Cost of Investors Money?

Question

The past year I have worked with one investor who bank rolled the entire operation and we split the profit. After two homes we decided to create a company and partner 50/50 on everything. We have 100,000 in cash. We also turned to private investors and a few have shown great interest in the product we are offering. In particular one investor wants to invest over $250,000 and complete 10-15 homes in a year. We have the capabilities to complete the work and the inventory too.

The investor wants 30% on all money invested. There is no cap of what I make as long as he makes 30% on the money invested. We are putting no money into any of the properties therefore allowing me and my partner to use the 100,000 for our own deals. Typically investment of 60-80,000 per property. My questions are: Is 30% too high? What do others typically pay?

Aaron Mazzrillo · Answer

David Beard - I don't follow your math. Even if one were to pay 5 pts and 15% interest, if the loan is repaid in 6 months the total money expense is 12.5%, not 20-25%. John Ellis If someone offered me money at 30%, I'd laugh in their face... literally. My common retort to such greedy pigs is "Money earns interest, knowledge earns profits." If they want to make that kind of return, they better get out there and take some seminars. I'm borrowing money from 4-12% with 0-4 pts. The majority of my buy and hold is 9.9% at 4 pts. Short term flip money is 12/2, due in 2 years. There is plenty of 10/2 money available and I just closed $45K at 4 pts, zero interest for 1 year. You can find much cheaper money. You just have to ask.

Michael Power · Answer

We participate as the 100% money guys with our partner for the JV deals in the Atlanta area. 2012 saw our 'effort', (risk), rewarded with 11.5% on the money or 1/3 of the profits. This isn't considered a loan, it's a business partnership. I certainly don't want to get under anyones finger nails, but it takes both sides of the equation to make money in this business, unless you are financially self-sufficient. We don't state a return of 11.5% but take our chances that there will be a return and share the profit. Which in this case turned out to be what it was. I hope 2013 is as good! To supply cash for the year does not guarantee security as the homes are sold after 3-months but the money doesn't necessarily come back...it goes into another house. So, lack of a continuos security adds risk to the equation. Banks make loans, (<6%), HML's finance short-term flips, (12%-15% + pts), and business partners build businesses...for an equity share. @John Ellis - your initial $100k investor turned out to be an equity player in the end, and he should be rewarded with the 50/50 partnership agreement you crafted. Your additional $250k participant crosses the line by stating a target return while placing himself first. He is focused on the "return ON his money" rather than the "return OF his money". You may not have him long as a partner. I'll hold my comments there... Mike P.

Aaron Mazzrillo · Answer

Got it. Thanks for clarifying.

Troy Sheets · Answer

Any update? I know this is old but I'm curious to see how it went and what you decided...

John Ellis · Answer

Thank you for all the replys. I am very nervous about the 30% return on money invested but the potential to hit on one and score big with no money in is what is intriguing me. Here are the three deals that I want to move forward with investor.Property 1: purchased for 20,000, rehabbed for 35,000 with an ARV of 120,000. Property 2: 32,000 Purchase Price, rehabbed for 35,000, ARV of 110,000. Property 3: Purchase Price 31,000, rehabbed 25,000 ARV 90,000. Plus with my partner of the original 100,000 Purchase 59,000, Rehabbed 25,000 ARV 130,000. Here is the breakdown House 1: 55,000 by outside investor 16,500 (30% return to investor) 14,400 (Closing Cost and Realtor Fees) 85,900 (Total In) 34,900 Profit for myself House 2: 67,000 by outside investor 20,100 (30% return to investor) 13,200 (Closing Cost and Realtor Fees) 100,300 (Total In) 9,700 Profit for myself House 3: 56,000 by outside investor 16,800 (30% return to investor) 10,800 (Closing Cost and Realtor Fees) 83,600 (Total In) 6,400 Profit for myself House 4: 84,000 by myself 15,600 (Closing Cost and Realtor Fees) 99,600 (All in) 30,400 Profit for myself All homes will go on roughly the same time. Although winter weather all sold between March 1 and April 1. Total Anticipated Profit: $81,400 I understand that 30% is high but I just don't see another way to possible due four homes at once until I get my own capital. I am not saying I'm not crazy for taking on so much work with the possibility that I am wrong but in the end I believe it is a chance worth taking.

David Beard · Answer

J, you mention a $15K profit--before any financing costs--on a property where the total investment is $80K. You are presumably selling this for $115K (around the 70% of ARV area), a gross spread of $35K. So selling and holding costs amount to $20K in your example, correct?. This seems plausible, given commissions, seller-paid closing costs, your own closing costs, staging costs, insurance, utilities, taxes, and gulp... before even allocating overhead from your business operation? So if you were to use a HML for 100% of the investment at 15%/4 pts, then on a 4 mth project that would subtract another $8-9K from your profit (considering all the loan fees as well), so you'd be left with $6-7K minus taxes. That's a pretty paltry return for 4 mths of hard work, admittedly. Is that the state of rehabbing these days? At any rate, 15%/4 pts (rate charge by Pine Financial Group in Denver) equates to 27% if you do three deals in a year, so yes the 30% is high, but so are 100%-financing HMLs. And the HML will charge more ancillary fees for loan processing and inspections than this investor, costing even more.

J Scott · Answer

OP said investors wants "30% of all money invested." This is different than 30% of all profits earned. But, perhaps he wasn't clear and your interpretation is correct...that would be more reasonable...

Chris Martin · Answer

Regarding "Perhaps offer 30% of the profit for the investment...that's reasonable. Or up to 12% interest on the loan." That's how I read the OP. Maybe I read it wrong, but I was thinking the K-1 (line J) would show 100% capital and 30% profit/loss

J Scott · Answer

True...that was an overstatement on my part... But, assuming the investor gets a promissory note on the business (and is the sole creditor) and also gets a personal guarantee, and assuming the OP is even a half-decent rehabber, the risk should be minimal. First, it's only a 75% LTV loan, and second, at 30% interest, it won't take too many years to get the principle paid off in full, at which point the risk truly is zero on the principle.

Joe Delia · Answer

To say the investor is carrying no risk just isn't the case.