A friend of mine started flipping houses a couple years ago with 2 friends of his through a company they started (which, after speaking with him got me interested in pursuing REI as well).
I am thinking of investing money with them to get some passive income and learn something along the way about that area of REI. While I will be reviewing their past financials and history of payment back to investors before making a commitment, I was wondering what the usual payout structure is in these scenarios, as well as the fair return I can expect.
His company has a minimum I find high, that I can disclose through DM. They promise 10% annualized return monthly starting from when they call on the money, to when they flip the house. Is that fair/in line with industry standards?
Also, from a tax legal standpoint, I am wondering if it matters that the investment comes from me individually or through my LLC. And best way to handle the repayment of investment and capital gains from the sale - from a tax implication standpoint.
Real Estate Agent · East Central Florida · Member since 2021 · 121 posts · 94 votes
4y
Andrew,
Sounds like you could have a good potential passive income stream available, but make sure to do your homework. It sounds like you plan to. Many markets are starting to slow, so past performance may not repeat going forward. I find, in my area, most hard money comes with points as well as interest. Most also has a minimum use period, so the investor is guaranteed to make at least a certain amount for their money. In your case, 10% may be good, if you are not financing a whole deal. I would say if you are just giving them $10k or $20k toward a larger project, you should expect a different return than a single lender funding an entire deal. There is a lot more information that should be taken into account before anyone says whether or not it is a "fair deal". Additionally, what might be fair in your eyes and fair in my eyes, can certainly be different. I can tell you there are US Treasury I-Bonds available right now, which are paying 9.62% and that money is federally guaranteed, so no risk to consider. Now, I am not an attorney or accountant, so I cannot give you legal advice, but there are many variables as to what benefits you may get, depending on how the money comes back to you. I would suggest you speak with a financial professional for the best approach. If you are a single-member LLC, it likely won't matter how you take payment as the IRS does not recognize single member LLCs anyway. However, I believe the payments would be counted as income, rather than capital gains when you are talking about interest on a loan. I probably wasn't much help, but might have given you something else to think about while you are evaluating the possibilities.
Real Estate Agent · East Central Florida · Member since 2021 · 121 posts · 94 votes
4y
Andrew,
Sounds like you could have a good potential passive income stream available, but make sure to do your homework. It sounds like you plan to. Many markets are starting to slow, so past performance may not repeat going forward. I find, in my area, most hard money comes with points as well as interest. Most also has a minimum use period, so the investor is guaranteed to make at least a certain amount for their money. In your case, 10% may be good, if you are not financing a whole deal. I would say if you are just giving them $10k or $20k toward a larger project, you should expect a different return than a single lender funding an entire deal. There is a lot more information that should be taken into account before anyone says whether or not it is a "fair deal". Additionally, what might be fair in your eyes and fair in my eyes, can certainly be different. I can tell you there are US Treasury I-Bonds available right now, which are paying 9.62% and that money is federally guaranteed, so no risk to consider. Now, I am not an attorney or accountant, so I cannot give you legal advice, but there are many variables as to what benefits you may get, depending on how the money comes back to you. I would suggest you speak with a financial professional for the best approach. If you are a single-member LLC, it likely won't matter how you take payment as the IRS does not recognize single member LLCs anyway. However, I believe the payments would be counted as income, rather than capital gains when you are talking about interest on a loan. I probably wasn't much help, but might have given you something else to think about while you are evaluating the possibilities.
Lender · Boca Raton, FL · Member since 2014 · 1k+ posts · 957 votes
4y
@Andrew Rascoll, 10% isn't bad, especially with someone who has an established track record. Will you have first lien position, or is it an unsecured loan?
Developer · Santa Clarita, CA · Member since 2008 · 15k+ posts · 10k+ votes
4y
10% is a solid return as a private investor. I didn’t see you mention what state the investment is in, but you should verify that specific states usury limits, each state has it’s own. Since you do not hold a lender license, you are not exempt from usury limits so your note and deed of trust must be within the state limits to comply.
Ensure you have a recorded deed of trust plus a promissory note to secure your investment. You can invest passively like this using your personal name or an entity. Your profits are NOT capital gains, it is interest income. Consult with your CPA for details on this. If you had an equity share instead of a debt position, the profits on flips for that are still NOT capital gains, it is earned income taxed at your income bracket.
The position of your investment (deed of trust) is very important too. If you are in anything other than first position, you have higher risks and as such, may warrant additional protections or higher returns. Additional protections can be additional collateral, personal guarantee by borrower (assuming they have assets to back that), or cross collateral of another investment.
