Protecting my money in a rehab partnership
Real Estate Investor · Saint Petersburg, FL · Member since 2013 · 56 posts · 13 votes
I am considering partnering with a contractor on a rehab and need some ideas on how to protect my investment in the property. The contractor used a hard money loan to acquire the property and would like for me to provide the rehab costs. We discussed putting a lien on the property for the rehab costs which is fine but being that there is already a loan on the property how can I ensure that my interest in the property will not go away if the contractor defaults on the hard money loan? Thanks BP!
Marc,
The best way would be to have the HML subordinate the loan. But I am assuming that isn't possible for this scenario.
How are you going to structure the deal? Are you just going to be a debt lender? If you put a 2nd lien on the building make sure the total ARV has enough potential equity in the deal to make it work. If the contractor doesn't perform do you have the capability to finish the project on your own?
Confirm with another contractor on the rehab pricing just in case something happens with the first contractor. He might say he can do the work for 50k however it actually would be 75k if you paid another contractor. Does the contractor have experience flipping houses? One of the best ways you can protect your investment is to properly manage your draws. I would include in your pricing to have a third party inspector come out every so often to make sure everything is going as planned. Be very clear about your method and approach at the beginning. Managing expectations is one of the most important things you can do in a partnership/lender scenario like this.
Good luck!
Chris
Marc,
The best way would be to have the HML subordinate the loan. But I am assuming that isn't possible for this scenario.
How are you going to structure the deal? Are you just going to be a debt lender? If you put a 2nd lien on the building make sure the total ARV has enough potential equity in the deal to make it work. If the contractor doesn't perform do you have the capability to finish the project on your own?
Confirm with another contractor on the rehab pricing just in case something happens with the first contractor. He might say he can do the work for 50k however it actually would be 75k if you paid another contractor. Does the contractor have experience flipping houses? One of the best ways you can protect your investment is to properly manage your draws. I would include in your pricing to have a third party inspector come out every so often to make sure everything is going as planned. Be very clear about your method and approach at the beginning. Managing expectations is one of the most important things you can do in a partnership/lender scenario like this.
Good luck!
Chris
I would not do this deal. The hml is probably charging 15% APR for their fairly secure 1st position, what do you think the risk premium on your 2nd should be? 30%, 40%, 50%. This is extremely risky. There are plenty of deals you can find that will give you a solid 1st, focus on finding those, you can start at your reia group, as well as ask for referrals from realtors that sell for flippers.
@Chris Winterhalter "The best way would be to have the HML subordinate the loan. But I am assuming that isn't possible for this scenario." I am not familiar with this. Does this mean the HML will hold 2nd position?
the Contractor wants 50% of rehab costs upfront, (not going to happen) then the rest on a draw. We are to have weekly meetings going over the costs, schedule etc... So I will have an "active role" in the partnership I guess you could say.
The contractor does have experience flipping properties and he showed me 2 completed projects and 2 ongoing projects. Clean job sites and quality work. I performed a background check, no liens, judgments, licensed and insured, etc ...
The profit split will be 50/50, the numbers are as follows:
28,209.13 due at closing
25k HML @ 15%
1 yr prepay penalty of 3,750.00
28,209.13 + 3750.00 = 31,959.13 + 35k (projected rehab/holding cost) = 66,959.13 + 5k closing = 71,959.50
ARV is 110K
110,000 - 71,959.5 = 38,040.50 / 2 = 19,020.25 potential profit.
My real concern is that the property is titled in the contractor's LLC, there is money owed and I have no control of the property.
An HML is not going to subordinate their position, I'd bet on that.
