Holding or Flipping: Which is Best for Private Money?

There's a source of some debate about whether private money is better suited for a 'buy and hold' approach or a 'flipping' strategy for real estate investing. Real estate investors correctly point out that their private investors will want to exit (or the availability of exit) from their investment at a future date, which could cause financing issues with the project.You don't want to mess with a good thing if you have a nice cash flowing property. So, which is private money best for: flipping or holding?

First of all, you shouldn't think in terms of either/or. You can successfully flip and hold properties with private money. How you structure the deal, though, will determine the extent of your profitability with each.When it comes to flipping, turning properties over quickly can generate healthy profits for you, but you must be careful to pay your private investors an appropriate rate. Set it up so that you pay them an 'annualized' return on their money. Here's an example:

Private Money Investment: $100,000

Annual Interest Rate: 10%

Deal Profits: $25,000

Money Invested for: 45 days

Cost of Funds: $1,250

*The cost of funds should not be total points on the amount borrowed - is should be prorated annually.

In the above example, you are borrowing private money to buy and sell the property, you are making a net profit of $23,750 after you pay your investor $1,250. While this may seem disproportionate in your favor, the investor still got a great return on their money. You must protect your profits. Too many real estate investors would be willing to give up more than necessary on this type of deal - you don't have to if you know how to set things up with the investor at the outset.

You can impair profits if you finance a long term hold with a private investor who has a 3-5 year time frame. If you plan on holding it for the rest of your life (and your kids' lives) then it isn't far fetched to consider buying your equity investor out with your share of the cash flows (it nets out to be the same cash on cash return for you) or setting up the note to be amortized, where you pay off part principal and interest each month.

However, private money equity partners are better than lenders for buy & hold properties. The investor comes into the project as a profit sharing partner with you and, thus, you both have the same time frame for investment going in. Many private investors would welcome a buy and hold investment, as it reduces their worry about how to turn the funds over when the investment redeems.

Private Money Re-finance

Another option to use on buy and hold with an investor that has a shorter time frame than project length is to replace their funds with those of another private investor. It can be much easier to bring a new private investor into your business on an already performing project than an altogether new investment. Keep this in mind to bring in new funds continually. You can set up the deal so that down the road, one investor can sell their interest in the project to another private investor or they can sell the note.  Take care to structure your promissory notes so that they can be sold from one investor to another or set it up so that one investor pays off the note and another investor re-loans you the money. Think of it as refinancing one private investor with another, just like a bank would do.

The best thing about working with private money is the financing flexibility you achieve with it. As long as the returns on there for you and the investor, everybody wins.