Is it illegal to ask investors for money on a rehab project?

Question

So here's my question, is it illegal or unwise to ask for money from investors on a major rehab project?

I have done all the leg work and calculated the ARV (about $980,000) the total cost to purchase the vacant apartment complex with renovation costs are 525,000 to 725,000. I even went as far to figure out the growth of the area and what renters where looking for by making fake craigslist ads for the area. So I know exactly what the tenant population wants and needs for housing.  I also have my own money invested into the project which is 44,000.

I would use a hard money lender but the interest rates are sky high, somewhere in the 12 to 20% range. There is no way I would be able to cover those types of rates, even if the contracting crew completed the renovation in 4 months.

Getting back to my main question, is it illegal to ask investors for money on the project even after iv shown all the numbers? I would much rather give individual investors a 6.8% to 8% return on the amount they loaned me after one year once iv refinanced the property.

This post became a little longer than I was anticipating but all input and advice is welcome. Thanks BP community!

Shawn Torsitano · Answer

Please take this with a grain of salt, I'm not a real estate or securities attorney. It would be good for you to seek one out if you're concerned. My understanding is that SEC regulations come into play when you(being whatever entity has the deal) begins advertising to the public trying to solicit investors. If you're going around asking people that you already know, it should fall into the "friends and family" category.

If there are big players in your area, and none of them are taking interest in the property, that could be a red flag. Could have a severe foundation issue, or something else potentially devastating to the finances.

When you get into refinancing the loan to pay back investors, there are some things you'll need to be aware of. With large apartment buildings, that could be a year or two long process. Renovations will take several months. Renting it out will take a few more months. And then you have to be able to show results, with the new rent rolls, to get the higher valuation. There may be a seasoning period for the loan with the property, I'm not sure.

Ultimately, if you don't have a track record of this sort of project, you will likely have trouble getting interest rates as low as 7-8%. I would run the numbers at 12-13% interest rates. Figure out a much more solid estimate for renovations. Prepare a very nice, very thorough presentation, and try and set up some financing with friends and family.

You could also go into it a slightly different way, and instead of borrowing the money with high interest rates, present the offer as an equity partnership, explaining your refinance exit idea. You'll own significantly less of the property when all is said and done, but the risk to you can be less, and you won't be paying interest rates on as much money. I would still recommend leveraging some, but the amount would be a call for you and your investors.

Shawn Torsitano · Answer

It is not illegal to ask investors for money, depending on the way that you are soliciting. "Friends and family" is the common first category. When you get into "advertising" your investments, SEC regulations come into play, as do the accredited investor status and such. Consult an attorney for more info on that, if that's something you're going to look into.

Vacant apartment complex sounds incredibly risky. I assume it's not all vacant. Your cost estimate is far, far too wide. Treat it like a flip. Find the ARV, subtract all your costs, your expected profits(may be different with commercial residential, depending on your exit strategy), subtract your financing charges at the 12%+, and figure out what you can offer.

This is me guessing, but if you're not sure about whether or not you can solicit investors, you probably have 0 experience in this area. Investors are unlikely to invest with you at 7-8% interest given your low experience level. There is a guy over here in Oregon who was on Podcast 140, he's been investing since the early 80's and he still pays 9% for private money.

Account Closed · Answer

There may be investors willing to take 8% on a such a risky deal but they will not be strangers to you. So yes, you can approach your friends and family and ask for investment. As an outside investor the risk on this with your experience level, vacant building, lack of other interest in the property are way too many red flags. I can invest with well known syndicators on similar apartment flip deals with far lower risks and far higher returns with an equity investment.

Anthony Wienke · Answer

I think ill leave my friends and family out of the deal. Not that I wouldn't include them but im looking for money from licensed and insured source so just in case things go south its only my **s on the line.

What it may actually come down to is just scaling down my expectations and starting out with a smaller property. I need to build up that equity before anyone will take me seriously.

Iv got a couple more sources of capital I could possibly tap into so I guess time will tell if the funding for the project will come to light.

Thank you for the info though

Shawn Torsitano · Answer

@Anthony Wienke

Looked through them, and I'm assuming you're looking at either the "Value-Add" or the "Moderate Rehab" loans in the "Conventional" section? I think you may have trouble meeting the LTV ratios that they have, and the experience requirements.

Value-add requires at least 15% down:

"Maximum loan-to-purchase (LTPP) / loan-to-value (LTV) ratio: 85%o Minimum amortizing debt service coverage (DCR) ratios: 1.10x – 1.15x depending on market"

"Eligible Sponsors:Developers/operators with experience in multifamily property rehabilitation and in the local market with sufficient financial capacity"

and Moderate Rehab requires 20%:

"Loan-to-value (LTV) ratio:o Fund up to 80% of the as-is value, supported by the property acquisition price if applicableo Periodic draws of unfunded loan proceeds (as opposed to an escrow) to reimburse the sponsor for up to 80% of the renovation costs on a monthly or quarterly basis, as work is completed, similar to construction financingo Appraisal must demonstrate 75% as improved LTV (with fully funded renovation proceeds)"

"Eligible Sponsors:Experienced and well-capitalized sponsors who have successfully completed rehabilitation projects of similar scope and who are familiar with the Freddie Mac loan process"

You're not likely going to be able to finance the additional amounts, most lenders will require first position.

The project could still be a possibility, but you may need to bring on an equity partner that meets the experience requirements.

Anthony Wienke · Answer

@Shawn Torsitano

Yes the link should be pasted here

http://www.freddiemac.com/multifamily/about/what_we_do.html

Shawn Torsitano · Answer

Do you have a link to that? I've never heard of it, sounds interesting.

Anthony Wienke · Answer

I think I may have solved my finance issue. I didn't realize that Freddie mac type loans can be issued for multifamily properties where there are repairs needed and can be included with the purchase.

If I can get some sort of forbearance for the first few months during the renovation ill be golden! But I think those are only allowed for individuals that lose their job but I may be able to work something out with the lender.

Any who, I appreciate the advice none the less. Ill continue to look at other avenues for funding in the project but I think the Freddie Mac multifamily loan may be the way to go.

I still need to have an inspector walk through the property so I have exact estimates for what's wrong and how much it will cost to renovate. The figures I gave you earlier were of course my estimates if I had contractors fix every inch of the building minus the structure itself.

Anthony Wienke · Answer

@Shawn Torsitano

Now when you say "advertising" are you talking about me conducting solicitations under a business name or as just my self (an investor)? I do know of a couple real estate lawyers in town so I might have to give them a call to find out the legality of it.

The apartment is completely vacant but its located almost dead smack center of town and a ten minute walk to the local university. Location, location, location its ripe for the picking so to speak but there haven't been any major players that I know of trying to snag the deal. There have been some quads around the outskirt of town in the same condition that have been selling.

The earlier figures I gave for a return to investors was just a ball park. Im more than willing to offer larger returns just as long as im not stuck paying monthly on an insanely high interest rate from a hard money lender. The primary thing I want to do is pay back investors after the renovation is completed and I can refinance into a traditional loan. This will also allow me to get the management team on board and move new tenants into the building.

Is it illegal to ask investors for money on a rehab project?

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