and may be regulated even at the state level. If you're looking for a short term single loan then this model may work best for you though you can have a long term relationship. Most of these private money lenders will limit you to 4 purchase loans and 1 rehab. You will pay the servicing company not the lender. 

An individual lender is in my opinion a hard money lender. They are not licensed nor regulated. That can be good and bad but you will have them more involved in your deals.

Originally posted by @David M. :

Hi Everyone.  I've been actively investing in single family residential properties for about five years.  I've bought long term rentals and short term rentals.  I've bought a freshly renovated property and I've bought an original property to renovate and refinance.  I have learned a lot and thankfully have a nice little portfolio today.

As I dive further into the real estate business, it is really what I want to do, but I see how much money it truly takes to grow.  I'm even contemplating starting a property management company to keep me close to real estate all the time, instead of for my "side hustle".  At this point, I'm considering pursuing private equity for the next portion of my portfolio.

My question is this, what does private equity expect in return?  As I understand the model, the general incentive to private money lenders is to put money in a relatively safe investment with a multiple better return than say, T-Bills.  I realize this can vary widely, as private money can be anyone from my Uncle to an unaffiliated wealthy investor.  However, is there a typical expectation of the total return of capital, or a long term position in the property?  It is hard to model properties without this basic understanding, of course.

I am a buy and hold investor, so the position I take is with the intent of keeping the property.  I don't understand the process to refinance out the private money if it is expected to be returned in five years for example.  The property's monthly net cash flow would have to generate the investor's return, which doesn't seem problematic.  But then what, are we partners in the property long term, or do I pay down the private debt long term with my net cash flow from the deal, etc.?  Also, what are some expected down payments for an arrangement like this?  Finally, if there is something obvious I am missing, please feel free to let me know (nicely, please).

Thank you for your input, it is much appreciated!!

 1st thing private money wants is safety. Biggest thing anyone trying to raise funds needs to do is convey in a clear and concise way why they have the ability & skill set to safeguard the investors money. That is A1 A1 A1.

@David M.   Private money investors generally want two things: 1) to not lose money, and 2) to make a good return on their money.  Usually in that order. 

As for your question about 30 year repayment terms, no private money investor is going to do a loan term that long.  Not even 10 years for that matter. 

Private money is typically shorter term (6-12 months is probably the most common I've seen). 

It sounds like you're thinking about using private money to acquire buy and hold properties and having some sort of fully amortizing loan that you pay off while you hold the property.  However, that's not how private money is typically best utilized. 

Usually, private money is utilized in one of two ways.  One way is to acquire properties that are going to be rehabbed and flipped (sold) in a short period of time.  In those cases, the private money investor is paid back when the property is sold. 

The other way is to acquire properties that also need significant repair, but are going to be rehabbed and held (as rentals). In those cases, the private money investor is paid back after the property is fully remodeled and rented and the ARV is increased enough to justify doing a cash-out refi (typically at a higher valuation). This is often referred to as the BRRRR strategy.

In both of these examples, the initial private money loan would typically be relatively short term (i.e. 12 months) and have a balloon payment due at the end of the loan term.

Hopefully this helps clarify how private money is typically used (and how it is not used).

Thanks @James Wise !  So in your experience, does the PM ride along for the entire horizon like a silent equity partner, or do they get a capital event somewhere along the way.  I guess my question is, would a private money buy always / usually / sometimes /never expect to refinance out.  It sounds to me like maybe 1/4 to 1/3 of PM likes to take an equity position with a solid investor to ride to the end, while the majority 2/3 or so, expects a cash on cash interest rate annually with a share of appreciation at recapitalization.  If so, does one always need to keep a commercial lender on the back burner because private money will need to be retired before even 15 year "traditional" term?

Thank you to everyone for your input, I'm sure this is pretty basic to some people.  It is by far the most conservative aspect of my portfolio.  I appreciate all of the information to help me understand this avenue better.  I've been hesitant to look for private money because this has been a side hustle and I've been able to get by with a traditional lender and down payments thus far.  No more W2 though changes how easy it is to get that next property, despite the usual 20-25% down ready to go...

