why invest in a deal if there is no value add?

Question

Hello BP, Looking for ideas or feed back!

So I own 8 properties just outside of Boston, all being rented out as sober living houses. The cash flow is awesome, so good I don't mind paying market value or a little over. While everyone struggles to find deals I can find a deal a week. Everyone is doing numbers based on market rent, I rent beds not apartments.

So here lies the problem I'm broke! I have great cash flow coming in on every property, I'm only leveraged at 70% on all the properties. But soon as I save enough cash for 25% down ill buy again, problem is it will take me a year to save up again.

I have friends and family that want to invest, I just don't know how to structure the investment.

-I'm not creating any value for an equity investor. I can offer 8-12% return on cash, If I offer an equity position on a 5-7 year deal they're not making much on the equity end of it. Any ideas other than contact an attorney?

Dan K. · Answer

@Dennis Powers -- But if it's a straight loan, how are the investors ever going to get their money back in a reasonable time? I think I'm missing something here.

If an investor puts $40,000 into the deal, obviously they will can get cash-on-cash returns that are above CD rates. But what is the exit strategy for the investor?

Christopher Richardson · Answer

So out of curiosity I had a evening chat with one of the lenders. He would do something along the lines of a SAFE note, where the note will be secured by future equity, and primarily looked for investors to loan that had unallocated capital but wanted cashflow (retirees, people with little time, or people that didn't have the skills to find assets that made sense financially). So most of the folks wanted to just count on a certain amount of dollars that they could use for junk, toys, expenses, without losing or having to think about the original capital. This lender would cash them out of their principle via cash out refinances, usually around the 5-6 year mark sometimes as soon as 3 years (depending on the market and principle pay down of the 1st note). Then offer them to reinvest the money, where most people do because they consider it easy money. He's gotten to the point that there so many millions that he just pays himself a salary via points off of the pool of funds (to the tune of 300k+) and pays out surprise bonus's to the lenders based of the profits of the properties, so they make even more than expected. He owns and develops high end properties in primary markets with his own funds as well.

Always with my best,

Christopher Richardson

Christopher Richardson · Answer

Dennis,

No seasoning for some of the NOO lenders I work with.

Here's one example  that you can come and visit if your in the area. My wife and I bought the corner 2 family of a block that we are improving. I used a personal unsecured line of credit and my wife did also for the down payment. All that was required was that I broker the loan and my wife be on the loan, we put the funds into one of her bank accounts, and that it'll be able to pay for itself based on an appraisers review. There was so little paperwork on the loan it seemed unreal, but I did it and we got that property and I've done plenty more since.

Dan,

I'm not recreating the wheel, this is how some investment fund pools start up. I know several lenders that started this way.

If I were Dennis, If I had folks not willing to loan me unsecured then I'd collateralize the equity that I have in my current properties to buy more. Since he's got 30% to collateralize by a second lien that could be useful.  Depending on how much profit there is, I would use a portion of any of the funds used towards new properties as a principle pay down (50%) for the personal loan to get them even more return and get them out of the loan over time. So an example would be a secured private loan, (secured by real estate a 2nd position on a property or properties), with a 15 year balloon, interest only. However to avoid it becoming to complicated or even a becoming considered a security I would not guarantee to pay down the principle, I would just do that personally so it doesn't balloon and if it did there wouldn't be much needed.

Always with my best,

Christopher Richardson

Dan K. · Answer

@Dennis Powers There is no seasoning requirement for money. The term "seasoning " is really only applicable when you are acquiring a property or doing something else with the title/deed -- often you need to allow the title to season for a specified amount of time before a bank is willing to touch it -- banks don't like uncertainty.

Regarding @Christopher Richardson's suggestion, if a private lender does not file with the registry of deeds, I don't see how they are protected from the equity in the property. Other lenders and claims can step in front of the lender by placing liens on the property. In essence, I would consider these lenders unsecured -- which is okay to some lenders.

Additionally, Christopher mentioned getting a commercial loan. Are you getting commercial or residential loans on these properties? Of course you're not going to get a 30-year fixed with a commercial loan.

If you do a loan from your investors, are you returning principal with each payment? If you are returning 8-12% ROC, how does the investor ever get their principal back?

Christopher Richardson · Answer

Dennis,

Keep it simple, have them write you a loan instead of partnering. They can have their funds collateralize by equity, instead of actually partnering and owning equity. A lot of commercial loan products don't source the funds, you just need to put them into a bank account so they can verify it's in there. Combine their loan for down payment with a commercial loan for the rest.

I would maybe even take it a step further and offer 8-10%, then if they refer you someone else that'll match their funds at 8-10% you will pay them 2% more on their loan. Cap it at 12% as incentive to get referrals. They will also be referring you better referrals and doing all the selling, by mentioning how much money they are making off of you.

Always with my best,

Christopher Richardson

Dan K. · Answer

Hi Dennis,

Sounds like you've found a very nice niche.

With raising interest rates you might feel a little bit of a squeeze -- Citizens bank is offering 3.15% for 5 year CDs -- obviously little to no risk. So if you're going to offer return on cash of 8%, we are looking at a 4.85% spread. Of course interest rates are only going up. That being said, that is still a decent spread.

You need to understand your investor's motivation. If they want to jump into real estate to see massive returns with somewhat high risk, you're not the right person for them. Making 100K on a 6-month flip is exciting, but you need investors who want a nice, steady and reliable return. Basically you need investors who have a lot of cash parked in a money market and aren't sure what to do with it --- the stock market is volatile but they know their savings are losing value every month because of inflation. That 5 year CD I mentioned would hopefully beat out inflation by about 1%.

As to how to structure the deal, why not do a cash out refinance after 3-5 year period and pay off the investor(s)? You could also look to sell the property if you have a long term lease in place with a group that does sober living -- do you have long term leases or are you just renting out by the room to newly sober people? 8-12% returns are not bad for a safe place to park money for a few years.

There are a variety of ways to structure the deal. A joint venture could be a good option. Keep in mind that getting a loan just on an LLC would be challenging.

By the way, I'm an attorney by the way in Massachusetts.

why invest in a deal if there is no value add?

Most Popular Reply