Should I raise more capital than I plan to need?

Question

Hi All:

I am in the process of working through a business plan with my partner to execute on the BRRRR strategy. We have limited funds ourselves but family and friends have expressed interest in investing with us. If we expect to need $200k for our first deal, how much money should we target to raise?

How much capital should we have committed in excess of our project budget? Assuming this capital will only be called in the event we end up going over budget.

What is a good assumption for % of money we will actually have available to us when we find the deal? I assume not everyone who expresses interest in the idea of investing in real estate will actually pull the trigger when it comes time to write a check.

Thank you in advance for your advice and experience!

Ivan Barratt · Answer

Private debt (no equity) would greatly reduce YOUR cost of capital and increase your upside in a small deal.

Taylor L. · Answer

I have not done that structure. I am not a lawyer, but from my experience I would expect the legal costs of that to be deal killing. Fixed legal costs for syndications are typically in the realm of $25k.

Why not just go with a straight up loan? Pay them something like 8% interest only and 2 points, or some figure that works with your deal. You can also network locally to find money lenders who have experience in real estate. If you find the right person, they'll look over your deal, give you advice, and help you through it (at least to some small extent, they won't run it for you).

Paying a bit extra to get someone with years of experience to look over your shoulder is a smart investment. If that person's loan costs you a couple thousand dollars more but they keep you from making a mistake of the same degree, then you're coming out ahead and learning without doing it the hard way (aka losing money and having to dig yourself out of a hole).

Kenneth Garrett · Answer

@Andrew Reyes

I have used private lenders for a debt investment which then had the option to be converted to equity.  I’m not a fan of this as usually the investor will get the short stick from some investors.  If the debt return was 12% on 200,000 for 6 months the anticipated return would be $12,000.  Say for example you converted to equity because the project took 12 months that would have been a return of $24,000.  The profit or equity was only $40,000 and you split it 50/50 they would only get $20,000 v $24,000. Are you paying them debt until the point the conversion takes place.  This is usually done for flips, not a BRRRR project.  BRRRR is typically a debt investor.

As far as how much to borrow.  I like to budget accurately and anticipate an overage fund within the budget to cover unexpected amounts.  Remember your paying on money you may not use so use it sparingly.  I tend to go 10%-20% deoo P.O. depending on the project.

You did not indicate the type of project so I assume this is SF or 4 units and less.

Andrew Reyes · Answer

@Ian Tvardovskaya Thank you for the advice. We generally carry a 20% overage in our rehab budgets when underwriting a property given our lack of experience.

Andrew Reyes · Answer

Thank you for the thoughts. Sound like we should look to get interest for about 4x our budget to account for back-outs and inexperience. We are first telling close family tat we are talking about putting deals together and will be engaging an attorney soon to better understand the legal considerations. Our initial thought would be to offer convertible debt, which will provide our investors limited risk during the rehab period and an opportunity to participate in future cash-flow by converting the debt balance to equity at refinance at the appraised value. Have you structured any deals with this type of product?

Ian Tvardovskaya · Answer

@Andrew Reyes plan your rehab with the highest end of any estimate and then add 10% to the total number for additional repairs not foreseen. Rehabs always take longer and cost more than we think.

Taylor L. · Answer

As one who raises money from investors, I can tell you that many of them will tell you "yes, I'm in!" but when time comes to send the funds, at least half are going to back out. For some it's not a good time, and for others they were never really committed. Just be ready for it.

I'd be more concerned with where your $200k number came from. If that is an estimate from an experienced investor, then it's probably a solid number. If it's from someone new who read a few books, then it's definitely in question. Still, if you can get commits for $400k then you should be comfortable.

Keep in mind the laws around raising capital. You can't just take funds from passive investors and give them equity, you have to go through all of the steps to properly syndicate.

Have you considered taking these funds as a private loan?

Should I raise more capital than I plan to need?

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