Secured note vs. equity syndication

[Ben Sowers]

Hi all,

I'm buying my second 4 unit in Wash Park, Denver with a small group of investors and am hoping to get feedback on two different approaches to structuring it.

Approach #1 is to buy the home in my name with a 75% conventional loan. I fund the down payment, quit claim title to an LLC post-close and fund the investor equity at that time. I have an Operating Agreement with my equity investors that dictates distributions, etc.

My concerns with Approach #1 are two risks: (1) having the loan called as a result of the due on sale clause (which I've read the BP posts and spoken to lenders about the likelihood of that) and (2) the challenge of refinancing. I'm more focused on a solution for the refinancing, and it seems I could either (1) refinance with a commercial loan or (2) transfer title back to my name, refi, and transfer back to LLC. The former would dilute returns with a higher rate and more closing costs and the latter seems to be sketchy in terms of moving title around.

Approach #2 is to buy the home under my name with the 75% LTV conventional loan and finance the down payment and any renovation budget post-close with a secured note from private lenders. These would be the same investors I currently work with, but they would make a debt investment instead of equity.

I like Approach #2 at first glance - avoid the risks of Approach #1, claim all of the depreciation, increase my levered return while providing a strong debt investment to investors - but am surprised that I haven't heard more about on BP or elsewhere. I know hard money is common for flips and cash deals, but this would be more of a buy and hold investment for me and my debt or equity investors.

SO the question to those who have bought 3-4 unit deals with investors, do you have a favorite between the two approaches?

Are there any fatal flaws (eg, could I refi it if there's a secured note that's subordinated to the first mortgage?) with Approach #2?

My goal is to scale my small multi-family portfolio with my investor group and optimize the financing of these smaller residential multi-family deals. I'm buying 5+ units and don't have to worry about this with commercial financing, so this question is specific to the <5 unit niche.

Thanks in advance!

Ben