I doubt I do this deal, but, your money in a partnership is protected in the by laws or operating agreement in partnership agreements, filing a deed of trust or mtg isn't necessary unless you want to be a lender. The LLC holds title, you can enter that LLC and under the operating agreement you can be first in line to sale proceeds as well as having the right to sell. Need to see your attorney on this. :)
A partnership option might be best if you are going to structure the deal at a 50/50 profit split...where you own 50% of the LLC that owns the property. The HML will need to lend to that LLC or give permission to the transfer. An operating agreement with all the proper language will need to be written up by a good lawyer. It's a lot of work and comes with higher risks than lending with a 1st position. That potential profit can drop quickly if things don't go as planned. To properly mitigate your risk it will take a fair amount of your time especially since this is your first deal of this type.
Like @David Beard said there are plenty of deals out there for lending your money in 1st positions. You might be better off pursuing those deals. However if you still want to pursue the deal make sure you are extremely upfront with the contractor. The structure he has laid out isn't going to work. Also pay the money for a good lawyer...it will be well worth your investment.
Originally posted by Bill Gulley:
Need to see your attorney on this. :)
Originally posted by Chris Winterhalter:
@Marc Pfleger
Just placed the call - thanks
what if my llc were to purchase the property from the contractor's LLC with an understanding that a separate partnership agreement will be drafted?
Marc, I have to admit that the profit numbers you're showing are very strong, and my view might change, as the ROI potential is 100%+. Pluses are that you're dealing with a contractor who should have the rehab numbers pretty tight, and he has some track record of success. I'd triple check the ARV, get a realtor who sells the area to provide a CMA, as turning a 25k house into a 110k deal is a bit unusual, and it doesn't sound like SF is being added to the house.
Do you have 25k to pay off the hml if the contractor defaults? Also, ask the attorney about doing a profit-participation mortgage rather than an LLC with the rehabber. There are some advantages to being off title, such as limiting liability, and its a lot simpler transaction.
Anyway, if your due diligence is coming up great on the contractor, and you can triple validate the ARV, then I definitely think the deal is worth some strong consideration.
Your terms could be handled in a shared appreciation mortgage, or participation loan, or whatever they call them in your state, @Marc Pfleger – assuming these are legal in FL. Speak to a good lending attorney. Unless you can get yourself on title somehow as an equity partner, you’ll be in second position no matter what. This is never a good place to be in my view; especially loaning to what appears to be a stranger, from the way you write, who's using an HML I bet you don't know. Knowledge of the borrower is the basis for private loans as these.
Before you do a loan like this you should get to know, like, and trust your borrower. Checking for “liens, judgments, licensed and insured, etc ...” is no assurance he has the integrity of someone you want to business with. I know you know this because of the concern in your post. This loan could work out well for you but it seems particularly risky to me since it sounds like you don’t know whom you're loaning to.
I really do agree with the others that, from the values you mention, you might have enough to do much safer first position loans. Don’t be blinded by returns.
If you do decide to go ahead with this loan, make sure the first position HML will allow a second since some have issues with these. Also, get a copy and read the first note and mortgage so you know who's ahead of you and under what terms. Have you spoken to and checked out his other lender? What are their feelings toward seconds? Delays happen frequently. How eager are they about loan extensions?
Good luck, Marc.
Jeff
Agree with David in nailing things down.
I respect Chris' opinions, but on this, I wouldn't say a mortgage is "better" in a partnership.
If you're a lender, you'll be foreclosing on that interest, you'll be selling to satisfy the mortgage interest only. As a partner you can force sale for a profit.
Agreeing to a profit sharing mortgage can have usury issues. Having a mortgage lien, you can't dictate a sales price either, if you were to say no to a sale as a lender that would have cleared your note, you just put your security interest in question. Another issue is checking on state requirements to do commercial lending, if you make a loan and are not in compliance with registrations, licenses or filings, your loan may not be enforceable, so you'll need to check and see if people off the street can make commercial loans.
Drafting an operating agreement as a modification to the original or changing it is not a difficult matter for a business/RE attorney, it's an issues of the priority of capital contributions and one member having the power of sale. Not complicated.
