How to payback friends and family after the deal is done?

Question

Hello BP,

I am a novice investor with three duplexes in St. Louis, MO. I acquired my properties by house hacking FHA loans. Now that I am no longer single the option to house hack is no more and I would like to scale my business by acquiring more properties at a faster rate.

I would love to source funds from friends and family, but I am hesitant because I do not have a efficient way to repay them in a timely manner.

I am looking to build wealth through the buy and hold method. I’ve listened to the BP podcast and the guest are open about how they received funds, but never mention how they paid them back.

Thank you in advance for any help you can provide.

Mauricio Rauld · Answer

Your next call is probably to an SEC attorney (a Syndication attorney like myself) as what you describes sounds very much like you are selling a security. In general, any time you take monies from Investors where the returns are generated solely from your efforts, then you are dealing with a security and must comply with Federal and State securities laws. The actual structure (Loan, JV, LLC, Handshake) does not matter. If your investors are passive, likely a security unless not structured properly. Based on the compliance cost, you will want to work with an SEC lawyer to ensure you are structuring it properly so you avoid the securities laws.

Hope this helps!

Mauricio

Hope this helps!

Mauricio

Amy Wan · Answer

There are a number of ways to pay back investors--but it depends on your business plan, the deal, and what you're investors are looking for (short v. LT opportunity). Some refi out, some flip or do some quick value add, some do buy/hold, some increase the value and occupancy over a number of years. Everyone's got a different business strategy

Jaysen Medhurst · Answer

@Lavall Brown, as @Jeff Copeland points out, if you're bringing in a lot of $5-10k investors, you have a syndication. That means you've created a security and are subject to SEC regulations. This is not inexpensive to set up and definitely cost prohibitive for something like a $100k property. There are also rules around accredited vs. non-accredited investors, which may preclude some investors.

The better plan is to find one equity partner to fund future deals. Partner is the key, they are a part of the business (and therefore not an investor, no syndication, etc.). Sounds like you've already proven yourself with the 3 duplexes. Start working your network, going to local REI meetups, hanging out at country-club bars...

Jeff Copeland · Answer

@Lavall Brown - That gets a little more complicated!

You can have multiple mortgages on the same property, so it would be possible for them to take first, second, third position notes (which would get paid off in priority order in the event of a foreclosure, for example). But the costs would increase when preparing and recording that many mortgages.

Another possibility would be for them to pool their funds into a entity such as an LLC, Trust, etc, with shares according to their initial contribution, then have that entity hold the mortgage (though this could also get complicated due to laws and requirements surrounding mortgage lenders).

Yet another option would be to pool the funds into an LLC that actually owns the property, with an operating agreement that spells out who gets what in terms of distributions (while holding) and payoffs (when exiting) - sort of a really simple syndication.

None of the above are do-it-yourself options, and it's best to seek appropriate legal and financial advice when setting this up.

Lavall Brown · Answer

@Jeff Copeland thank you for answering my questions. I now have a better understanding and direction. Initially, I was thinking with a mom and pop mentality, but now I understand how to professionally structure funding from family and friends and make it legit. My next search is for a real estate attorney.

Thank you, Jeff!

Jeff Copeland · Answer

You should not expect family and friends to just drop off a wheelbarrow full of cash.

For buy and hold, they would normally invest by providing you a loan in exchange for a mortgage note.

For example, Aunt Sally may agree to loan you $100k at 6% interest with a 15 year amortization (or whatever terms you and she agree to). A title company or attorney would prepare the mortgage and note, and you and Sally would agree to said terms, sign the necessary documents, and transfer the necessary funds as part of an acquisition or refinance.

You would then pay Sally $844/mo for 15 years, netting Sally her $100k back as well as $51,894 in interest (these numbers can be worked out using any widely available mortgage calculator).

Like any mortgage, in the early years you'd be paying more interest than principal.

And the mortgage protects Sally - if you sell the property prior to paying off the note, the balance of the mortgage has to be paid off in order to clear the title, just like any other mortgage.

The details will differ slightly depending on whether you are in a lien theory or title theory state, but the general idea is the same.

Theo Hicks · Answer

Generally, passive investors receive a return of capital upon a supplemental loan, a refinance, or a sale.

Lavall Brown · Answer

@Jeff Copeland thank you for providing feedback. I appreciate that you provide a detail example that’s easy to understand with numbers that make sense. Now let’s say I don’t have one aunt sally with 100k, but multiple aunt Sallys with 5k to 10k?

How to payback friends and family after the deal is done?

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