How do I setup a private money loan with an investor?

Question

Hi all -

As you can see, I am a bit new to the forums and somewhat new to RE investing in general. So, after many, many posts read on this forum, I think i have a plan and I was wondering what the best way to go about this situation is. Please note that I will be consulting a Real Estate Attorney to get this setup right, but wanted to get any feedback the great people on this site might have.

So with that...here is the situation.

My investor wants to buy a foreclosure in my state (he is in another state) and he knows that I have the right connections to get this done. Instead of paying me a simple fee to find him teh right price, he wants to help me out with some seed money...so here is how i see this working. Please comment as you see fit.

1. He loans my LLC $100k to buy a property. This loan is a 24 month, no interest loan (promissory note with balloon?) wherein I will pay him back the full amount in month 25
2. I then sell this property to him via traditional financing
3. He now has his house that is cash flow positive and I have $100k (or some sub amount of that) in seed money to invest as I see fit over the next 2 years

I know this is one of those 'too good to be true ideas'...or so I hope it is, but you have to understand that the initial discussions were around me looking to find investors to loan me $$ so I could buy, fixup and then resell. The goal was to give the investor 60/40 of the profit and return the $$ in 3 months.

Because this investor wants to own a property and does not want to pay cash, he sees this as an opportunity to get a good property (I do actually have that know how) with positive cash flow while helping me out in more than a referral fee method.

Some of my questions around this are tax implications and how the 'flip' takes place. Can he simply come in with traditional financing after I buy this house for cash (through my LLC) at a trustee auction?

Is the best way to setup the loan a promissory note? If so, can I do a 0% interest note or does there have to be a minimum percentage?

I have a ton more questions, but I think this gets my basic premise out there to see if there are major holes I am missing or why this woudl not work/is not legal.

Thanks a lot for reading this. Sorry for the long post. If I missed any details let me know and I will try to fill them in (if I had thought about it...)

thanks
-peeklay

Jon Holdman · Answer

The reason I think this might be loan fraud is because its not an arm's length transaction.  He's buying a house from you that you bought using his money.  In effect, he already owns the house he's "buying".  If he paid cash for this house, then tried to refinance to get his money back, the bank would make him wait a year.  But he would get 70-75% of his money back after a year.

OK, he gives you the $100K, you buy and fix the house then sell it to him for $100K.  He goes to the bank and gets a loan.  He has to put in down payment, say $25K.  How's that different than just buying a house for $100K from the start?

Now, maybe he's going to buy it from you for $133K.  He puts down $33K and gets a $100K loan.  You get paid $133K.  But you have to give him the $33K back.  I guarantee you that is loan fraud.

Any time money moves between the buyer and the seller, and the lender doesn't know about it, you're at best in very shaky territory.  Maybe the first case works, though I don't really see how it helps.  If you're doing the second situation, then you've definitely crossed the line.

Brian Levredge · Answer

I understand the part about the two year, 100k loan.  What I don't understand is the house purchase part of it.  You are getting a 100k loan that you will have to pay back.  Let's say for the sake of argument that you buy a house with that same 100k.  For you to profit off this (in order to repay the loan) you would have to sell the house above what you purchase it for back to your investor.  In essence, he would be paying himself back with his own money.  If I'm not understanding you correctly, let me know.

Brian Levredge · Answer

There are a few issues as I see them.  First, even if you sell your investor/lender the house at your cost, he still has to come up with a down payment in order to obtain financing.  We still have the same conditions.  Why not just borrow the money, find him a house and have him buy the house directly?  You could still make the improvements and get it rented.  That could be condition of repayment for the loan as well.

A RE attorney would certainly know more than me, but what is being used to collateralize the loan.  If you don't have any assets to begin with, you are setting him up for risk, especially if he is loaning to your LLC without any type of guarantee.  Furthermore, the 100k at no interest may constitute a gift, which is a taxable event (again, check with a good RE CPA or attorney).

Brian Larson · Answer

Thank you both so much. I really appreciate it.

I can definitely see how this is loan fraud. I think the best approach here is one of the scenarios Brian gave. I will let him buy a house with tradional financing and I can help him fix it up and get it rented. This will be a condition for repayment on the loan.

I will also find out details on interest and what the minimums are on this loan so it is legitimate.

Thank you both so much

Jon Holdman · Answer

I'm with Brian, this doesn't make sense as stated.  Here's what I think you're saying.

The investors loans your LLC $100K.  Your LLC buys and fixes up a house for the $100K.  After two years this investor buys the house from your LLC for (say) $120K.  He puts down $36K and gets a loan for $84K.  (I'm neglecting costs here).  Your LLC gets paid the $120K.  You pay him back $100K.  You keep $20K.

He started with $100K, paid the $36K down payment, and got back $100K.  So, he's out of pocket $36K and has a $84K loan.  You could have just bought it from the start for $100K.

OK, great deal for you, but why in the world would he do this? It makes no sense.  There must be something more to this story.

If he's getting a conventional loan, this sounds like loan fraud.  He's buying the house from himself, really.

Brian Larson · Answer

Ah, thank you both so much for the comments. let me clarify a bit here.

The goal of this investor is to get a SFH that is cash flow positive. My goal in this is to get an investor that loans me some seed money so that I can buy a property, fix it up and then sell it in the 'low end retail' space.

This investor does not want to pay cash for a property since he wants to have the conventional loan (tax reasons?).

So, the idea here is that he is loaning my LLC the money to go and get him an auction home (paid in cash). I will then fix it up and get it ready to rent. Once this is done, he will then buy the house via traditional means (put 25% down and fixed mortgate, etc)

At the end of it, I will still have the $100k in seed money that we wants paid back in full (without interest) in 24 months and he will have a rental property with conventional financing.

Just to be clear, the original thought was for him to loan me the money, I woudl then buy, fix, resell a home and then pay him 50% of the profits and then do it again with the same money. He says, he woudl rather let me do that game with his loan as long as I can get him a positive cashflow house as my first buy, fix, sell.

My intention is not to make any money on the sell of the property to him. That is kind of the deal in order for him to give me the 0% loan for my seed money. I agree, if he pays an extra $20k for me to flip him a house...that doesnt make sense! haha.

I hope that clears it up.

Also, there was a mention of loan fraud. Is what I explained above loan fraud or have I clarified it better?

Oh, last thing. I will still be seeing a RE attorney as I want to make sure everything is legit. I just feel that the more I know what I want to do (and what I can do) before going in will make the creation of contracts much easier.

Thank you for your time
peeklay

How do I setup a private money loan with an investor?

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