I suggest you not buy the LLC from a contractor who has done rehabs in the past in that LLC. He likely has liabilities out there on his work that can come back and haunt you. Either go in as a member being held harmless by him, or form a partnership and put the property in the newly formed LLC.
I'm a little skidish too on the partner having the lack of funds, so you need to be in a position to sell with the least amount of issues. Another concern is his ability to cover liabilities in his LLC, another hard look which makes me lean to a new LLC, you may not get hung in his company and you may have priority, but if he folds you'll still have problems. :)
Marc -- this is probably a lot more advice than you bargained for! Great comments are being made by these seasoned guys. A few things that might swing this in favor, in my view.
This is a low entry investment. Funding a rehab deal usually involves $70k+, but you can do this for half that amount. You might not have $70k cash laying around just yet.
If the numbers all check out, and it's truly a 60%-of-ARV deal, there is enough meat on this for you to come out whole under all but the most adverse of circumstances that might occur (i.e. bankruptcy, lawsuits going back and forth while property sits vacant and gets vandalized, etc.)
Also, it's a great opportunity for you to learn the rehabbing business. Spend time over at the project (stay out of the way), and ask lots of questions to the rehabber about why he's doing things a certain way, what are the costs, selection of finish quality, how to best manage subs (make notes of who those subs are and what they're being paid, for future reference), marketing the finished home, etc. Perhaps soon you'll be doing your own projects and capturing all of the profit.
Heck, some people pay $25-40k to gurus to learn the business. You can spend the same and probably walk away with your investment back plus $10k of profit. (I don't buy the $19k each on such a modest investment, just feels too rich and likely over(under) estimates various items.
I agree with @David Beard: buy out the first mortgage and your investment becomes first lien on the property. I would prefer to be a lender vs. a partner. Why? You share the risks (liability of a vacant property; what if the house remains did not sell, etc) with being a partner. As a lender, if you structure the deal correctly, you get to have first lien on the property and you get the property if the rehabber defaults. Also, if he has done only 4 deals with 2 properties that are not yet sold, he has not done enough deals to be experienced enough. Whenever I lend money, I require at least 5 HUD settlement statements showing that the rehabber-borrower has done at least 5 deals.
Call me if you have questions.
Wendell, we usually don't solicit posters to contact us outside the forum, they should post questions, however you can PM them, just make contact .
Let's run another issue by for all those wanting to jump on the lender bandwagon. Something happens to your borrower, like drops dead, you as a lender with your deed of trust don't have the authority to walk in there and put another rehab guy in there to finish the property, you're a lender, you have no ownership rights. You can't get a DIL from a dead guy, you might through the estate settlement, but an administrator or executor usually sells property, they don't give it away. If you foreclose, you're a lender,, you're not entitled to any more than the debt and costs outstanding, the borrower can sue for the overage if any.
Just saying, making a loan is easy, but most small, occasional lending types usually are not aware of the liabilities and risk of lending, taking an ownership interest is better in every situation with jointly owned properties, I can't think of a single advantage of holding a deed of trust, especially a second. Once a lender, always a lender.
I know David and Jeff make loans, they may not partner that much I don't know, both have made good points. Maybe another lender type @Dion DePaoli might give insights to lending vs owning. :)
If you have an ownership interest and the owner gets sued, that's you getting sued, as a lender you are not a party to the lawsuit. I see that as an advantage of a debt position over an equity position. Also, if you have a deed of trust, you can wipe off liens that might attach, an owner can't. That actually happened to me, I loaned a guy some money secured by a dot, and a giant IRS lien attached that I was able to wipe off with a foreclosure.
David, Not necessarily true as to a law suit and liability of a partner after the fact. If there are concerns an LLC can be the member in another LLC and the property transferred.
A foreclosure doesn't "wipe out" IRS liens, if they cut loose of the lien it was by choice and it's common, but not required. There is also the innocent party defense with the IRS where they may be just as inclined to release a lien where there is joint or a minority interest to property.
