How to Structure Your Private Loans: An Interview with 4 Real Estate Investors

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[This article is an excerpt from Brandon Turner’s The Book on Investing in Real Estate with No (and Low) Money Down. You can pick up a copy from the BiggerPockets bookstore.]

You can structure a private lending deal in numerous ways, so rather than explain each one in theory, I want to introduce you to some other real-life investors who actually use private lending every day to run their real estate business. In this section, you’ll meet four BiggerPockets members who have agreed to share how they’ve structured their private money relationships, so you can gain some insight into how you might structure yours.

However, before I get to their stories, let me make a quick disclaimer: You can structure a lending arrangement in many different ways, but legalities can differ by state and even by county. These four investors are all highly professional real estate investors, and all have sought legal counsel before devising their current system for raising money. It’s vitally important for you to do the same—to sit down with an attorney to discuss your plans before you have an official meeting with your potential lender. Consider these interviews descriptive, not prescriptive.

1. Will Barnard—Barnard Enterprises, Inc.

Will Barnard is a full-time, professional real estate investor and developer in Southern California. He currently specializes in flipping luxury homes with values above $1 million. Will has experience in almost every aspect of real estate investing, including spec building, rehabbing, wholesaling, landlording, short sales, land development, and notes. He conducts millions of dollars in real estate transactions each year, primarily using money raised from private lenders.

How do you use private money?

“Typically, I will locate a great potential real estate opportunity and present it to my private lenders, explaining the deal in detail. I don’t utilize a ‘fund,’ but instead treat each deal separately and utilize certain lenders for each specific deal, sometimes using multiple lenders on one property by ‘fractionalizing’ the note, which basically means the note is split between different lenders based on their contributions.”

What kind of security do you offer your lenders?

“Each property we purchase is secured by a note and deed of trust, which gives the lenders the right to foreclose if I don’t fulfill my end of the relationship. Typically, I never borrow more than 70% of the total after-repair value, which gives the lenders a significant cushion against default. They are secured both by the deal and through the proper legal channels.”

“Additionally, I always list each of my lenders on the property insurance as ‘additionally insured,’ so if something were to happen to the home and the insurance money was to cover the loss, I couldn’t simply run off with the insurance settlement check.”

What kind of legal entity do you use?

“My business is a legal corporation (Barnard Enterprises, Inc.), so the private lenders actually make the loan to my corporation.”

Can you describe your money-raising process?

“Through consistent networking, I come across a lot of individuals looking for a secure place to diversify their portfolio. Whether it’s online in the BiggerPockets Forums or in the real world at a local real estate club, people with money are everywhere. My goal is to simply offer advice and tell my story, and the money usually finds me.”

Related: 7 Truths About Private Money That Will Help You Raise Capital

“Once I have a deal under contract or am close to it, I send an email out to my private investor list, giving them the entire rundown of the deal, including the ARV, comps, repair list, repair costs, and the purchase price. I also provide the math for the LTV and how much of my cash will go into the deal.”

“I will also, on occasion, post a thread in the BiggerPockets Real Estate Marketplace as well. Most of my private investors started out as family, friends, and people I had a relationship with. My web presence on BiggerPockets.com, my website, etc. also provided the opportunity to build new private investors.”

“My goal when raising money is to attract repeat lenders. I want my lenders to be happy with every part of the deal so they’ll come back to me time and time again.”

What kind of terms and rates do you offer?

“Typically, the terms are 6–12 months and 10%–12% annual interest, with interest and principal due in one balloon installment on maturity date.”

What kind of problems have you run into, and how have you overcome them?

“I have done a few loans over the past year that had interest-only payments rather than balloon payments. Due to longer holding times and holding costs, this has created cash flow and operating capital depletion at times.”

“I have had to borrow more money to complete rehabs to resolve this issue and, in the future, will likely not do any loans with payments. Other than that, I have had little to no problems, and all investors have been paid back both principal and interest every time.”

