Share Your Experience Working with Family Members?

Question

Hi everyone, I am just getting started in REI. I have about 6-8 months before I can realistically purchase my first investment property on my own. For that I plan to go the FHA route to house hack a property, ideally a multi-family. However I would be able to expedite this process if I were to receive a loan from a family member. I am considering this route because a few of them have expressed interest to me in getting into the Phoenix market, it would be their first time acting as a lender, and would be my first time receiving private money. So, we all are on the same page about using this to make money, but more importantly as a learning opportunity.

It would be on me to structure the deals, and I don't really know a good starting point to doing that. I have seen plenty of examples of deals, but without much explanation to the why they are structured in such a way.

So to keep this simple, can anyone share their experience receiving loans from family members for financing properties? How did it ultimately work out? How did it affect the relationship between you and that family member?

One the flip side, can you share any experience you may have purchasing a family members property from them?

I am hoping to open up a discussion for anyone considering this route to jump start their REI career, and we can learn from those that have already gone this route to help make educated decisions. Thanks!

Ryan Swan · Answer

It can be a great way for both parties to invest in real estate. In my opinion, there are three rules to follow if you are going to be borrowing from family member(s):Don't borrow more than the family member can afford to lend you. If you're borrowing $150k from mom and dad and that's literally their life savings, then that's far too risky of a loan to be making. Borrowing the same amount from rich uncle Steve who has $3m in the bank is a great way for family to help family and also diversify. This one sounds obvious, but don't borrow more than you can absolutely afford to pay back (even under worst case stressed financial models). Draft a contract and make the terms clear for both parties - this is still important even if borrowing from a close blood relative. I can protect both of you if one party suddenly dies and then the rest of the estate is trying to settle the debts. I've helped quite a few investors get started in multi-family using FHA...feel free to drop me a line if you want to learn more about the ins and outs of it.

Ryan Swan · Answer

@Alexander Persky yeah I have some experience working with family members, both for primary and investment properties. The IRS/Dodd Frank rules are different for each scenario, and there are also different Fannie Mae rules governing down payment gifts for owner occupied vs non-owner occupied loans.I believe there's also a minimum interest rate that needs to be charged in the eyes of the IRS for a loan, even between family members. Be sure to speak to your own CPA and legal professional regarding all of my above comments. Feel free to send me a PM if you want to just chat about my experiences.

Ryan Evans · Answer

I've worked with both family and friends. In my opinion, it all comes down to expectations. If you get everything out in the open and they know what they are getting into with a new investor who doesn't know what they are doing, that's very different then a family member who claims the ability to make them a certain percentage based on experience or some made up assumptions. Just let them know all the worst case scenarios, and more importantly, what you're going to do to mitigate those risks. If they're still keen to go ahead, then get a lawyer to draft it up to make sure everyone knows who's accountable for what. Then you're not leaving anything up to interpretation.

Alexander Persky · Answer

Thanks for the input.@Caleb Heimsoth I think your response is telling of the (positive) dynamic that you have with your family. For me, my family and I frankly are not emotional people, and we do business with each other quite often. This would be a larger deal though, but I wouldn't let anyone in my family borrow $100 from me without a written agreement for when I'm getting paid back. Thats just how we are.@Eric Delcol I agree with you entirely and that is the approach that I would take for sure. It sounds like you may have done a deal with a family member, how did that turn out in the end if that is the case?@Ryan Swan do you have experience working with family members in situations like these? In my case, any money I borrow would be put towards rehab, or structured as a gift to put towards the down payment only. I need to check on how smoothly the gift option would actually fly with a lender, but I will just ask if it gets to that point. In any case, I definitely wouldn't be borrowing in the hundreds of thousands.

Eric Delcol · Answer

Working with family and friends can be a fantastic opportunity for both sides if you structure it right. The best approach is to treat the entire situation the same way you would if you didn’t know them. I.e. clear documentation. Write out who is responsible for what, how funds are to be distributed and when, and contingencies. You may also want to seek a lawyer to write up the papers and ensure things are done properly and fairly.

Caleb Heimsoth · Answer

I have not worked with family in REI and probably never will. I usually advise against this sort of thing, especially for newbies. You can lose money very easily and if it’s your family’s money that could damage relationships. To me my relationships with them are more valuable then investing with them and I won’t risk it.