Investors want to partner with me, what are my options?

Question

I sold my house a few months ago and am getting ready to buy my first multi-unit property. I have a high income and can buy my first property myself.

However, I have many friends that are nearing retirement and are looking to partner with me on one or many real estate deals.  THEY are approaching ME, wanting to get "in on the action".

With outside investors, I have the ability to buy many properties quickly.  They are looking for a reasonable return on their money (6-10%) and want to be silent.  I will manage all aspects of the property.

What are my options for structuring a deal?  Do you have any examples of where you partnered with someone, formed an LLC, and secured a mortgage under your name? I'm curious to hear what others have done and how the deals worked out.

Will Barnard · Answer

You stated you had friends as in plural, wanting to get into the action. If each has the ability to invest enough for purchase, you don't need the banks and simply have one friend/investor for each deal and you put up the rehab money.

If you want to place say 5 friends capital into multiple deals, you could certainly form a new entity (consult with your attorney on proper entity structure) and have the friends as limited partners and you as the general partner. Keeping the quantity of investors small, you can avoid the higher costs of SEC filings and legal costs.

Jon Holdman · Answer

I think you're saying you want to use their money as the down payment and then get a loan from a bank for the rest.  That would require a much more complex structure.  You should also budget about $10-25K for a securities attorney.  Not kidding.

A lender is not going to let you have a loan from them at 80% LTV and then a second loan from one of these investors for 20%.  They will want to see some of YOUR cash into the deal.  So, what you would end up doing is forming a company and having the investor buy into that company.  That's a private placement and that's where the securities attorney comes into play.  Then, the company would get a loan to buy a property using the companies money as the down payment.  These would be commercial loans, not conventional.  You would likely still need to give a personal guarantee.  This is do-able, but its complex.

Justin B. · Answer

I have basically the same question.  I have read that if you form an LLC with the people who want to invest with you, you can avoid any involvement with securities and the SEC.  I've bought multiple SFR properties and others have seen our success and have approached us to "get in on the action" so to speak as David Kay says.  We're looking to buy a small apartment building and don't quite have the capital to do it all ourselves (we can do 50% comfortably) and looking for the best (and least hassle) way to partner with others.  Is this the best way or are there other ways that keep the SEC and tens of thousands of dollars of attorney's fees out of it?

Will Barnard · Answer

Jeff, correct me if I am wrong, but under the Howey test, interest is not profit thus number 2 of the test is not met.

Jeff Greenberg · Answer

It seems that there is always mis information going around.  Rather than rehash it, here is an excerpt from a BP thread and a link to the full thread.

You decide if your deal is a security under this test.  One point from Gene Trowbridge is "interest is not considered profit"

An investment contract under the Howey Test was defined as follows:

1. an investment of money due to
	2. an expectation of profits arising from
	3. a common enterprise
	4. which depends solely on the efforts of a promoter or third party
	
	What this meant for J. Howey, and for all real estate investors in the future, was that anytime you're searching for investors, no matter if the investor goes on the deed or has a mortgage, if the investor is relying on you to make their profits you are considered to be selling a security. The Howey Test set the standard for securities laws in raising money for real estate investments.

http://www.biggerpockets.com/blogs/862/blog_posts/4376-the-howey-test-otherwise-known-as-why-private-money-investing-involves-the-sec

Curt Smith · Answer

@Justin B.   Do it the legal way, call Jillian.  Pooling investors money is the 3rd rail.

Only some states have a Securities exemption for one lender onto one property onto a 1st lien and no advertising.  GA and NC at the least have this exemption.  Other states are the opposite like OH won't even allow the above simple situation.

All is ok until your first lender gets mad and calls the state SEC. Or they find you because you are advertising.  There's a few true stories along these lines of REI folks getting into trouble.  Just saying.

For a MF deal the legal costs aren't that large relative to the funds you'll be raising anyway.

Curt Smith · Answer

This lawyer is nationally recognized for being good and I view her to be the cheapest of any SEC Lawyer I've talked to.  I've not done a PPM with her but have been researching a reg D PPM for some time.

Jillian

She does this all day long and knows exactly what you need to set everything up in your LLC, classes of members, the operating agreement, subscription agreement, the PPM, everything.  This is well known territory re buying commercial props.

Since you've not bought and run MF businesses before I suspect the commercial lender will require you to find a local expert, local to each property if you buy in different locations who will be a Sponsor.  You may not have problems finding a sponsor but I have (starting at zero MFs) because of the liability involved and I've been told the problem is the "bad actor Act".

David Kay · Answer

Will, thank you for the response.

I'm not looking to rehab and flip houses. I'm looking for a long term strategy personally, but will pay each investor a return for 10 years. I am even willing to add appreciation into the payback, as my numbers still work.

Advantage for me:  Low out of pocket costs to purchase. I still have all the benefits of real estate (appreciation, tax, equity, cash flow, etc).

Advantage for investor: Very good rate of return with very low risk.  They are completely silent and receive a check each month.

If I could structure a reusable formula using a securities attorney for a cost of around $10k, I will do it.  It will pay off in the long run as I anticipate more and more people wanting to join forces with me.

David Kay · Answer

Exactly what I was looking for. Thank you.

David Kay · Answer

Yes, they do have enough cash.  However, I'd like to spread the cash across multiple properties.  This is for my benefit as I can buy more properties by using a bank.  I have execellent credit.

Investors want to partner with me, what are my options?

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