Private Money for fix and flip

[Sipan Y.]

I found a person who is willing to make some investment in my future fix and flip real estate business (private money). Basically I don' t want to do a project as joint venture. He wants collateral for his investment. My question is what is common in the industry for private money cases like this. What should I do? Any recommendations are appreciated.

Thanks! 

[Jeff S.]

There are a few ways to do this, @Sipan Y. Traditionally, when someone is paying all the costs, i.e. purchase and rehab, and you are doing all the labor (acquisition, rehab, selling, etc.) then you would split the profit 50/50 as a partnership.

Your friend would buy the property in an entity he controls 100% and there would be a partnership agreement between you and that entity. Don’t forget, he’s taking all the financial risk. If you are not able to perform, per your partnership agreement, the entity could “fire” you and perhaps pay you a finder fee of some sort (or nothing since you’d likely be leaving him with a busted flip).

If the deal goes as planned, you would split any profit from the sale after all of his costs were subtracted.

On the other hand, your friend could fund the purchase to you as a private loan using professionally prepared loan documents. You would fund the rehab and do all the work. In this case, you would own the property 100% but with a first position lien from your friend.

You could make monthly payments to him or pay everything back at closing, as negotiated into your loan docs. Here, he would be entitled to his interest (and points if he’s sophisticated enough to require them) and you would keep the remaining profits.

Only about 1347 variations on this, but those are the basics of an equity interest and a debt interest in a flip.

Just so you know, it typically works out that a hard money lender will end up with about 25% to 33% of the profit in a flip, for relatively little risk. In a 50/50 partnership, your partner will obviously get 50% but incurs all the risk. That is, even at the confiscatory rates most HML's charge, financially you're almost always better off borrowing the money.

[Sipan Y.]

 Thank you @Jeff S. 

Very helpful. Also, I need to know if a partnership agreement or a private load documents need to be prepared by an attorney (customized), or there are templates available that can be used. Thank you! 

[Sipan Y.]

@Jeff S.

Thank you @Jeff S.

Very helpful. Also, I need to know if a partnership agreement or a private load documents need to be prepared by an attorney (customized), or there are templates available that can be used. Thank you!

[Jeff S.]

@Sipan Y.

If you asked a friend to risk 100% of what could be a life-changing amount of money, and then added that instead of using a lawyer to protect him, you’ve chosen to obtain your documents off the web, how do you think he would feel? As importantly, do you think this is a fair way to treat a friend willing to help you?

Realistically, once you decide your involvement with one another, your friend must hire an attorney to protect his interests. You perhaps, could sit in.

[Sipan Y.]

@Jeff S.

Make sense . Thank you! 

[Matthew Jordan]

To @Jeff S. point, borrowing the money will always boost your returns because you are giving away less profit. The question I think it whether you want to use private money or hard money. Private money can be great depending on the relationship you have with the person and how sophisticated they are. With hard money it is more of a process and typically a lender will require the rehab budget to be lent out through draws. I think this helps the borrower by keeping them honest as well as require a 3rd party inspector to approve the work. Even the best borrowers miss things and a 3rd party inspection helps insure the work is done properly. In addition, your private money lender could run out of money as you grow or decide they don't want to be in the business anymore whereas hard money has the pockets to grow with you. Food for thought.