Private money/investors capital

[Nikko Tountas]

Hello,

I was wondering does long term real estate holding properties such as properties work using private money/investors money? If so how would you structure a deal where they get there ROI monthly/quarterly/yearly. Using their money as a down payment to purchase properties but will there be enough cash at the end for me to have a profit? Just trying to learn some ways to be creative using outside money as down payments for long term hold investing properties. As always thanks for reading and appreciate any feedback!

[Alex Breshears]

Hi Nikko! This question comes up a lot around private lending! 

This is often asked about because active investors are looking for this sort of product, and the reason there are not companies offering it is because of the amount of risk involved in doing this type of loan, especially in the current economic climate.

I just want to explain from a lender's standpoint why this might be above a lender's risk tolerance, so you can possibly find another alternative. First, when borrowing funds for the downpayment, that means the property is 100% completely leveraged. As the person providing that 2nd lien against the property, if that property loses value for ANY reason (and not all of them you control) that means my loan is automatically underwater being in the 2nd lien behind your financing to acquire the property. If the property values in your market soften, if the tenant moves in and destroys it, fire, earthquakes, floods, hail, hurricane, another lock down requires you to keep a non-paying tenant - honestly anything - and my position in the property is at jeopardy. I'm not saying no one will do this type of loan, but I'm explain why looking at it from a lender's risk perspective could help you look for another alternative.

Another reason, other than being over leveraged, is that a borrower that is not well positioned with capital is also at a much higher risk of default. If a borrower stops paying on that first mortgage, and then the lender goes to foreclose, any equity that might have been had in the property is now gone because default interest, late payment penalties, legal fees, etc will eat up anything left after the principal balance of that first lien is paid. As the 2nd lien holder, again, I'm wiped out entirely. So again not a good place to be. If you close on the property and then discover the roof is leaking, the main sewer line is nothing but tree roots, really any major expense, that can easily put a borrower in a position where they do not have enough actual cash to solve the problem, so the property loses value due to deferred maintenance, or the borrower digs themselves into more debt, making it even harder to get another loan to cash me out of the equation at that upper 20% of equity.

Now what can possibly be done, with the properties you already own. If you have equity in the properties that are getting ready to sell, you could find a private lender that will do a 2nd lien on those, again as long as the equity is there. So for example if you are pretty far along in one rehab, and you have about 50% LTV with your current financing, you could potentially find a lender that will do a 25% LTV second, so your total LTV isn't above 75%. The 2nd lien holder position has a few considerations that need to be in place, such as it can't be a hard money lender, there can't be a large pre-payment penalty, it has to be current, etc. These types of loans I have seen done, and I've personally done a few in my chosen market.

AS far as structure - with a private loan it would be a recorded lien against a property. There would be a normal closing if you are acquiring a new property, lender's title insurance and appropriate hazard insurance would need to be acquired as well.  My suggestion is to keep the lines very clear with borrower and lender. Do not try your first deal with debt and equity from the same person.  The lender will provide the capital under the terms which you sign for in the promissory note and the lien instrument (mortgage or deed of trust depending on state). The difference between a hard money lender and a true private capital lender is that we are much more flexible on terms for the loan. Since it is literally one individual talking to another individual, the loans can be tailored to suit everyone's needs, as long as everyone has realistic expectations of what is going to happen.