IMO it's not worth having to comply with lender's requirements for one small loan trying to put your hooks in a deal.
You could go at it on two fronts as well. Have another entity as the lender and partner individually or as another entity. There are endless combinations.
I suspect too that anyone who may advocate the use of a profit sharing arrangement in a note hasn't been exposed to the claims that can arise if the parties disagree and things blow up. They may work fine, like any agreement through clear sailing, they don't work as well in storms as any debt instrument secured only secures the financial interests outstanding, not the possibilities that may have existed if things went as expected. You can't add in the what could have been in the balance owing in a foreclosure. But, we all have opinions. :)
wow, the feedback is amazing. I need to read through and digest all of this. The more I think about it the less I like the deal. Thanks BP. I will do some more homework and probably will have more questions. thanks again everyone!
Do you know when your lawyer tells you to put a silly what-if clause in a contract because, “What if someone dies,” and you shake your head at his conservatism? Some years ago I was flipping a few out of state properties (in Cincinnati no less, David) and my partner on the ground there was killed in a car accident. He was a good looking 28 year old, who had the world by the tail; so I am no stranger to your comments, Bill. I understand them, but I do not agree. These things do happen, but you can’t let them run your business. Since then, my wife and I no longer partner, in any form, but it’s not for why you think.
We much prefer the security of a first trust deed than relying on some else’s ability to make a profit on a rehab for us. We are fortunate to work with many skilled and honorable flippers, who also work their butts off – a skill I have much respect for, and earn every dime they make. Understandably, they don’t hit every property out of the park.
Partnering at even at the “silent” investor level still requires work and a level of trust not necessary in a loan. I have neither the time nor the inclination. So long as we know our borrowers well and the numbers work (that is, they bought right and can control costs) our security is reasonably assured (note: I didn’t say certain). This is all easy to establish. While I agree that best-case numbers almost always support partnering over lending, there is no assurance we would make money in a partnership or even come out whole or unscathed.
Yes, if one of our borrowers died it would be nightmare and our percent return would likely drop. But, as secured first position lenders we’ll eventually get repaid what we're owed plus costs. I much prefer that than having to rely that someone actually knows how to flip a house, keep the books honestly and accurately, and not succumb to the whims of the market, or the building department, or the IRS, or who know what else.
I mean, it’s not like anything bad could happen.
Jeff
Yes, much more than you bargained for, Marc.
It's a nice thread to walk through the issues, because these "partnering" questions come up constantly.
I'll mention the tax issue as well. A lender's return may be construed as investment income (passive), whereas a partner's return in a flip is without doubt a-ctive income, potentially incurring self-employment taxes. And if done from a tax-qualified account, then passive income can be deferred, but active income is likely subject to UBIT.
I can do (1) straight loans (11%+3 pts for example, for 9 mths), (2) 50/50 participating mortgages, or (3) 50/50 LLC partnerships, in the cases where I have a choice. Typically straight loans require the rehabber to come out of pocket with at least some cash during the term of the deal, whereas the last two options typically require zero cash from the rehabber. Clearly the straight lender is less risky since they get paid ahead of the rehabber's profit.
@Jeff S. - I think you're defending doing straight loans rather than doing either (2) or (3). I was looking at the merits of doing (2) versus (3) in cases where I'm funding it all and am willing to take the risk to earn an outsized return (this is what the poster is looking at as well). In practice, I have been doing both (1) and (2), and attorney is comfortable with (2), though I know that Bill doesn't like the approach, and he makes some good points. I felt like I had liability issues, and the potential for partner squabbling, with being on title, thus my preference for (2) over (3). I'll check with a couple more attorneys and get a better read on it. I'm definitely "smaller" and still relatively new to the lender game, but I do like doing my homework thoroughly, so I'll check into it further. Also interested in tax implications/differences of (2) versus (3) for both taxable accounts and qualified accounts.
