Is it considered a security if I offer my private lenders a bonus

[Jean G.]

Hello,

I buy and hold properties, and I am trying to find a deal structure by which private money lenders would be interested in providing me long term funds at reasonable rates, as opposed to typical hard money (high interest rates, short loan terms) which is intended more for flipping.

I like to buy my buy and hold properties the same way as wholesalers or flippers would, usually 25 or 30% below ARV, which allows me to start with immediate equity (and it creates a buffer in case the market turns). I will also do some basic rehabs if it helps build equity.

One deal structure that I am getting some traction with, and which works well because the properties start out with existing equity, is to pay a low interest rate (say 5 or 6%) over an extended loan term, but offer the lender a profit share on the equity gained upon sale (say 25% of the profit from the sale for example).

So if we take a property bought for $105k today, worth $150k+ at closing (that's actually a real example which I closed in May, courtesy of Homesearch) that may sell for $200k when the loan matures in 10 years for example, the lender would get an additional $23750 profit share at the end of the 10 year loan (I'm not counting selling costs or broker commissions in this example).

Say the loan amount was $80k at 5% interest, then with the additional profit share, the lender gets the same amount of interest as if the rate was almost 10% (I'm probably not accounting for time value of money properly in my math, but hopefully you get the idea).

My question is this: I know that when a passive investor receives equity, this is considered a security and we don't want that. But if a lender gets paid a profit share (which is not equity, but is calculated based on the value of the equity) as in the example above, can anyone say for sure if this is considered a security or not, and falls within or outside the scope of the SEC?

Thank you!

Jean

[Jean G.]

@Charlie Fitzgerald

Thanks for the referral to the RE attorney. Just to clarify, the "lenders" I am talking about are not professional hard money lenders like yourself, but rather high net worth individuals who are not involved in real estate, and to whom a 5% rate sounds very exciting compared to 1% on their savings account. I completely agree with you that my model is not interesting for professional lenders.

@Christopher Brainard

Thanks a lot for the info on Meadows Bank. I believe the contact there is Shawn Pitts and I have spoken to him several times. The 6% fixed rate is for a 5 year term from what I understood. But whenever I have a property with equity available, there are other better (longer term rate) solutions available. For example Clark County Credit Union has a 15y fixed rate at 5%ish, and they will go up to 80% LTV (on both purchase or cash out refi). I'm in the same situation as you that I haven't done any loan with them yet, as I still have a few conventional loans available before I reach the 10 property limit, but was gathering the information to have it on hand. I was also able to convince Wells Fargo to do a 30y fixed cash out refi for me recently as a portfolio loan with 5.125% rate. I'm not sure if they'll do it a second time and a third time, but I'll sure try.

I'm also looking at unsecured business lines at the moment, and I know that Meadows won't do these.

@John Aranton

Yes I guess I should have been clearer, by "private lender" I meant a non-professional lender, ie a private person.

I will update the thread if I get an answer on this from an attorney.

Jean