Private Capital Interest Allocation

[Francisco Solano]

Hi BP Community! 

I am actively working on sourcing and locking up fix and flip deals. These deals would have adequate equity in them. I am looking at 1-4 unit properties. The properties would be in a distressed state and I would lock them up at a minimum of 65% of ARV. In this effort I have sources that can provide private capital. My question then is, what would be a fair ROI on the private capital? I know this depends on the deal itself, but are there any general guides as to how to pay the investor(s) via points or equity? I'll articulate a deal for better specifics.

So let's say I have the following deal:

SFH - 4 Beds 2 Baths - Purchase Price: 170K - ARV: 350K - Repair Cost: 55K

So I source private capital. I obtain 80K in liquid cash. This is to cover the repair cost and part of the purchase. I would obtain a hard money loan for the rest of the cost.

In this scenario what would be best way to leverage the deal? How many points or how much equity in the deal would you give to pay the investor?

Thanks!  

[Alex Breshears]

Hi there! 

I love that you are being proactive and thinking these things through now. 

In my mind there are two paths you could go down that I would keep distinct and separate at this point. One is debt and one is equity. 

On the debt side of the house - the capital provider would loan you/your business the money with terms that are mutually agreed upon. It could be monthly interest payments, a larger lump sum at the end, maybe you pay all the interest up front - there’s options. The loan could be unsecured or secured against real estate. There needs to be defined length of time the loan is out (so maturity date), rate, payment amount, frequency, etc spelled out in the promissory note. If you want to remain partners/friends - I highly recommend having this drawn up by a professional to make sure it is legal and clear. This option can offer the capital partner either a steady monthly cash flow (if that’s what they want) or a lump sum at a future date if you sell/refinance later when you pay back the principal amount. This is a very fixed return model. For unsecured personal loan - that’s a lot of risk for the capital provider so I’d say minimum 15% annualized interest rate - MINIMUM. 

For the second track - there's equity. This is where they are a partner with you on the property in some capacity. Maybe it's the two of you as individuals, your business entities or you form one together. In this model you have outlined everyone's roles and responsibilities- who's bring whst to the table in terms of money, time and effort. In this framework the capital partner is exposed to the upside AND the downside. If the rehab goes over budget, the market turns, the project can't be completed for some reason - they are exposed to that downside risk as well. They also might be signing on for the debt of the HML - and if there is a personal guarantee - pledging personal assets. There is no fixed return on this model because they are part owner of the asset. So as far as the percentage to compensate them - that really depends on who is doing what and for how long. 20% of a deal that will only get $10k of profit at the end isn't very attractive - but that's the gamble you take with equity. The pro forma numbers are just that - numbers. When the dust settles and the deal is done - that's the real numbers and those could look paltry. Now saying that will be the case but a lot of investors think equity is all upside - when in reality it isn't. You are on the hook for taxes, insurance, liability claims, and the mortgage as an owner - none of that as the lender.

I think the real question to answer first is asking what you capital provider really wants. Do they want consistent stable income? Debt might be a better fit. Do they want to learn the flipping business by your side and see the possibility of doing multiple deals with you in the future and you two are compatible business partners? Then equity. Whatever you choose for this first deal doesn’t have to remain that way for subsequent ones either. So ask what they are looking for - and then see if there is a way to meet that ask both in terms of structure and financial amounts.