Let's put it this way, there is nothing in a deed of trust that can't be adopted in a partnership agreement.
There is nothing in a note that can't be agreed to in a partnership agreement.
You will likely be held to principal and interest only being secured my any loan arrangement, you can do the same thing in a partnership agreement.
A lender can't force a sale (besides through foreclosure) nor demand a property to be sold at or above a certain price, partners or owners can.
I had a few borrowers that I wish I could have fired, going over budget requiring more money to be poured in to save a project due to screw up, but as an owner or controlling manager I can fire a partner, make him go sit in a corner so to speak and if I go over budget, it's my fault since I have the purse strings.
If my borrower sees that more money is in another deal for him, walks off for two months, I can't run to my deed of trust to motivate him, but I can under a partnership agreement.
I've been through all of the "life events" as a lender, I can't demand full payment or require property be sold under any of such matters as a borrower dying or going to jail or getting divorced, but I can as a partner. I can also protect my investment if my partner takes bankruptcy, just as any lender may and, in some cases more so as loans are subject to cram downs, reduced principal or interest more than the interest of a partner might be.
I've probably had about 40 borrowers die. I can't terminate my loan at the grave site, I can a partnership. As a lender I can only hold my borrower to the covenants made under the note and deed of trust. If the borrower's spouse makes a payment, I have no recourse in getting something accomplished.
There is going to be a preferences by those who do what they usually do, being comfortable in doing what they do and having greater understanding of what they do compared to other ventures, naturally.
Not saying there are no advantages in lending as much as saying in comparison I see more advantages in a good partnership and ownership positions than those of a lender. I'm thinking that many if not most on BP have used or use or have seen the loosey-googsey partnership agreements and may not be aware of how well you can nail a working partner's feet down in a really good agreement.
I'll stop, but as a lender you only have those interests conveyed to you as a security interest, that's all you can be entitled to, ownerships rights are superior to any security interest, as they can only be conveyed by an owner. In the concept of the bundle of sticks of property rights, a lender only receives a few sticks out of that bundle.
Oh, and those who think they can wear two hats, being a lender and then calling the shots, without ownership, if your deal goes south you can bet the borrower is going to claim that the reason for the deal blowing up was due to lender involvement in management and if you did get involved, guess who looses, won't be the borrower. This is an old issue as banks use to take such positions, they were blamed, they lost, they lost money and they are not allowed to get involved any more in such loans. Don't try to wear the lender's hat and then act like an owner. :)
...I felt like I had liability issues, and the potential for partner squabbling, with being on title, thus my preference for (2) over (3).
... Also interested in tax implications/differences of (2) versus (3) for both taxable accounts and qualified accounts.
Yes, straight loans only though I’m not defending anything since everything here is viable. Just stating a personal preference. I see no difference between a 50/50 participation loan, 50/50 LLC partnership (assuming security rules are met), or any arrangement that relies on someone else to make the profit. It’s the reliance I don’t like, though I believe any loan is safer than direct LLC ownership since it avoids the squabbling and title liability issues you mention. Bill does make some good points.
All of these require your participation at some level, even if it simply means reviewing the books. What happens if something doesn't look right, even innocently? I also like the security of a note, even if it's a participation loan, which is something you can't get from an LLC.
We don’t do them, but you have me wondering how the return on a participation loan is treated for taxes. Are the active and passive portions split out? Good question, David. Let us know what you find out.
Jeff
Great thread. The one piece that I see missing is the fact that by lending funds and entering into a contract with the expectation of profit (not interest) solely through the effort of the sponsor, he has created a security. If he doesn't die but loses your money, you can call on the SEC to get your money back. Seriously though, he is in trouble with this deal without setting up Private placement through a state or fed exemption.