Learn more about Will Barnard and his luxury house flipping model by listening to his full interview on the BiggerPockets Podcast. You can also connect with Will through his BiggerPockets Profile or through his website at BarnardEnterprises.com.

2. Brian Burke—Praxis Capital, LLC

Brian Burke is co-founder and managing director of Praxis Capital, LLC, a real estate private equity investment firm created to provide high rates of return to his investors while tactically managing risk. He has been a real estate entrepreneur since 1989, purchasing more than 500 properties valued at over $150 million, primarily from foreclosures.

How do you use private money?

“I use private money in three different ways: I borrow it in the form of a private money loan (Loan); Blind Pool Funds (Blind Pool); and in identified asset funds (One Off). Both Blind Pools and One Off deals are considered a ‘fund,’ but in the case of a Blind Pool, the money goes into a pot, and I buy whatever I want with it, so long as the parameters of the deal match the
fund objective. In the case of a One Off, the asset is identified ahead of time, and the fund is assembled for the sole purpose of acquiring that asset and executing the predefined strategy.”

“On a Loan, we use one investor per loan per property. In the case of a fund, it could be funded by one person, but more often than not, it is funded by multiple investors into a pool.”

What kind of security do you offer your lenders?

“In the case of Loans, the source of funds is truly a lender, and the security they receive is a first deed of trust on a single property. I use this strategy to leverage the equity in my Blind Pool funds with debt. In this case, the fund buys a property for cash, then borrows money from a private lender who gets a first deed of trust, and the cash goes back to the pool to purchase more assets. In the case of the Blind Pool and One Off, those investors are not lenders, they are limited partners, and they receive no security other than an ownership interest in the entity.”

“The entity will own all of the acquired assets, so there is real estate behind their investment, but no direct security, as there is in the case of a Loan. Hence, the Loans are not securities, and the investments into the funds are.”

What kind of legal entity do you use?

“For a Loan, my ownership entity, either a Limited Partnership (LP) or Limited Liability Company (LLC), is the borrower, but no entity is formed for the purpose of the loan. The lender is either an individual, trust, LLC, corp, or whatever the lender uses (that’s up to them, and it doesn’t matter to me).”

“In the case of the Blind Pool, I typically use an LP, but that is only because I’m in California, and the LLC fees are high for entities that make a lot of income. Outside of California, I use an LLC. My management entity is the general partner of the LP (or managing member, in the case of LLC), and the investors are limited partners or LLC members.”

Can you describe your money-raising process?

“In the case of a Loan, they write a check or wire money to the title company, and when escrow closes, we receive the funds. In the case of a Blind Pool or One Off, the investor writes the check or wires the money to the LP or LLC, and the money goes in the account.”

Related: 4 Risks and Drawbacks to Using Private Money

“We have control of the funds and use it to make purchases (Blind Pool) or close on the transaction (One Off).”

What kind of terms and rates do you offer?

“Loans are 8% with interest-only monthly payments, and the principal is due in one year. Funds vary by the deal. Terms range from 30% to 70% splits of the profits; some funds offer an 8% preferred return, some do not.”

What kind of problems have you run into, and how have you overcome them?

“The biggest problem is recruiting new investors. I have a full-time employee as my director of investor relations, and his job is to conduct outreach to current and future investors.”

“Deal structure is the one thing that most new investors seem to get hung up on, but deal structure is simple compared to recruitment. That said, they are directly related to one another. If your deal terms don’t match the appetite of your audience, the project won’t get off the ground.”

“I have one fund that offers investors 30% of the profits, and initially, there was a lot of resistance on behalf of the potential investors, because they thought they weren’t getting a big enough share. I combated that in two ways: first was to offer funds with different strategies that had richer profit splits (70% to the LP), and the second way was to show that despite the fact that one fund had a 30% split, the investors are earning over 20% return consistently.”

“Some investors don’t care about the return, they just want a larger split, so we have something for them. Some don’t care about the split, they just want high returns. We have something for them, too. Some investors don’t want to tie their money up for longer than a year. We have a product that meets that criteria. It’s about having a menu of options for investors so that they can choose the right fit for their situation.”

