Private money lending advice

[Paul Altman]

Hi

I am considering loaning money in a situation where I would be getting 35-40% of the profit and also a preferred interest rate on my money. This would more so be a partner situation so not lending to strictly a borrower.

I would be funding the entire project which would come out to around $175k - $200k including purchase and repairs.

I have never lent private money before and would appreciate some advice from some of you guys out there with experience in this area.

Just want a quick explanation of the basic steps i should take in this process.

Ex.

1 Contracts/documentation to make sure is in place

2 How to be prepared legally

3 Best ways to make sure investment is protected

4 Making sure no one can run away with the money.

5 How ownership of property should be held

6 Dos donts etc

I have heard that securing your money with your name on the deed of trust isnt always good bc of certain risks.

Any advice much appreciated.

Thanks

[Paul Altman]

@Jeff S.

I have never done this before which is why, in addition to seeking advice form an attorney, I am also trying to learn from others who have experience in these situations. I did not say "these are the terms that I demand from a partner" as a matter of fact these are the terms that the potential partner drew up himself for the deal. So i dont believe saying someone is greedy is accurate when that person doesnt know "the ropes" of private lending and is simply here to get advice and learn from what others know from their experiences. So with that said I do not know what is considered greedy or not greedy.

From researching companies and individuals that use private lending from investors to deal in real estate, I have noticed that in a lot of cases they provide a 10-12% interest rate on your money. I do not think that is "smaller money" never said that, I was saying that 10-12% is likely smaller than what others were suggesting I make on my money, which was 50% or more of the profit. So what I was curious about is why do some investors accept that 10-12% on a their money and why do others suggest making 50% of a profit. In my case I am funding 100% percent of the deal as a partner and not really taking on many if any of the project duties and will have my name on the deed of trust, so why would I be entitled more than 10-12% bc the situation is very similar to a situation where i wasnt a partner but just a private lender?

Maybe others were just suggesting I take 50% in the case that I WAS involved in the project duties as a partner but considering im not maybe I should just act separately and not as a partner and just lend but again, I dont know because never done it before.

Also, because I dont know anything about private lending, I didnt know the prevailing rate is higher than 10-12% bc I thought usury laws stated that you couldnt charge more than that.

Also I would be a little weary of someone who had resentment towards making payments to someone else who lent them the money they probably didnt have themselves and is now able to potentially benefit and make a profit from that lender. I would think it wouldnt matter how much money was lent, that lender is making it possible for that borrower to be involved in the deal in the first place and the borrower would most likely know those terms before going into it and if didnt like then could not take part in the deal or find another lender.

I am just trying to understand how things should be structured in different types of scenarios, how you should protect yourself in these scenarios, and what is considered fair or not fair.

[Mike G.]

Originally posted by Paul Altman:

So what I was curious about is why do some investors accept that 10-12% on a their money and why do others suggest making 50% of a profit.
Also, because I dont know anything about private lending, I didnt know the prevailing rate is higher than 10-12% bc I thought usury laws stated that you couldnt charge more than that.

There is no rule as to what should be done or shouldn't be done. It's up to the parties involved to determine what they each feel is fair. Why some investors "accept" a 10-12% interest rate over a profit split is because there is less risk, especially here in SoCal where profits can be quite slim right now. Like @Account Closed said, oftentimes you will do just as well with a fixed interest rate loan as you would with a profit split, and possibly even better. Let's say the profit to share is $0. Would you rather have half of that, or a 10% interest rate on your loan? Also, there are likely to be more complications when dealing with a profit split, like the questions that are raised about who owns the property, do you form an LLC, or what kind of JV agreement should be in place.

As to the prevailing rate being higher than 10-12%, I don't know where that comes from, but it's certainly not what I'm seeing. Even most of the big hard money lenders around here aren't charging much higher interest than that (if at all). And yes, there is the potential for usury for charging more than 10% interest on the loan. There are ways around that (such as the original proposed loan terms presented to you, I believe), but that's best left for a discussion with an attorney.

[David Beard]

Certainly in the eastern half of the country, hard money lenders earn 16-25% annualized APR when looking at both rates and points, prior to expected defaults. Assuming a 6 mth deal, that might be 10%+3 pts to the better borrowers up to 15%+5 with a median of perhaps 12%+4.

[Bill Gulley]

Wow, and they do that without a gun? And I suppose you're saying hard money lenders, as with a license, not some individual off the street as a "lender".

Anyway, set your partnership up, lend the money to the partnership, to yourself and your partner(s), do it in the capital accounts, you won't need a deed of trust/mortgage since your company owns it. Your operating agreement or partnership agreement governs so just cover the bases there, see your attorney.

;)

[Mike G.]

Originally posted by David Beard:

Certainly in the eastern half of the country, hard money lenders earn 16-25% annualized APR when looking at both rates and points, prior to expected defaults.

Even if the interest + points were the same here in SoCal, it doesn't seem like your comparison between hard money returns and private lender returns is valid. Hard money lenders are most often brokers who are actually connecting rehabbers with private lenders, and the private lender gets the interest while the HM lender gets the points. At least that's my understanding from speaking with a number of hard money lenders. Obviously there are hard money lenders who lend their own money as well, and they will of course make a much better return than the private lenders they are working with. But for the private lenders loaning through hard money brokers, they are making a similar rate of return as if they just loaned directly to the rehabber.

[Paul Altman]

Do any of you guys have any recommendations for a good attorney that specializes in private lending?

Thanks

[Bill Gulley]

Paul, if you get a good business attorney, a good partnership, you can loan the money to yourself in the business, you won't need a mortgage'deed of trust which then keeps you away from volumes of lending issues. A good partnership agreement can protect you better in many ways than as a lender with foreclosure issues and security agreements. :)

[Paul Altman]

Thanks @Bill Gulley I think I would be more comfortable in that type of situation.

[Bill Gulley]

Well, the company owes the interest to you, the principal goes to your capital account and split profits. You can get more creative along these lines than in making a loan, taking a security interest and then working a partnership and splitting profits. Even easier is take a % split that reflects the interest.....don't forget the golden rule, he who has the gold makes the rules! :)

[Mirinda Lowe]

Paul, I'd love to connect with you and keep abreast of what you find out. I'm next door in Woodland Hills and becoming a lender is a goal of mine as well. I do my own deals, but sometimes also want to put other money to work for me that I don't have the cycles to keep busy myself. But...I trust no one with my money but me; assume everyone is a Bernie Madoff, and do mountains of due diligence before I step into anything. Just haven't had enough time to dive into the due diligence on this one yet. Perhaps we can help one another.