Pooling investors money for a cash purchase.

[Mitch Kronowit]

There was a topic on this about 2 years ago, but I wanted to update it with my own information. Plus, I think it's a very useful and relevant discussion for other investors out there, considering especially the current financing climate.

Those who have followed some of my more recent posts know we're looking for our 3rd rental property. Conventional and traditional financing is tough to qualify for as the ink on our lease for rental #2 is still drying, sending our DTI ratio too high for tight-wadded banks. Seller financing and buying "subject to" in my area is about as promising as mining for gold in my backyard.

However, I do have a few friends with money that would like to invest with me. They are getting pathetically low returns on their current savings vehicles and they know I do a good job fixing up properties for rent. Our idea is pool their money and, along with some of our own funds, buy a small condo or home for around $50-60k, all cash. Rather than bring in my friends as equity partners, we would like to simply borrow the funds from them and pay them a decent return. IOW, they would hold a mortgage on the property we buy and rent out.

The question is how best to combine the funds from 2-3 different people? Obviously, nobody is going to want to be in the 2nd or 3rd mortgage position, so I would like to place them all in 1st. I'm thinking the investors form a partnership and lend the money to our LLC. Our LLC purchases a property and hands the lenders a promissory note and a trust deed to secure the loan. We're thinking the note would provide a healthy return and be due in 5 years or so (we should be able to refinance by then). Sound good so far or are there other suggestions and recommendations?

Also, are there any federal or state regulations that are going to mess this arrangement up? Who can I use as a trustee (I've read some attorneys just list any prominent title company without notifying them that they're the trustee)? Our interest payments are still tax deductible, right?

Obviously, I am going to go over this with the professionals before anything official transpires. I just want to be armed with as much info as possible so I can have an intelligent conversation with my attorney and accountant.

Thanks everyone!

[Bill Gulley]

Hi, SEC regs allow less than five individuals to fund a partnership without filings by exempt investors. Mortgage loans are specifically exempted under certain conditions.

Really, the easiest way for them to do a loan is individually. The promissory note would say John Smith and his wife Sally Smith together with Robert Jones and Rebeca Jones (H&W) together with Sam Allen and his wife Susan Allen, singularly and collectively, hereinafter as "Holder".....

They can simply do a letter of agreement as to how they break up the contributions made between themselves.

Now, are there pitfalls to this, yes but the question here is this a business enterprise between the three families or an arrangement to lend money for a one time event? Depending on state law, they may get by with such an arrangement. For taxes each treats the contribution as an individual loan, how it is secured has no bearing on taxation. . Bankruptcy, divorce and other issues can be taken care of as a separate interest in the letter of agreement. One of them will have to agree to collect that payment and break it down. You could also write three payment checks. Check with state law as some states limit such arrangements to three individuals (including married couples). I know this may sound strange to many, but these are considered private loans, where parties are related or have other social connections, as Jon eluded to above. If you take bankruptcy or have any problem, they are as secure under the security agreement as individuals as they would if they had been a business entity. If one of them gets sued or has a bankruptcy, it is simply treated as any other asset according to their interest. Such interest may be assigned, but the loan agreement can not be accelerated to maturity due to any fault of any one lender. The Deed of Trust will list the names in the same manner as the promissory note. Lenders have very little risk to each other, say in a divorce, one party would simply be awarded the asset in the property settlement and it would have little effect on any other participant.

Having two parties who are unrelated as a lender, for a one time loan, is common between unmarried partners who are named individually.

Such an arrangement is FOR A ONE TIME SHOT ONLY! If you are contemplating doing more than one loan, do it as an LLC amoung the partners with the LLC loaning the money to you as suggested above.

The fact that they are friends has no bearing on the arrangment as to a lending or pooling of funds to the SEC. If you begin to lend money as a business enterprise, it must be structured within the exemptions of the SEC otherwise you will need to register that entity, you don't want to go there!

Check with your attorney and have him or her to draft the documents. IMO Bill