To learn more about Brian Burke, listen to our full interview with him on the BiggerPockets Podcast. You can also connect with Brian through his BiggerPockets profile or on his website at Praxcap.com.

3. Glenn Schworm and Amber Higgins—Signature Home Buyers, Inc.

Glenn Schworm and Amber Higgins, a husband and wife team, are the owners of Signature Home Buyers, Inc., a real estate investing company based in upstate New York. Glenn and Amber’s business focuses heavily on flipping houses. Over the past several years, they have successfully flipped more than 100 deals using private money.

How do you use private money?

“We have raised over $2 million in private lending from average people, not lending institutions or savvy investors. We use the financing to fund our real estate flips. We finance 100% of the deal, including purchase, renovations, and some holding costs with the cash we raise.”

What kind of security do you offer your lenders?

“The lenders receive a note and mortgage for security on the loan. We also give the investors an insurance certificate made out to them so they know they are also protected with insurance in case of a total loss.”

What kind of legal entity do you use?

“We are a subchapter S corp. It is how we started and still operate to this day.”

Can you describe your money-raising process?

“When someone shows interest in investing, we mail them a professional packet explaining who we are and what we do. If they are local, we suggest they come and spend a little time with us, touring some of our current projects. At the end of that tour, we ask them, ‘Are you ready to invest with us?’”

“We typically take a minimum of $100,000 or more to start. If they have concerns, we suggest they start with one house and see how it goes for them. We tell them if they like the process, then they can do it again and again, as long as they would like. If they are ready, we put them in our queue, and when the next house comes up that is close to the money they can invest, we let them know we are almost ready.”

“When we have a close date in place, we ask them to wire the money to our attorney’s office to be held in escrow until the closing. At closing, our attorney uses the funds to make the purchase, then they wire us the difference with our closing statement. Remember, we borrow enough for the entire project up front. Then the investor gets their note and mortgage for their protection.”

“Each month, we send them a statement to show what their investment is accruing. At the end of the term, when we sell the house and close, we wire the principal and interest back to the investor, and we look for the next deal.”

“When we began, we did not have multiple investors on a project. However, once investors begin to grow their portfolio, we usually need to break it up on multiple houses in order to keep them fully invested. We try to not have more than three on any one deal. They are all individual mortgages, all in different positions.”

What kind of terms and rates do you offer?

“We pay from 8% to 14% annually. However, we only pay for the months we use it. It is a fixed rate, so the investors get paid whether we make money or not. When we were new, we paid higher rates, as we were a riskier investment, but now that we have a long, solid track record, we can pay less, as we are a much more secure investment.”

“All investors are paid at the end of the term in full. Our mortgage with investors is set up for a maximum of one year; rarely have we gone over, but when we do, we make sure the investor knows our plan, and their interest gets compounded starting on day one of the second year. We ask for an extension if necessary.”

What kind of problems have you run into, and how have you overcome them?

“The only problem I can think of is selling a house for less than expected, or holding it much longer than anticipated and having to bring money to the table in order to pay the investor. It is not fun, but it has happened.”

“My advice to all investors who use private investors is simple. Always pay your investors, no matter how good or bad you do on the deal. They have a set rate, and that is their investment. You have the risk of making it profitable, and if you do your homework up front and run the job efficiently, you should make more than the investors to make it a win-win.”

“However, if everything goes wrong, never screw your investors out of their money, or you will soon be out of business, and you will give us all a black eye! Treat your investors like gold, because they are the lifeblood to your business. Always send gifts at Christmas and birthdays. Make them feel special. Do what you say you will do, and you will build a huge base of investor money to grow your business as large as you want it.”

To learn more about Glenn and Amber, be sure to listen to our full interview with him and his wife Amber on the BiggerPockets Podcast. You can connect with Glenn on his BiggerPockets profile or on his website at SignatureHomeBuyers.com.

