How to Start a Private Fund for RE-Investment

Question

Hi, I've been a BP member for a few months now and I am so glad to be connected with so many great minds here. I did some private funding thank to this BP network and now I am thinking of moving one step further. I am planning to start a private fund so that my friends and colleagues who are interested in RE investing can put money together. Then I can help manage the fund by investing in a variety of vehicles such as private funding to developers, buy&hold apartment complexes, etc.

My question is-  1) what licenses/certificates do I need to start such business? I live in CA and I've heard somebody saying a real-estate broker's license is enough for brokering these funds here in cali? 2) what business structure will be a best suit? LLC, S-corp, C-corp? Any advice or thoughts are welcome! Thank you in advance.

Jeff S. · Answer

Sorry, @Sean Yang , but there is some uninformed advice here. You are not a bank, you are a lender. These are legal terms. In its simplest form (one loan from one person on one note), brokering loans in CA does not involve the SEC or a securities license. To loan against real estate in California, you either have to be a CA licensed real estate broker or California Finance Lender (CFL).

A CA brokers license allows you to transact real estate, hire and fire real estate agents, and also originate and broker real estate loans to the public. A CFL allows you to originate loans using your own money, though there are some ways around this. CFL's also have a restricted ability to sell their loans. Both brokers and CFL's get the coveted usury exemption in CA. We hold a CFL license.

CA brokers can also originate fractionalized loans – among the simplest and most powerful way to loan, in my view. Here a licensed CA broker can arrange relatively small amounts of money from several individuals and put all their names on one note, along with their percent participation, thus creating a relatively high dollar loan. You could call this pooling, but it's perfectly legal in CA and several other states and does not involve the SEC.

In all cases, the dreaded SB 978 would apply to any loan originated by a broker (but not a CFL!!). Too much to go into here, but one rule is that your investors can not invest more than 10% of their net worth on any one loan.

Alternately, and well beyond your skill set at this point, Sean, would be to form a mortgage/investment pool. This would involve an SEC registration, a PPM, and all the brain damage that goes with managing investors. Cynical as I sound, this is probably the hottest topic in lending now.

As directed by a good lending and securities attorney, you would form several LLC's to both loan and manage. This is a heavily regulated industry and it's not clear your friends and colleagues would have the wherewithal to participate. DON'T EVEN THINK OF DOING THIS ON YOUR OWN WITHOUT AN EXPERIENCED LENDING AND SECURITIES ATTORNEY.

There are also some very simple strategies involving hypothecation that a good lending lawyer could explain.

Last, only because someone mentioned it, hard money and private money are marketing terms. Period. Some on this board get hung up on this but there is no legal difference between the two. Licensed lenders can generally call themselves what they want -- but not a "bank" :-)

Sean Yang · Answer

@Adam M. Thank you for your advice. Ya this is what I've been doing recently- lending my own money to rehabbers with my name being added as 1st or 2nd lien position. Now I am looking to expand this business by pooling more money from families and friends by offering them let's say a flat rate of 7% and then lend out to rehabbers and get a return for 12% for example and pocket the 5% difference as profit. What you suggest is great if I am a rehabber myself and need to raise capital. I think I will need to talk to a lawyer about my situation. Btw, I will read the book nomoneydown from Brandon Turner :)

Sean Yang · Answer

@Stanley Parsley Hi Stanley, thank you for your response! That's what I am afraid of getting into... What I am hoping to do is simply one step further from investing my own money versus using my families and friends's, so definitely want to stay away from the bank/sec route- with all that cost and regulation it's just not worth the effort for us small players. Anybody knows if there is a way around it?

Sean Yang · Answer

@Jeff S. That's great advice Jeff! I just got my CA sales person's license and I am planning to take the broker's license a couple years down the road so that part should be taken care of by then. The ability to originate fractionalized loans sounds powerful, but does it only work if there is a subject property and therefore require a deed of trust to each investor?

Adam M. · Answer

Yeah lawyers always a good idea. Not sure how taking a margin like that works out legally. Might only be able to charge some points and a service fee. I would think Dodd-Frank would come into play when it comes to lending. I know it does when we've looked at seller financing.

Sean Yang · Answer

@Kevin Yang Thank you for the suggestion. I think I'd go with the LLC route

Adam M. · Answer

@Sean Yang An alternative would be to look to raise private lending monies. This is similar to a HML situation except they are generally not a company in the business of short term lending. They tend to be mid to high net worth individuals or other flippers w/ excess cash. Your terms are a lot more broad and open for negotiation. For example you could offer a note that is interest only @10% due in 12 months or 13% due in 12 months interest only but no payments except the final balloon with accrued interest. You offer them first deed of trust on the property and the right to foreclose as well as list them as additionally insured on your property insurance so that if something catastrophic happened and the insurance company had to pay out they could be protected. There is a whole chapter on it in the following. https://get.biggerpockets.com/nomoneydown/

Adam M. · Answer

Uhh you won't be a bank but you do face issues when it comes to securities law. Get a good lawyer that has done it before. Look up your states blue sky laws. You may have to get your Series 7 and Series 63 if you want to raise money from anyone that isn't immediate family. You might also run into issues on whether not you can take money from a non accredited investor. I'm no securities lawyer.

Stanley Parsley · Answer

you have to remember you are going to be a bank

that means you have to follow criteria according to the sec

it is a lot of work and a lot of bucks to get it set up

plus you will have to have insurance on the funds

look up banking rules and regs

enjoy

How to Start a Private Fund for RE-Investment

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