Gap funding? Does it work?

Question

Hello,

I have recently rekindled an old friendship with a friend whom I happened to meet at a local coffee shop one day. We started talking about our careers and he told me that he started a real estate business and was helping investors by pooling their money together to create capital for his business and was rehabbing homes and offering a lower rate to prospective buyers.

This peaked my interest and I told him I had a savings of about $50k that I would like to invest with. He told me I could earn $2,500/month and within 65 days I would have $10-20k from homebuyers making a down payment and their monthly mortgage. I was skeptical at first, as it sounded too good to be true, so I asked him to come up with a proposal so he drafted a presentation and walked me through somewhat of the process.

He told me I would basically be owning liens on the properties (5 to be exact -- at $10k each) and that when each tenant makes their payments it would go directly to me, thus equalling $2,500/month ($500/month x 5 properties).

Now, this still sounds a bit odd to me. I have little to no experience with investing or real estate and although I consider him a good friend that I've known throughout the years, my gut tells me that something still isn't right about this deal.

Please help. Any information or suggestions with this matter would be greatly appreciated!

Aaron

Neal Collins · Answer

What good does a notarized disclosure serve when he absconds with your money? This doesn't protect you in anyway.

His model is straight forward and many people use a basic function of it. You give him money for capital improvements on a rehab project and then he gives you a trust deed (a lien) against the property as security. His returns, however, seem  out of line with anything I've ever heard of. He may not be trying to con you and that somehow the yearly return is being conflated with monthly return. If he really is promising $2,500 monthly return, just interest and not principal, then I would be a little hesitant because it may be a scenario where it really could be too good to be true.

Neal Collins · Answer

Aaron H. I'm going to revise my earlier statement that his model is straightforward. After looking at the numbers he proposed it doesn't seem to make much sense to me. I could be wrong, but generally speaking I like to know how my investment works before going forward. Good luck to you!

Brent Coombs · Answer

Aaron H., sorry to say, but, this reads just like a pyramid/Ponzi scheme would have sounded back in 2006-7! He likely already has too many loan sharks chasing HIM for their high interest payments, and is now desperate to keep his merry-go-round from stopping!

ie. If/when payments stop, you'd only get your money back IF there was still equity after every other investor (and lawyer) in front of you get their money first! ie. You wouldn't!

Thanks for posting your concerns. Hopefully some proper investigating will uncover the truth.

Please keep us apprised of your research results. All the best...

[Edit: I didn't see your above post before I posted - but, hmmm, is that clearer, anyone?]

Aaron H. · Answer

@Brent Coombs thanks for your response and participation in this conversation.

I hate to say this, but that is where I'm beginning to form my conclusions. Sounded too good to be true from the beginning and too much of a "get rich quick" scheme.

I guess I just expect more from my friends and would hope they had every good intention when it came to my personal business, especially my finances.

Well, that is a shock but I have reaffirmed my original belief and now with the help of yourself and @Neal Collins I have potentially avoided a landmine.

Thanks so much for your contributions. I may still seek further opinions in other forums, just to learn more about real estate and the process (more so those involving this scenario).

Best of luck to both of you!!

Aaron

Aaron H. · Answer

I see your point @Neal Collins

Here's what the projection he drafted for me looks like:

Year 1:

$50k investment. Cost to do business: $5,500 ($1100 for 5 properties). Down $2k-$4k (Or $10k-$20k annually - on 5 properties). Approx $2,500/month. Net $24,500 + Down ($2,500 x 12 mos = $30,000 - $5,500 cost to do business).

This results in $24,500 + Down ($10-20k) = $34,500 - $44,500 for Year 1.

Years 2-5 show an increase in profit and net earnings, considering I reinvest.

My first thought is: After Year 1, instead of earning profit, I would actually be losing money ($50k investment / $34,500 - $44,500 Net).

I understand the market fluctuates, as do decisions involving buyers, sellers, investors, etc so I assume some risk involved. But tell me - how can this make sense to a real estate guru with years of experience (unlike me)?

Aaron

Aaron H. · Answer

@Neal Collins Thanks for your response. And forgive me if I didn't emphasize or if I left some information out. He didn't give me too much detail and I am fairly new to this so I don't quite understand the process yet.

The way he described it was I would basically be investing or purchasing liens on rehabs to fund capital for his business. In return, I would be receiving $2,500 a month, plus down payments which would equal $10k-20k a year.

Unless I am not aware of something, it sounds good - on paper. I have asked him to draft me a mutual disclosure agreement form and have an attorney notarize it (which may or may not be possible).

Again, I don't really have any experience dabbling in this type of investment, but from a business perspective, the deal sounds too good to be true.

Just wanted some thoughts on precautions or legal resources to legitimize this offer.

Aaron

Gap funding? Does it work?

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