We have called these profit sharing loans, profit sharing mortgages, I suppose there can be some other slang names, but a "participating loan/mortgage" is one by legal definition a loan made by two or more lenders. Not picking really, as it carries a completely different meaning in lending with legal aspects as to participating lenders and how these loans can be sliced up.
I'll say too that what is customary in your state and local area will certainly be a factor, it always is. Sharing in profits is more accepted and accomplished in developments with general partnerships in larger transactions. I'd say someone took the idea and adapted the concept to HMLs or private lenders in doing small deals simply as a profit motive, no issue with profit so long as you're compliant. But these are not really common on a SFD with a rehabber, not in my area, or in Missouri I'd say, not structured as a loan.
David is right on my hedging away from partnerships inside of a note sharing profit as a loan cost to a borrower comes from personal experience in three different transactions.
My first bankruptcy with a borrower, I didn't even show up as my attorney took care of it. Long story short, property was ordered to be sold, I wanted it and would forgive the loan, no, there was apparent equity. That's why I learned and say, you can't secure profits expected. I think the place finally sold and I got the cash principal and some, not all interest as I expected, but nothing above that.
Next the contractor was building new homes on a golf course, actually more of a proposed golf course that was more of a cow pasture. He got a divorce, plans on hold. One property was built nothing but a small punch list left. Properties were ordered to be sold, I barked about the proposed profits, attorney told me to take a hike and I did as it was a court ordered sale, just got paid off again as my profit sharing note only had a deed of trust.
I do learn. Slightly singed on this strategy, a commercial deal came along, business and RE. Having learned at that young age, I did my note and did a partnership agreement. This was a welding shop, I'm not a welder but the welder wasn't a business guy either. Sounded like a good marriage. Welder turns out to be a drunk, my oversight. While he too got a divorce, "his" business was not sold, no or little equity really, she didn't go for blood and his tools of his trade are protected. But that just started the downward spiral. I got involved on the business side, as we agreed, he lost jobs, couldn't cover costs, looked like he was heading to that same bankruptcy court, but no. So, he gave me a deed in lieu of foreclosure since he was like 5 months behind. Plan was, I'd take the property, he'd close and reopen taking different types of welding work more as a job on that site, paying rents. Thought all was good. Nope, he goy sued by other creditors and got an attorney. The ink wasn't dry on the DIL. The attorney called and informed me that, as he claimed, 1. I had no right to take a DIL on a deal I had partnered in. 2. Due to my participation in management (I already knew where this was going as I was aware of banks not being able to do such things for the same reason) that the reason he failed in the first business was contributed to my guiding him in the business. 3. That I was going to be sued for wrongful foreclosure I believe it was by accepting a deed that he had not offered, 4. that the entire loan amount would be damages, that there would be no further business dealings. I do recall him saying "predatory lending". Now this was way back when too, way before predatory lending was a common phrase. Okay, again, forget it, you can have it all back, save a fight and just pay the initial loan back, which was the agreement reached.
I don't really believe I was any more naïve then as most here, I've never been one to just skip off at the drop of a hat. However, I could see they had valid issues and there was really no way to argue the point. Best to gather your toys and go home.
That was my last profit sharing arrangement from a lending position involved.
Since then I had several successful deals, one very successful in a steel fabrication business, a grocery store and several smaller deals. Those were no problem due to a very good partnership agreement. In those deals I went through another divorce matter, no problem; and the death of a spouse of a partner, no real issue; and a personal bankruptcy of a member partner, no issue. All of my lending was done inside the partnership I didn't hold any deeds.
So, there you have it, not just experience from my barking regulatory platform but from personal suffrage as well. I too had a learning curve.
A really good partnership/LLC is about 60 pages long, it's no simple 5 page deal drafted up off the internet. It only cost about $1,500 back then. Let's see, it saved and or made 100 times that, a heck of a deal!
