Financial Structure for Private Lending Deal

[Steve Sorensen]

Hello! I have recently been searching for a mentor prior to making my next investment and I found one, and he's in private equity so he and his friends are pretty wealthy. He's willing to act as a mentor, and he also proposed investing with his friends. He threw out a number of $1.5MM for an investment pool; they first want to do a small SFH deal with the potential to expand up to (and hopefully eventually beyond) that $1.5MM number if the first deal is successful. There will be 3 other investors most likely, so a total of 4 of us will be involved in the partnership.

I'm talking with several people I know to try and paint a complete picture of what this will look like, but I haven't contemplated this amount of money or considered working with a number of investors like this before as I've been funding projects myself...at most I've considered bringing one investor in to split equity and cashflow 50/50 which is very straightforward.

Since I'll now be working with more robust investors, I want to make sure I'm structuring things in a way that will be favorable to all parties. Can I get some general guidance on how I can structure this partnership to work toward my personal goals while providing what these wealthy investors will be looking for?

- Personally, my goal is to replace my current W2 income with real estate income so that I can leave my job and pursue REI full time.

- These investors are already very financially secure so they're not looking for cashflow so much as a solid ROI. They also will want to avoid paying taxes as much as possible (as we all do)

- My expectation is that the investors will each bring, say, $200k to the pool, and my financial contribution will be negligible in comparison; my primary contribution to the investment will be the sweat equity.

- Would it be reasonable to purchase a property with their contributions and keep the cashflow for myself since they're less concerned about cashflow and more concerned with their ROI? In that situation, would it be reasonable for their payoff to be a larger return at the end of the investment period? I was told that they'll likely be looking for 8-10% ROI, not sure if this is compounded annually or if it would be a simple interest calculation...these are some of the nuances I need some direction on.

- What should the length of the investment period be? Will they be expecting periodic disbursements or a lump sum at the end of the period?

- Would I sell each property at the end of the investment period? Would I refinance into a traditional loan after the rehab? In my head, I would like to use the BRRRR model so that I don't use up the entire investment pool with just a few properties, but I'm not sure if that's a realistic way to provide the returns they're looking for. It also seems like it defeats some of the advantages of buying with "cash" since that would involve refinancing into a relatively high interest rate mortgage.

I know there's a lot here, so feel free to answer any of the individual questions or provide any response you see fit. Thanks in advance!

[Don Konipol]

Quote from @Steve Sorensen:

Hello! I have recently been searching for a mentor prior to making my next investment and I found one, and he's in private equity so he and his friends are pretty wealthy. He's willing to act as a mentor, and he also proposed investing with his friends. He threw out a number of $1.5MM for an investment pool; they first want to do a small SFH deal with the potential to expand up to (and hopefully eventually beyond) that $1.5MM number if the first deal is successful. There will be 3 other investors most likely, so a total of 4 of us will be involved in the partnership.

I'm talking with several people I know to try and paint a complete picture of what this will look like, but I haven't contemplated this amount of money or considered working with a number of investors like this before as I've been funding projects myself...at most I've considered bringing one investor in to split equity and cashflow 50/50 which is very straightforward.

Since I'll now be working with more robust investors, I want to make sure I'm structuring things in a way that will be favorable to all parties. Can I get some general guidance on how I can structure this partnership to work toward my personal goals while providing what these wealthy investors will be looking for?

- Personally, my goal is to replace my current W2 income with real estate income so that I can leave my job and pursue REI full time.

- These investors are already very financially secure so they're not looking for cashflow so much as a solid ROI. They also will want to avoid paying taxes as much as possible (as we all do)

- My expectation is that the investors will each bring, say, $200k to the pool, and my financial contribution will be negligible in comparison; my primary contribution to the investment will be the sweat equity.

- Would it be reasonable to purchase a property with their contributions and keep the cashflow for myself since they're less concerned about cashflow and more concerned with their ROI? In that situation, would it be reasonable for their payoff to be a larger return at the end of the investment period? I was told that they'll likely be looking for 8-10% ROI, not sure if this is compounded annually or if it would be a simple interest calculation...these are some of the nuances I need some direction on.

- What should the length of the investment period be? Will they be expecting periodic disbursements or a lump sum at the end of the period?

- Would I sell each property at the end of the investment period? Would I refinance into a traditional loan after the rehab? In my head, I would like to use the BRRRR model so that I don't use up the entire investment pool with just a few properties, but I'm not sure if that's a realistic way to provide the returns they're looking for. It also seems like it defeats some of the advantages of buying with "cash" since that would involve refinancing into a relatively high interest rate mortgage.

I know there's a lot here, so feel free to answer any of the individual questions or provide any response you see fit. Thanks in advance!

I can tell you how I structured syndications for the last 22 years - but that isn’t necessarily how you should do it, or how it should be done to be attractive to investors.

So here’s my advice:  research all types of real estate syndications and get their PPMs and read through them to familiarize yourself with the terms and concepts.  Then read Structuring and Raising Debt and Equity for Real Estate” by Rob Beardsley.  By then you’ll have a general idea of the possibilities.  

Btw, based on some of your comments I think you are going to be surprised by (1) in all syndications I know of the money gets a “preferred 6-10% annual return BEFORE  the sponsor gets to take a cut (2) I haven’t seen a deal in years where the sponsors get anything over 20% of the profits and (3) the only money the sponsor earns upfront are fees that would have been paid to a third party anyway where the sponsor also acts as the third party, I.e.  property management, leasing, brokerage fee.  “Promote” interest is earned on the backend AFTER the investors receive their preferred return.

Sponsors with extraordinary long term track records can cut a better, sometimes much better deal for themselves.  But when they do they setup the competition to seduce their investors away.  Here’s the real facts; it’s HARD to scale, even is someone is very successful on a small scale it hard to FIND the same type opportunities in bulk, when you do expenses increase geometrically because most of the tasks you do will be farmed out; people are unreliable and a key investor may back out the day before his money is due; some lawyers love to kill deals, sometimes people who ‘talk a big game” don’t really have the money or courage to invest and use “my attorney killed the deal” as a face saving mechanism; and if you started investing after 2009 you have NO IDEA what a market cycle is like.  

it takes a S___ load of education and learning to make up for a lack of experience, BUT it CAN be done.  Do lots of research and determine if it’s worth doing. The majority of people who try syndication do not find it a profitable use of their time or energy believing that can earn more money with less hassle investing on their own.