Passive investors funding buy and hold properties

[Account Closed]

I'm aware that there are a few people on this site that have successfully built up rental portfolios by having passive investors getting a stated return on their money. I want to educate myself a little more about this and I know this is the place to come so here goes...

By day I'm am accountant in a local public accounting firm. I have a pretty good understanding of what works and what doesn't in my market as far as rental properties go. I can also save up money pretty efficiently and get into the real estate buy and hold strategy (long term wealth as my goal) and I'm not really looking to buy and flip because that doesn't really interest me too much.

1. How would you go about getting started using outside investors? Would I be better served making a few acquisitions with my own personal resources to build up a track record so to speak that I can deliver the returns needed to satisfy passive investor requirements before seeking outside investors?

2. Logistically speaking, investors who want to get a stated return (say 10%) on their capital I understand how the interest payments work but where I'm getting a mental block is that real estate is one of the most illiquid investments out there. If an investor gives me $100k to acquire properties that meet the requirement to provide the returns, what happens when the investor wants his principle back out of the deal? It's not like a mutual fund or something where we can just sell it off and cut him a check so quickly. How do these arrangements work mechanically? If I needed to cash out an investor who needed access to his principle but it's tied up in a now illiquid rental property would I need to seek permanent financing to get the investor his principle back? Do you set it up to where the money is tied up in the property until the rental income has hit the tax return for two years and he now has the option to get out? If I had to refinance the property to get the investor his principle back, who pays the refi fees? Do you treat it as investment expenses required to "cash out" the investor?

From what I'm picturing here, I, the landlord would tell the outside passive investor that I will give him a fixed rate on his money (lets say 10%) but that his principle is not available to him until the property qualifies for permanent financing.

Thinking about this from the passive investors shoes, committing money to a buy and hold project is great if I get paid my standard rate of return, but I may not be able to get my principle out of the deal for quite some time. Is this a common problem and how are you all who do this setting up these transactions mechanically speaking?

3. Soliciting investors. I know there are rules and regulations on how you go about seeking investors for your projects. What's the proper way to do this?

4. Are there investors on this forum who understand the illiquid nature of real estate that will lend on buy and hold properties for a stated return?

5. Would you keep the passive investor's money in place permanently or would you eventually seek permanent financing so you could own the property free and clear yourself?

Hopefully my questions make sense. If not, I'll clarify on my questions.

Thanks!

[Ned Carey]

1) Yes building a track record is best.

2) Typically they would either be a lender with a mortgage or an owner of the property. The terms of the mortgage can have a balloon payment after a certain number of years. If they are an owner, then they pretty much understand it is illiquid.

There are three possibilities for an investor to cash out. They can sell their mortgage, you can find another investor to replace them, or you can refinance them out with traditional financing. Once a property is seasoned (has a record of positive cash flow) it is easier to refinance.

3) The problem is almost ALL private lending runs afoul of securities laws. Much of what is taught by gurus and written here could easily be construed as violating securities laws.

The Securities Act of 1934 defines a security as "Any note . . . Investment contract. . ." Well a mortgage is a note. The Supreme Court in the "Howie" case defined an investment contract as basically any passive investment. Those two pretty much shoot down any private investors.

The two keys to avoiding securities laws are no public solicitation and making sure all partners are active in the management, of the investment. You have regularly used the term "passive investors." I would not use such language. Partners who are active in the management of the investment should pass the securities regulations.

To find financial partners simply talking about what you do and your successes often leads to people offering to invest with you.

5) What works better, financial partners or traditional financing, will vary with the market. The decision what to use and for how long will vary. If I could get long term low interest traditional financing right now I would jump on it.

I am not an attorney the above is my laypersons understanding of the law. It is not intended to be legal advice for your specific situation.