If you guys want to do your 50/50 loans, be my guest, good luck and stay away from getting involved in any way shape or form I'd say. I did those early few without a hitch, the more you do the more your risks will increase as your exposure to those life events are more likely to surface. I just learned there was an easier way by keeping with customary practices in my area. :)
Would an easier, less complicated option be to purchase the property from the contractor so I own the property outright and then draft a contract basically stating the contractor will be compensated for his time when the property is sold? I do not want to get into the lending game as I know next to nothing about it.
Yep, that would be much cleaner and easier. That's the customary way. :)
Sorry it took me a moment to join the conversation, I seemed to have messed up my BP notice emails.
Anyway, in my personal own opinion, this is not a good deal to be a lender. I don't think we really need to venture too far away from the first most basic question, how is it an experienced construction guy and rehabber takes on an asset with insufficient capital?
The HML this borrower has teamed up with is not doing him any favors either nor do I have a lot of pleasant thoughts about their skills, which in my opinion shows a lack of expertise as being a lender. The HML has a built in prepayment penalty which is essentially making sure they get their 15% for the year regardless of completion time. To that extent, there is no incentive to pay the loan off prior to the end of the year.
To me the conversation 'seems' to have become interesting because frankly, you are being asked to clean up both these two folks mess. Let's be honest, the HML guy got into this without making sure the contractor can finish the project as well. So between two of the main parties here, we get a house that needs completion but no money to complete it. This is a mess waiting to happen. The construction guy is over extended, it is subtle hidden, but it is here. The borrower has other projects in process, not completed. So the borrower made a decision to frankly take on more than he can handle in terms of capital. I would be curious to know the term of those other projects, how long they have been owned and if all involved parties are the same here.
I might be inclined to offer to take out the HML and rehabber and own the deed in full. Make the rehabber pay for rehab costs and material in full, since that is what he is performing (built in incentive to be cost efficient). This also reduces admin risk on draws and such. I like to call it, "Aces in places". You do the part your good at and I do the part I am good at, that is a union that get's things done.
To setup the arrangement, you would likely need to contract the rehab guy like a normal construction contract with itemized list of costs and a time to complete. He would want a clause that protects his expenses and I would want the same, so any abandonment on his behalf would be a forfeit to the labor which would be deferred as profit from the sale. Any material put into the property would be paid for dollar for dollar provided it is placed in the property. Any material paid for but not installed would be the construction guys issue not the deed owner issue. I am describing terms of breach here, for the record, it's a little short hand. If all goes well, no issues, if all goes south terms of breach kick in.
I think you get the idea of how I would approach it. Some might think that is a little tough and frankly, I would agree, it's tough because this to me looks a little messed up and seems like there is some risk under the hood that I am not sure the OP has washed out yet. I would want control over the destiny of my capital. There is plenty of other deals out there and better operators to work with. Not only do you need to be compensated for the risks, but you need to control your exposure here so the risk doesn't turn into a loss.
That prepayment penalty, btw, comes off of his side since he was silly enough to agree to it.
Hi Marc, It's been awhile, and I wonder what you decided to do. Read some of these answers and your reactions, lol.
I've been a real estate broker and investor/flipper out here in CALI for 31 years now, and I'm in the shoes of your contractor, so to speak.
