Pluses/Minuses of investing both the equity and debt on a home

[Scott L.]

Hi, I'm a relatively recent home flip investor. There's a property going for $200K where I've been offered an equity participation and optionally the debt side. Is there a good case for doing both equity and debt?

The house can be acquired and fixed for low $200K range, with good potential. It would be financed 70% short-term hard money, 30% equity. I would contribute 90% of the equity for 10% preferred and 40% of profits. I optionally could take on the hard money loan at 12%.

I'm not clear what the impact is t if I take both equity and debt. For example, if the developer (10% equity holder) becomes unavailable, what does it really mean that I am responsible to myself for the loan and for the rehab?

On the plus side, I think the property is low risk with 30%+ equity returns, and I could enhance those return on a single project with debt.

Thanks for thoughts,

SL

[Ann Bellamy]

So if I have my numbers right, 90% of 30% of 200K is $54K.

If you choose to do both, you will be in for $194K of a $200K purchase.

Don't look at just the returns, look at worst case scenario:

1. The developer walks ($6K is relatively nothing), and depending on the legal structure of the deal, you may have to foreclose the second position in order to pick up and complete the rehab. That will cost you quite a bit, both in carry costs (think taxes and insurance) and in legal, advertising and auctioneer costs.

2. If you're not in second position but are a partner in the entity that is the equity side, you may not have to foreclose, but will still have to pick up all the pieces, complete the rehab (where is that money coming from) and sell the deal.

3. If you don't do the first position hard money, but only do the equity, if you are 2nd position lender, you can't do much, the first position lender can foreclose and probably wipe you out.

4. If you are the controlling partner in the ownership entity and don't do the first position hard money, you will still need to take over the project to protect your position.

Since it doesn't sound from the tone of your post that you know the developer all that well, I would only do the 70% 1st position, and never do the 2nd position (either equity or loan)