How To Structure a Private Lending Agreement for a BRRRR?

Question

Hello, I'm a first time RE investor looking to buy my first BRRRR property out of state as my local market would not work well at all for it. I'm in the process of identifying my offer to private lenders, so my question has 2 parts, 1) Do you think my offer is enticing for passive investors, and 2) What type of clause should be in the agreement if the refinance doesn't fully recoup the initial investment?

1) Private Lender Offer: 8% APR, paid monthly, while the money is invested. After refinancing, initial investment amount paid back with a 25% equity holding for the life of the property (meaning they receive 25% of the cash flow after all expenses/reserves for vacancy, maintenance, capex, etc. and/or 25% of profits when property is sold)

2) When executing the BRRRR strategy, ideally 100%+ of cash invested is returned after a refinance, but I've seen a lot of investors still may end up leaving some money in the property (~$5,000). If this occurs when using a private lender, what's the best approach for this situation? Should I cover the gap so I can fully repay the investor? Continue to pay the 8% on the remaining funds owed until the cash flow pays off the gap?

I really appreciate the feedback and insights that any of you can share with me!

Andrew Postell · Answer

@Ryan Phelps keep in mind that a Hard Money Lender (HML) would likely provide you with a loan of 75% of the ARV on a single family home at about 10%.  so a PRIVATE person had better be giving me much better terms....or I'm just going with Hard Money.

I usually provide a choice to my private lenders - I'll give you 6% with payments or 8% with no payments.  You can certainly customize those numbers to what you need but I never give up the ownership of the property to anyone.

I hope all of this makes sense but feel free to ask anything additional if you need.

Andrew Postell · Answer

@Ryan Phelps most of my private lenders know me personally.  I don't mean that to come across in an arrogant way but the rate of return is part of it I guess....but you are the other part, and the more important part.  Think of approaching your grandmother and asking her for money.  She would likely give you money because she loves and cares about you.  The same thing when you fundraise.  Being passionate, honest, knowledgeable help that private person believe in you and your returns.  Sometimes no matter what the return rate is a person just isn't going to be a part of a deal....but if they believe in you, then that rate of return may not matter at all but in the other direction...in your favor.  Work on selling yourself and the return will be fine for your investor partners.  Hope all of that makes sense.

Scott Wolf · Answer

@Ryan Phelps, my apologies, I forgot there is no sarcasm font on the internet....yet.

A true private lender is an individual who is lending money.  You giving up 25% equity is an absurd notion.  You should pay the interest and NOTHING ELSE! Anyone who tries to take equity from you is not a private lender, and I'd be worried about them being a predatory lender and actively trying to take the property from you.

As others have mentioned, if the refinance portion of the BRRRR falls short, you need to be prepared to bring more money to the table to take them out of the deal or have something in the initial contract that provides for them to extend the loan even further (though most won't love that idea).  Happy to chat more and see if my few Pittsburgh contacts know of any private lenders.

Joe Splitrock · Answer

I am not sure it is a good idea to give a lender permanent equity. If you are going to do that, you are actually taking on a partner. That means you need a partnership agreement and maybe even an LLC. Most private lenders dictate their own lending terms, so I would start by seeing what they want. It is customary to pay points up front and have a high interest rate, then the lender exits the deal when you refinance or sell. I would only enter into a permanent partnership agreement if you found an experienced investor who brings more to the table than money and has capital (skin) in the game.

Nate Bell · Answer

@Ryan Phelps

I think there’s a level of detail that you’re overlooking that would help clarify your thoughts on #2. Private lenders don’t operate like a credit card company where when you reduce the balance owed, they reduce the payment/interest owed. If a private lender gives you $50k, they generally don’t want to take partial payments and they’re going to charge you interest on $50k until all of that $50k is returned.

You should plan on having cash reserves that would allow you to cover any shortfall in the refinance so you can close out the private money loan.

Nicholas L. · Answer

@Ryan Phelps I am assuming based on your post that this will be your very first investment.  This seems like a risky way to proceed - you will need the cash to cover all of the expenses and keep your investors whole if the deal does not turn out the way you planned.  Not trying to be negative, just wanted to weigh in.

Chris Levarek · Answer

@Ryan Phelps Why not ask the Partner or private lender? No point in offering something that doesn't meet their needs. If you have an existing relationship, just explore what a good investment would like to them. If they want equity, offer equity. If they want a hands-off roi from interest, offer that. Get to know the investor or private lender needs first.

I've done equity and I've done private lender with simple interest. Both have there place. I'd say equity is going to be bit trickier properly if you want to have it legally defined. Names will be on LLC and property will be in LLC name. Otherwise, is there really equity ownership? So it's more of a marriage and less of a dating scenario.

Ryan Phelps · Answer

@Andrew Postell, do you find that private lenders are happy with a 6-8% ROI with no equity stake? If I'm wanting investors to invest with me over and over again, a small equity stake that provides mailbox money for every property they invest in with me seems like a great way to generate ample capital for scaling.

I'd be fine giving up some equity for faster growth and scalability but I'd love to hear your thoughts for not giving any equity while still keeping investors engaged with all your projects.

Thanks!

Ryan Phelps

Ryan Phelps · Answer

@Scott Wolf, I'm looking to BRRRR small multi-family properties in the Pittsburgh area. The market analysis I've done shows a pretty promising investment opportunity there.

Scott Wolf · Answer

@Ryan Phelps, I'd gladly take a free 25% equity stake to lend private funds, but as @Curt Davis mentions, you'd still need to pay by the entirety of the loan I gave.

Both parties should draw up the loan documents using an attorney.

Where are you looking to BRRRR?

How To Structure a Private Lending Agreement for a BRRRR?

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