Real Estate Investor · Point Pleasant Beach, NJ · Member since 2014 · 103 posts · 52 votes
Hi BP!
Quick summary of what I am doing: Acquire small multi-family properties with capital partners to put up the down payment money, bank finance the remainder of the loan. Create win-win for all involved. I've never worked with capital partners before, so I am wondering ...
Is it better to find capital partners first and get commitment from them, or should I find the deals first?
It depends on how you go about picking up the leads. If you get a good deal the money will come quick. But if they're wanting a proof of funds letter then you might need to get your partners in place. I say don't hesitate either way you look at the situation, meaning just keep trying to get a deal, while you're trying to secure the funding. If one happens to come before the other then great, but don't stop...keep moving forward.
It depends on how you go about picking up the leads. If you get a good deal the money will come quick. But if they're wanting a proof of funds letter then you might need to get your partners in place. I say don't hesitate either way you look at the situation, meaning just keep trying to get a deal, while you're trying to secure the funding. If one happens to come before the other then great, but don't stop...keep moving forward.
Thank you for your feedback! I agree that it is very important to keep moving forward. Admittedly, I'm not to good at multi-tasking so I never thought about pursuing both at the same time. But it makes a lot of sense and it is definitely a way to keep the momentum going.
I've done it both ways and personally I prefer to formalize the capital partner structure and partner commitments prior to locating the property. I explain to my partners that the market will determine the deals and that we could find a suitable investment quickly, slowly, or not at all but that my goal is to find them properties that fit the investment criteria. They have no obligation to fund until we locate the investment.
Also, we form LLCs for our purchases, so by having the partnership structured up front we avoid having to assign the contracts to the entity prior to close which can often be a red flag to sellers.
Thanks for the advice. I can definitely see how finding the deal first and then scrambling to find suitable partners can get messy, especially when you put yourself in the seller's shoes. Like you, I also plan on using LLC's for our purchases.
Can you walk me through the main points of how you structure the LLC with your partners?
Do you form the LLC and operating agreement long before purchase?
Many capital partners will require the properties be held by a LLC. Especially once you grow your portfolio and unable to get a loan through conventional lending due to owning to many properties and other rules. If you find the right capital partner they may be able to provide all of the financing you require - hence one stop shop.
Thanks for your comment! Agree, I am planning on using LLC's and using creative finance as opposed to conventional lending for the reasons you stated. Speaking of, I will need to establish a relationship with small community banks in my area that can underwrite portfolio loans in case my capital partner's aren't the one stop shop. If they are comfortable with the numbers and it makes sense to be the one stop shop though, that would be icing on the cake!
Yes. We try to have the LLC and operating agreement in place prior to purchase. I've actually put a couple of these together on the fly, but to make it happen in the typical 30 day closing period requires having some ducks in a row. Most importantly investors ready to commit and a boilerplate agreement. I think this would be difficult in most instances. The only way we managed was that the investors in the pool had already created a similar vehicle in another state so they were comfortable with the structure from day 1.
We have two entities created. One vehicle for buy/hold and one for flip.
Both of our vehicles are cash. We don't use any debt. You could probably use something similar if you were covering the debt expenses for your contribution and none of the investor partners were signing personal guarantees for the loan.
The structure for the buy/hold investment is as follows:
GP receives a 20% incentive and 6% property management payment. The incentive is calculated after paying a preferred return of 6% per year.
So for example: $1M investment pool and assuming the GP put up 20% of the capital, the GP would receive 40% of all profits after the 6% was paid. This creates an accelerated return structure for the GP.
Each quarter the GP receives 6% PM (calculated on rent collected) and 1.5% preferred return (6% annually) on the 20% contribution. All the investors receive their quarterly 1.5% based on their investment. Excess funds are paid out as return of capital to the partners. Once all capital ($1m) is returned, the GP would own 40% of the remaining pool and receive 40% of all profits.
The flip pool has a higher (8%) preferred return due to risk and a higher GP incentive (40%) due to the work required to manage flip properties vs buy/hold.
Thanks for sharing your detailed response. Sounds like a solid structure you have in place and I agree that it would be very difficult to put all this together in 30 days. There are a lot of moving parts involved so having the vehicle set up in advance seems very advantageous.
