How do I approach potential private money lenders?

Question

I've been doing lease options for the past year and now I want to get into rehabbing. I have drawn up a business place and am in the process of creating an private money investment proposal. I am going to send this out to family and friends that I think would be interested in becoming a PML. How do I present this to them? My plan is to use 100% PM to purchase, rehab and flip properties in the first year and then use 50% cash reserves and 50% PML after that. I was thinking of offer 12% interest rate with a 2% origination fee and no more then a 12 month note. I was going to compare this investment with others and point out the fact that you will in find returns like this any where else. Also, make a point that the money would be protected and always handled through a self directed IRA from Trust ETC. What else should I say in my proposal? My business plan already outlines everything they need to know about how I will do business and my goals.

Michael Seeker · Answer

Justin Morris - Including the lender (relative) as an equity partner makes it much more reasonable for you to not have any money out of pocket.  I would suggest offering either a 50/50 equity stake or a fixed return.  You shouldn't have to give up 12% interest and 60% of the profit as well.

Since this is a family member, there's a lot more flexibility on both ends.  I'd just make sure that whatever you guys agree to, you come up with an iron-clad agreement in case there are any issues down the road.

Justin Morris · Answer

Michael Siekerka & Sam Craven thank you both for your response and advice my appreciate

In terms of your point Mr. Siekerka, I do completely understand where you are coming from. I'm in a situation where I don't have the funds to contribute to a project, I have the knowledge and contacts to get it done and the family member in question has the money. They have done some conventional REI before and I believe that they would be more open to the idea of doing this then anyone else I know. I'm not only asking them to be a lender but to help me kick start my company but doing this first deal with me. I plan on being extremely conservative in picking the deal, it may take me a few months to find something but I'm not going to put the trigger until I find something that is going to work and make money. I'm looking for something I can buy at around 40K with a 90K+ ARV and no more then 15K in rehab costs(probably REO or short sale). This situation would be as following, my family member would receive 10% on a 6 mont note on his money plus a minium of 10% ROI. So I would like to make a minimin of 20K in profit in which I would split that with him 60%-40% and out of my 40 would come the 12% interest on the loan. This way they are making money two ways, with a interest rate on the loan and a decent ROI on the over all investment.

Sam Craven · Answer

Justin Morris is asking about private money, not hard money.

The terms he outlines are more than favorable.  We work with private lenders using favorable rates for both parties and no points and they are happy to do it!  Just build the relationship, build confidence, pay early, and disclose everything.  Once you build a track record, and start networking, private lenders will find you.

Michael Seeker · Answer

Typical HML funding terms would be 90% of purchase and 75% of ARV.

If you buy a place for $100K that will retail for $200K when rehabbed the funding will look like this:

Initial purchase - $90K private money, $10K personal funds
Rehab - $60K private money available for repairs (0.75 * 200K - 90K), funds distributed as draws only AFTER work is completed.  You'll need to have operating funds to complete the work before you're reimbursed for it.

For such a project you should have 20-30K to start just to get the ball rolling.

You may be able to find somebody to fund you on the terms you've outlined, however I would strongly advise them not to lend money on those terms unless they're okay with losing it or they owe you a personal favor.

Sam Craven · Answer

It sounds like you have hit the high points.

Dont forget that EVERY investor....above making awesome returns, wants their money back.  So show them how they will be on the deed, and on the insurance as a loss payee, and on record as the 1st lien position, and that you will never be in a property for more than 70% of its value.  Illustrate that if something happens to you, chances are they will make MORE money if they have to foreclose.

Otherwise i have learned that raising money and building those relationships are the key to growth.

Michael Seeker · Answer

Their money should be secured by a first lien (mortgage) on the property.

The terms sound fair with the exception of you using 100% funding to do the deals.  Typically HML's require some skin in the game, otherwise the risk is all on them.  If you're dealing with friends/family, you might be able to swing the no money out of pocket, however you're not really being fair to them as they probably don't understand the risk involved if you do not make any money on the deals.

What happens if your first rehab is a flop and you lose $5K on it?  With it being 100% financed, the HML will not get all of their money back...are you willing to come out of pocket to pay them the $5K loss?  If so, why not stick your money into the project at the beginning?