I feel like I need to say a few words on behalf of both sides here:
For your sake, putting that much money into a project with this much risk is why it has the potential to pay such a high return. Why, I do believe that's why this website was created! :)
On behalf of the contractor who's doing the deal, presuming he's seasoned, serious, dedicated, and driven: Hey all you advice givers, the very LAST thing this contractor and for that matter any of us hands on flippers want/need/or have time for is a nervous first time workmen's comp accident magnet investor following us around on the job site day in and day out, distracting our focus and interrupting our daily project management. Now Marc, and others thinking of such foolishness: If you're bound and determined to be out there, LEND A HAND! Do some grunt work, like pickup, cleanup, mop up, and misc. gofer work in trade for the contractor's education. If you can't think of anything else then for Pete's sake go get the poor guy some lunch! He's NOT paying you to learn. That wasn't the deal, was it? He's already paying you a premium rate for the money. He owes you NO education. You are a risk to the project physically, and to both of your success if you are on the jobsite (bringing it in on time). If you absolutely insist, and he's foolish enough to acquiesce, fine: get some steel toed boots, a hard hat, a good pair of Levi's and be sure to wear working gloves and a heavy Carhart jacket so you at least reduce the chances of getting poked, cut, stomped on, whacked in the head, run through by a saws-all, or do anything else stupid while you're busy out there sweating, wringing your hands, and nervously looking out for your money. I'd say you should wear a retracting harness with a tether so you don't fall, but hey, any contractor I know would shoot you if you followed them on top of a roof so I think you're safe from falling, (not safe from bullets, so don't try going up there after them!) lol.
So, Marc, if the contractor should get sued and mess up your chances of resale, guess who'd be the first in line to think about doing that after falling down or hurting themselves on the jobsite?? (If not you, maybe a friend who you invited so you could show off a little....without thinking about the consequences?)
If the contractor should not get the project finished on time guess who might be holding up the show?? If the contractor should be delayed in being able to finish the deal most likely it's because of a rookie investor who's too nervous to trust and let the poor contractor grunt guy do the job. Don't agree? Guess again. Here's a few scenarios I can think of:
He had to take you to the hospital a few times and of course he had to send the crew home. He had to take you to the hospital a few times and of course missed the city inspector so had to reschedule! He had to go home and tie one on because you asked too many questions! He had to go home and tie a few more on because you asked too many questions, he missed too many city inspections, and his head hurt! He had to go to his shrink and get signed in to a rehab from tying too many on.
SO: Here's what I would do if I were you:
a. If you want to learn the biz, then learn the biz but since you are still learning, do this: put your money in a lower risk 1st td or a safe little cd somewhere until you've learned the biz. Read everything you can about the subject and see if this contractor will HIRE YOU as a gofer. LEARN by doing. See for yourself if he's a worthwhile investment. No doubt not this project, but maybe future ones.
b. If you want to jump into the biz *** over teakettle, take a chance with this guy and let him do the job. Be Helpful!! Then record the deed of trust as a second, interest only, balloon payment all payable at term, or however you agreed to do the deal. HOWEVER, I'd make sure you are cross-collateralizing that note with a note on one of his other projects with equity, or his personal residence. If he's the standup guy he says he is, he'll do it. If he's not, see item a or move on.
All kidding aside, the HML's are all out there looking for the cream off the top of the flips, and the market's changed considerably. That leaves you private investors holding the bag if something goes wrong. The rich equity flips aren't in abundance now, but good business IS out there if you get good partners that aren't greedy. Pigs get fat, hogs get slaughtered. I MUCH prefer to work with equity partners, forget HML's, unless they're reasonable and tuned in to today's market. I can give them good business in volume, but if they want to retire on ONE deal, they aren't going to get it from me. Good equity partners are wonderful to work with. I personally offer my equity partners a full 56% ride on everything if they bring 100% pp, rehab and closing costs on both ends to the deal. They are protected under my LLC, and they get full security with first deeds of trust, cross collats (if they want them, most of them don't bother because of our volume, and because of my track record) and they also receive the benefit of FREE accounting services for these transactions from my 27 year relationship with the same wonderful accountancy firm...speaking of outstanding track records! I always have several projects going in a pipeline and the after repair values of these projects range from $550,,000-$1,700,000, with $!1,200 000-$1,500,000 being a sweet spot price range in select prime target market areas.
Maybe this project was a little scary for you the first round. Hopefully I've been able to shed some light on the other side. If the contractor is a pro, seasoned, and serious, maybe not this time, but next time for you. If he's a winner, he'll make it with or without you, and you can team up another time when you've got a little more experience under your belt. Wish you the best of luck.