I have a private lender or two, and I'm trying to figure out the best way for me to utilize their money for investing (flipping). Some ways I've come up with so far:
- Note on each property - this is the most common way I've heard about, where they bring money to the deal by means of a promissory note and DOT. Disadvantages: have to go through this process for each property, and have to go through SEC for approval (not too difficult, but just another step).
- Note on personal property - my portfolio lender mentioned that I can just use my private lenders like a home equity loan (with my personal residence to secure the loan). I like this because it's a one-time thing, but not sure if I have to go through SEC for this as well.
- Form an LLC - Have them just put money into the LLC, and I as the manager would just control how the money is used and give them a certain return based on operating agreement. Seems like the same advantages as the note on personal property, but seems easier to pool multiple lenders together (assuming I can bring more in). If I was a lender, this approach has the look of the most professional, safe, and enticing one; I would feel more involved in the real estate business and get to brag to people that I am part of a real estate company, etc. The downside is more overhead (and I still don't know if this would involve SEC).
I like simplicity and liquidity (because I need to move fast in my very competitive market). The first option doesn't seem very attractive to me because I'd have to approach the lender every time to borrow money, and mine tends to travel a lot. The 2nd one adds a bit of risk to me due to the collateral (although they would be in 3rd position) and might make it harder for me to refinance and/or add HELOCs on my home, although I doubt that I'd be doing that anytime soon (since I just did it last month). And the 3rd one is just... more overhead.
Which way seems best to you guys, from a tax and legal perspective?
Use an LLC approach, no more than 2 money guys with you, work out the security in the operating agreement put the property in the LLC.
After a few loans or disbursements using your home, you'll put them in a lender position on a consumer loan, not the way to go at all.
Doing each property is fine too and the simplest IMO. Yes, they can say no, but they can say no at anytime in any other method, you can't hold a private party to future loan commitments as you can an banking institution. In fact, it's safer not to have discretion over their money, that leads to other issues.
If these individuals are personally known to you, you have some relationship with them, you don't have any SEC issues with them. The issues can come in later on as they become a regular lender, at that point you can go to the LLC.
Before you start using other peoples money, might run it past an attorney, that protects both of you and you'd spread any cost of future deals, not as bad as most think. Good luck :)
I'm with Bill, among those options a note against the property is the easiest. No SEC. Just a few documents to execute. Travelling is fine, these days everything can be done digitally.
Once you've done a handful of deals that way and like working with the person and want to keep working together you can discuss setting up an LLC. Forming an LLC is easy. Properly managing and maintaining it is a little more work.
If I was a lender, this approach has the look of the most professional, safe, and enticing one;
I disagree with that. I manage a bunch of different LLCs that I flip houses with various partners taking equity positions. But they're all experienced real estate investors who I know personally. When I'm lending money to someone else I'm not giving money to their little LLC. I'm getting a note, deed, and personal guaranty and a bunch of other documents too.
So for the first option of giving the note, do they own the property/on the deed ?or just have a right to foreclose through the note if something goes wrong?? Can someone explain what exactly the note is/does?
If you have lenders go into an LLC with you, are they equity partners? Or can you draft the operating agreement anyway you choose and still keep them as lenders getting a certain % on their money for however long?
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