My conceptual plan for setting up the structure is more simple:
50% equity for me - I do ALL the work including property management and accounting
50% equity for capital partners - No responsibility in terms of making business decisions or operations of the business
Monthly cash flow paid out after all expenses (including budgeted expenses) are paid out and accrued for. Keep in mind that my deals will most likely be 2-4 unit residential this year, with the intent on acquiring larger 5+ commercial multi-family in years 2-5.
I think 50% is great if you are doing it with investor cash and your credit. Would you have the investors covering the debt cost as well? If so, all the better for you.
Plus you are shielded from the majority of the downside risk since the investors would have to lose their money before the bank got involved.
I like where this thread is going. I am also trying to come up with common strategies for partners.
Is it pretty easy to get financing in deals like this even if it is not specifically your money?? For instance, let's say you have a great credit score, but are lacking capital. If you find a partner to come in and finance the down payment (20-30%) and use your own credit, is the bank going to be more lenient on other things like your income and DTI ratio? Would the bank look at both parties' income in determining credibility or only the person using their credit to finance?
If the numbers work out favorable for the investors to cover the debt then we will go that route. It is a favorable alternative, as opposed to dealing with a bank. Most likely though, I foresee a bank covering the debt (70-80%). And yes, I plan on using investor cash for the down payment and my credit.
I agree with your downside risk comment, but I will move mountains before I let my investors money disappear. Priority number one in this business is to protect and grow capital - especially when working with capital partners.
Thanks for jumping on the conversation @Cody Steck . Those are great questions and I am wondering the same things. Any thoughts and comments are greatly appreciated!
I would meet with some commercial lenders in your area. My lender doesn't care where I get the down payment as long as I have the credit worthiness to approve the loan. Most investors won't sign a personal guarantee. If they did, they would effective be providing the financing along with you so their share of the company would be arguably greater.
But you could partner with someone with solid credit as a co-GP and split the GP profits with them in exchange for providing operational sweat equity.
The great thing about qualifying by yourself is that you've covered your contribution with the bank's money and none of your money. Great OPM strategy
Scott Sutherland when you line up your capital partners prior to having a deal, do you have them sign a commitment or even further, make a deposit to the LLC account?
Just wondering how you hedge against finding a great deal and then having a capital partner that you were counting on back out, change their mind, or not have the cash available.
Funds are typically deposited after due diligence (option period) but prior to closing.
Our LLC agreement provides the commitment levels for each member and if they fail to contribute, their interest would be available to other members. We typically have 5-10 investors so one backing out could easily be absorbed by the other members.
But our investors have worked together for a number of years, so I couldn't see someone failing to contribute unless they had a life event in which case we'd work it out.
I will definitely keep you posted as things progress, and thanks again for the detailed advice. If I ever take a trip down to Austin I owe you a lunch (at least)!
@Derek Carroll , thanks for jumping on and asking that question. I think it's really important for us to understand how the process works before seeking capital from seasoned investors.
Another question, who files the LLC with the state and puts together the operating agreement? Is this something you recommend your RE Attorney handle or is it worth doing it yourself?
You can do the LLC yourself for $300 or you can have NRAI (national registered agents) do it for about $600 which includes being your registered agent for receiving any documents.
One of my partners works off a boilerplate agreement we've used before. I typically form the LLC and the company reimburses me after formation (once we get the bank accounts set up).
Feel free to ping me if you're ever in Austin. We can grab coffee or catch up at a local investor meetup.
Great thread guys!!! Besides family and friends what is usually the best way to find Capital Partners? Great point about partners backing out at the last minute @Derek Carroll . @Scott Sutherland Once relationships are established I understand how your existing investors can pick up the slack of an investor backing out of a deal but if I'm doing a smaller deal lets say me and 2 other investors, how can I contractually make sure my investors don't back out of the deal at the last minute. Thanks
Family and friends have been my go to. But also friends of friends and business associates of friends. Trust is very important when sourcing capital. I've focused on building my real estate resume and providing capital alongside the other investors. Sometimes as little at 2.5% of the investment, but investors like to know that you have skin in the game. On other deals, I've subordinated my investment (I lose everything before they lose anything) to illustrate my confidence in the project and my abilities.
I'm not an attorney, but I do know that when you start sourcing from investors that you don't have a prior relationship with that you can run afoul of the SEC.
If you have concern about investors not funding, might I suggest that you require any interested investors to replace your earnest money prior to the expiration of the option period. If they back out and the deal dies, it's their money. In my market earnest money is typically 1% of the purchase price.