@Kyle J. thanks for the explanation, that's a big help.  It seems hard money and private money are not necessarily that different in function.  As such, these are great flipper tools, but don't benefit the long position as much for the points you mention.

What are some avenues a buy and hold investor can look to that are win-win like the flipper and hard/private money? I have a HELOC on one investment property, but it's really more of a down and rehab amount, not a cash purchase amount. I do have a prequal for my preferred price range of $200K for 30 years with 25% down but at 7.75%. It sounds like that is my best option as I wouldn't need to refi in 6-12 months or find anyone else. Basically kick this question down the road to the next property...

Originally posted by @David M. :

Thanks @James Wise!  So in your experience, does the PM ride along for the entire horizon like a silent equity partner, or do they get a capital event somewhere along the way.  I guess my question is, would a private money buy always / usually / sometimes /never expect to refinance out.  It sounds to me like maybe 1/4 to 1/3 of PM likes to take an equity position with a solid investor to ride to the end, while the majority 2/3 or so, expects a cash on cash interest rate annually with a share of appreciation at recapitalization.  If so, does one always need to keep a commercial lender on the back burner because private money will need to be retired before even 15 year "traditional" term?

Thank you to everyone for your input, I'm sure this is pretty basic to some people.  It is by far the most conservative aspect of my portfolio.  I appreciate all of the information to help me understand this avenue better.  I've been hesitant to look for private money because this has been a side hustle and I've been able to get by with a traditional lender and down payments thus far.  No more W2 though changes how easy it is to get that next property, despite the usual 20-25% down ready to go...

 Everyone wants to get paid & beyond that paid as quickly as possible. Getting a return sooner rather than later is more attractive then having to wait a longer period of time.

Now is there enough private money out there in the world to fund your deals with the long term money? Sure there is. But that doesn't mean they will. It's up to you to attract them to you & not the next guy or opportunity. 

Basically you're gonna start with nobody wanting to lend you any money. As you increase your value & brand you'll start to see some short term money come in. As you get bigger & better so does the amount of money coming in. Along with  the amount of money coming in comes more attractive terms such as longer payback periods & lower interest rates.

@David M. Most private money deals are between 6 months and 5 years if your lucky, with a balloon payment at the end which you would have to pay them in full with interest. As an example, you borrow $100k for a down payment, most of the time you would pay interest only payments which would help your cash flow in buy and holds or holding fees with flipping homes. 10% interest only payment would equal out to $833 a month payment. 10% of $100k=$10,000/12 months= $833. You would pay that 10% each year you don’t pay back the private lender. At the end you would owe exactly what you borrowed, $100k. In your case a private lender would not make much sense unless you went through a friend or family for a very good interest rate.

@David M.

Dont worry about it crashing just run your numbers and if it makes financial sense for you just do what it takes to secure the deal. If it crashes you will figure out how to cross that bridge when it comes.

Private money wants their money back.  Good underwriting is done by making sure all risk is minimized and the chance of return is high.  Bad underwriting brings on risk.  It's that straight forward.

Originally posted by @Kyle M.:

@David M.

In the 1% chance the market drops 10-20% in the next 6 months, you will break even.

In the .1% chance the market drops 20-50%, you will figure it out when it happens. This is what cash reserves are for.

In the .000001% chance there is a catastrophic drop in the next 6 months, you will have more important things to worry about such as fighting off the zombie apocalypse.

a 1% chance of a 10% to 20% correction? HA. The market has surely shown this tendency in its history. 1 year out of every 100 year period, the market will, and has corrected 10%-20%. And, while we are on statistics, the market has far surpassed your .1% theory in its history. The market has not even been around for 1,000 years and it has already landed on 0 once, and I am sure many more times greater than 1 in 1000 "years" it has corrected greater than 20%. Your numbers are off. I'm not worried about zombies.