4. Dave Van Horn—PPR The Note Co.

Dave Van Horn is the president of PPR The Note Co., an operating entity that manages several funds that buy/sell/hold residential mortgages, both performing and delinquent. Dave has been in the real estate business for 25 years, starting out as a realtor and contractor and moving on to everything from fix and flips to raising private money. Dave currently raises millions of dollars from private investors in the rather unique niche of real estate note investing.

How do you use private money?

“I started by raising money from one investor for one property. Then I started doing private placements for real estate deals, and then I started doing them for notes. So for me, it was a natural progression. Although I started by doing one-offs, today, as a company, we use private money in our fund.”

“I suggest hosting Investor Open Houses (Q&As) to provide investors with the opportunity to “see under the hood” of the business. We like to encourage transparency, and hosting these events is something that our investors have really shown an appreciation for.”

“We attend a lot of events and strive to teach people about raising money, for example, self-directed IRA events. Teaching people your business model and how you raise capital is actually a great way to raise money. Raising capital for charity is another great way to mingle with the accredited. Another great way is to join CEO and networking groups.”

“Developing a solid reputation is very important. With other people’s money comes more responsibility, especially since it is their hard-earned money or retirement money. Even if you are a private offering, and reports aren’t necessary, constant communication with investors (before, during, and after) is still the way to go, and it also keeps retention up.”

“Do the right thing, do what you say, and spend the money to hire a securities or real estate attorney to get the paperwork done right. I do the same paperwork regardless of who’s lending to whom.”

“If I’m lending money, I use the same paperwork that I require of my lenders.”

What kind of security do you offer your lenders?

“A property or a note is collateralized through the recording process at the underlying asset’s county courthouse. Equity investors in our fund are collateralized by a blue sky filing in the state that they’re from. In other words, our investor’s capital is collateralized by the assets of the LLC that’s tied to the offering (i.e., they own shares of the company).”

What kind of legal entity do you use?

“We use an LLC structure as part of our private offering. The owners are Class A members who own more than 50%. All other classes of members are equity investors. We use a securities attorney to set up the private placement and register all the filings, including our blue sky filings.”

Can you describe your money-raising process?

“If we’re tying a lender to a property or an individual note, funding is wired at the time of closing, when it’s going to be recorded.”

“For an interested investor of our note fund, the process usually starts with an interview with our Investor Relations Department to see if there’s a qualified fit. If so, we provide this accredited individual with a link and secure access to our private placement documents, which includes the offering, operating agreement of the company, purchaser’s questionnaire of eligibility, W9, ACH form, signature pages, etc. The offering includes risk disclosures, our business plan, and a descriptive use of proceeds. The offering explains how everything works—the fund, the company, etc. If they want to move forward, they fill this paperwork out and send it in (via mail, email, or fax).”

“They submit their subscription agreement and fund their involvement with certified check or wire. We pay our investors a flat return every month, whether the money is in use or not. We utilize capital from the fund to pursue deals as they come up.”

What kind of terms and rates do you offer?

“In our note fund, our current offering is for $15 million. It’s a three-year term with a set preferred return of 11%, which is paid monthly via ACH. The minimum investment is $10K, $5K a share.”

“When we borrow against an individual note or lend on a property, our rates and terms vary.”

What kind of problems have you run into, and how have you overcome them?

“We once had an unforeseen expense, when we had to hire our securities attorney to review the investor content on our website in reference to our fund. To avoid this, be careful with the content you make available online for investors, especially if you have a private offering.”

“We’ve learned from other decisions we’ve made along the way as well. For example, we used to have higher minimums, but we learned that people usually prefer to have their money spread out, so we actually received more investor capital after lowering our minimums. We also tried to pay investors quarterly until we found out that they actually prefer a monthly payment.”

“Also, we used to have multiple rates and categories in each offering, but today, we keep it simple.”

Learn more about Dave Van Horn by listening to his episode of the BiggerPockets Podcast and by checking out Dave’s BiggerPockets profile or visiting his website at PPRNoteCo.com.

Any questions about structuring these kinds of deals?

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Note By BiggerPockets: These are opinions written by the author and do not necessarily represent the opinions of BiggerPockets.