So I learned some stuff, found some capital, now what?

Question

Writing this post to get into some nitty gritty details that I can't find elsewhere on the forums:

First time investor! Woo!

Knowledge, hustle, money. Those words were so subliminally heard in a number of BP podcasts, little did I realize how profound their reverberating echoes were in my conscious. Last year, I decided to commit to the grind-- analyzing a handful of properties per day, starting to understand certain niche markets, and finding that there really are deals out there to be made right now. Regardless of how fast the hot cakes are selling, I started to see gems. Then, I encountered burnout. I felt this overwhelming lack of catharsis in front of an obstacle named "capital." Unrecognizable by myself, in myself, were two aggregated points of that triangle, knowledge and hustle. They came to the forefront of a conversation about the RE asset class with a friend, whom unbeknownst to me had money sitting in a savings account and was struggling to find something to do with it. A mention of how I spend my free time unveiled the missing tool, money, to climb over my imagined obstacle.

I have a market that I've been concentrating my time to understand, and left our conversation promising to bring to him some of my research on the best 2 or 3 deals. That, we'll go over the details together, set some guidelines, and jump into the venture.

Great. Awesome. Now what? How do I structure this agreement? Do I need to hire a lawyer? Should this be a handshake with some written SOP guiding our expectations? Both of us are veterans that have served together, so we implicitly trust each other. However, we both agreed that we need to be as transparent as possible about the deal, our expectations, and our exits.

Thoughts:

-This would be both of our first RE investment. He is a homeowner, I am not yet. Wife and I plan to purchase our own residence this year, so DTI is of my personal concern.

-Strategy. I have been analyzing deals with a lens for either BRRRR or Flipping. The latter seems to be the cleanest cut, and I see it as the type of venture upon which to start this sort of relationship. I believe that buying and holding would be great under a joint entity for a long-haul, or scaling endeavor. But this is based on my gut, not experience.

-"JV," "Partnership," "LLC": this is where I get lost in the sauce. This deal will be for a sub-200k ARV-type property. Not looking to run away with the bank, I am hungry to get deal #1 under the belt and grow from there. Do we need a formal entity? How do you deal with hard money/traditional lenders, if (for example) I am not in a position to take the credit liability for the mortgage or loan (the consideration for my own home mortgage)?

-To be clear, this will be one of those situations where my partner brings all of the cash-- I will not have my own capital in this one.

Apologies if my thoughts are jumbled, I think this is one of those situations that I don't know what I don't know.

Claudio Salvatorelli · Answer

Hello Stephen,That's great that you finally want to jump into RE. 1) I would use FHA and VA loans available to you and take advantage of that. 2) Househacking will be great to start and to use as a combination of a primary residence plus investment.3) I would not worry about forming an LLC yet. usually, that is when having +5 properties, However, it is your decision.Good luck,Claudio Salvatorelli

Annie Drommond · Answer

Also, something to consider, since DTI is a concern for you. If you hold a mortgage on a rental property, but the mortgage is 75% of the current rent, it’s usually a wash on your debt to income (ex. rent $1,000, total monthly payment $750 or less). If it’s been on your tax returns for 2 yrs, they will usually go off those numbers. If you run the numbers right, it won’t affect your DTI. You’d just need enough in savings to cover 3-6 months of rent, depending on the lender.

Antonio Cucciniello · Answer

@Stephen Bernard Similar to what @Claudio Salvatorelli said, do you think its possible for you to start with a house hack using your VA loan?This can allow you to live and invest at the same time. Helping you feel way more confident about starting out, rather than jumping into a FLIP or a BRRRR which is a higher stakes situation.

Annie Drommond · Answer

We did a conventional loan on the property. My partner funded the initial 20 percent down and I funded the rehab. The loan is currently in our personal names, we closed fast and didn’t yet have an official partnership set up. Most regular loans can’t be done in an LLC, they have to be in a personal name. So even if we had an LLC, we would have held the loan in a personal name. We are done with rehab and it is rented, and we are going to refinance the loan into the name of only my partner (because I already hold multiple mortgages and am fast approaching the magic 10 number while my partner only has one), with us just on title. Then immediately after it closes we will transfer it to an LLC, that we are currently setting up, which will specify percentage of ownership for each partner. That is what my lender recommended, and it will make taxes easier, because percentage of income for each partner will be specified on K1’s.

Stephen Bernard · Answer

@Annie Drommond I didn't realize that. Noted. Did you undertake the loan if you had a capital partner with none of your own money in? As in, it under your name or did you form an entity like a LLC?

Stephen Bernard · Answer

@Annie Drommond Thank you for the insight! That's really actionable, and simple. I truly believe I'm overthinking it, but keep me posted on your experience!

Annie Drommond · Answer

I’m in the middle of my first partnership (with an unexperienced partner) and feel much the same way you do. Feel like I don’t know what I don’t know. I do have rental properties of my own. My (unexperienced) thoughts after some pondering and research are to have a real estate attorney help draft up an operating agreement, etc. Then there’s someone experienced to help a bit. Then just jump in and learn as you go? It sounds like you trust your partner, so you both may just need to be open to learning together.Experienced mortgage loan officers/lenders are a huge help and can help you figure out the best way to fund. Don’t use the cheapest, unexperienced one. Find one that’s worked with investors. Call around. You may pay more fees, but their knowledge could be invaluable for a newbie. They helped me a bunch when I first started. My title guy has also been very helpful.I’m currently listening to 2 podcasts from Real Estate Rookie, from September, on partnerships to see if they may help fill in some of my gaps. So far they’ve been a little helpful... I haven’t finished them. They may be helpful for you?

Stephen Bernard · Answer

@Antonio Cucciniello @Claudio Salvatorelli thanks for the tips and comments!Unfortunately, I'd have to do this as an out of state investor. My primary residence will be in Southern California (current station) with a VA loan. I'm from the Midwest, so I have some 'boots on the ground' there and selected potential investor markets that way. I've been looking around for house hacking opportunities here, but they all seem a bit beyond our means.