The experience level and track record of the borrower is the primary factor and the loan to value is the second factor. Each should be more than adequate to protect your capital.
Lender · Springfield, MO · Member since 2020 · 351 posts · 504 votes
4y
I'm going to stop you for a second and say the worry should be focused around the return OF capital and then the return ON capital. You need to have certain safeguards in place and price the loan according to the risk involved. For example, a borrower that only needs 50% of the ARV on a cosmetic rehab in my market is far less of a risk in the loan that someone who wants 75% and is then bringing in more of their own capital for the rehab, so maybe make $5k off the deal, if everything goes smoothly. So I would price the first loan lower (given all the other parameters of the loan are same) than I would the second one.
Things to do to mitigate your risk on LOSS of capital (hence return OF capital ) would be:
1) All money flows through the closing agent/attorney. The borrower signs docs there, they record them, you get some originals back after recording and some after closing, and the funds provided get wired directly to the closing agent, NOT THE BORROWER.
2) Make sure there is adequate insurance on the property. You want replacement cost value (RCV) policies as opposed to ACV policies. RCV will give today's dollars in replacement cost, versus the other option which takes into account depreciation of the assets being replaced (so hence lower payout if something happens). You are lending on the structure AND the land, but you can only get insurance for the structure. Make sure that structure coverage is enough to at least cover your loan, preferably more. Get added as a mortgagee/loss payee to the insurance so if it lapses or there is a claim, you are notified. In the case of it lapsing you can then force place insurance to protect the asset.
3) Get lenders title insurance (the borrower pays for this as well). Read the policy, make sure you understand are comfortable with the exclusions. IF you don't understand it, ask your title rep or attorney familiar with lending.
4) Get loan docs professionally drawn up by someone familiar with lending in your market. DO NOT use templates you found off the internet. Most states have bare minimum information and language that has to be included in lien documents in order to be enforceable, so you don't want to lose all your capital just because you didn't feel like paying an attorney $1000 to draw up documents protecting 100k+ plus in capital. PS. This can also be added on to the borrower to pay.
5) Know the USURY limits in your market. There are many states that have upper limits on the amount of interest and fees. You again don't want to be over that and have your loan declared illegal. You could lose your capital or have to pay back all the interest the borrower paid you over the course of the loan. Do not mess with the usury laws!
6) Get scope of work for the project, have them supply live video walk throughs if you are not local to the property. You can google walk the neighborhood as well to get a feel for the area if you aren't local. Make sure that scope of work makes sense for the property and the area. Over improvement is a real thing! THe last thing you want is a borrower that spends too much on a property, and now they have no reserves to do a refinance into conventional financing or the market softens and they have to sell at a loss (and hopefully not your loss because you aren't lending all the way up to 100% LTV).
7) NOW you can think about interest rates. Again, this is going to be widely different from market to market, and potentially loan to loan because no two loans are the same. First lien mortgages are usually 8% to 14% from most private lenders I know personally. For those that do 2nd lien loans, those are costlier (because of the higher risk) and they are generally starting at around 14% and just go up from there. Again, private lending if very flexible so don't take these ranges as gospel. Protect yourself first, and then worry about the return.
Accountant · New York, NY · Member since 2015 · 8k+ posts · 3k+ votes
4y
Somethings do not make sense...
How are they able to provide monthly returns if they are performing flips?
Flips as a business practice do not provide monthly returns. They normally have a large cash-outflow in the start, outflows throughout the project and then an inflow at the time the project is sold. I normally also run away from projects that 'promise' or 'guarantee' a return.
Lender · PA · Member since 2019 · 533 posts · 461 votes
4y
If your borrower is financing the transaction other than through your friend you will be unable to get a mortgage position. If you are going to provide all of the financing than it is much lower risk as you can take a first mortgage position on the property.
Be aware it only takes one deal which does not pan pout to put your capital at risk. So it is not risk free. Honestly, unless you are getting a first mortgage I would steer clear of financing flips. As to 10 percent as a return at time of sale, it seems to low if you are essentially the equity partner in the deal.
Finally, if your friend is doing so well how come he needs to borrow money from you to do his deals? Just something to think about. If you are going to lend him money I would want a credit report and also a financial statement. You should essentially follow the steps any lender would take before lending money into a real estate transaction. Good luck.
Hi everyone - thanks for the input. Great things to consider and I'll definitely be following some of the steps/thought processes put forth.
The property to be purchased would be in the Philadelphia area.
I am hesitant to provide such a large investment for such little return. If the investment was 100k, and the flip takes 6 months, I'd only see a profit of 5k.
