Simple ways to raise money for Real Estate Investing

[Devin James]

Let’s say you need to raise $100K for a deal that will net $50K in profit

1) Equity Split – Split profits with your investor.

- 50/50 split on $50K profit

-  $25K to investor, $25K to you

2) Preferred Return – Investor gets a set return FIRST.

- 15% preferred return ($15K to investor)

- You keep the remaining $35K

3) Preferred Return + Equity Split – A mix of both.

- 8% preferred return ($8K to investor)

- Remaining profit split 65/35 ($22.7K to investor, $27.3K to you)

Each structure has its pros and cons—what's your go-to strategy?

[Greg Scott]

Quote from @Devin James:

Quote from @Greg Scott:

It is worth noting that no matter how profits are split, all of these scenarios would likely require the assistance of an SEC attorney to create a PPM.

The example you used was a pre-determined profit.  In reality, at the start of an investment you don't know exactly how the investment will perform. When thinking about how to structure a deal, it is more useful to wargame different scenarios. What if the deal loses money? What if it only makes $10K profit?  What if it makes $200K profit?

Personally, I will never invest in anything with a Preferred Return or Waterfall structure. (I would not offer one as an investment either.) Through wargaming, it is easy to see how the motivations of the operator can become very misaligned from that of the investor when they use a Preferred Return or Waterfall structure.  You don't get that with a fixed percent profit sharing.

I definitely left out a ton of information with the goal of not making this a lengthy post.

But I do question your dislike towards Preferred Returns?

Aside from the misalignment of incentives, this little chart I created shows why I won't invest in deals with preferred returns.

The only thing we know going into the deal is that the returns are projections and projections are always wrong.  They may be high and they may be low.  Most returns will end up in some sort of bell curve like I've displayed below.

Yes, on a middling to poor deal, the passive investor wins out.  With a waterfall return, when a syndicator hits their projection, they are usually getting the majority of the profit.  If they happen to crush it, they get massive returns.  Because I only invest in deals where the syndicator gets a fixed %, I've had passive deals return over 400%.  In a waterfall, that same deal would have given me more like 100% or 150%. 

In the end, my portfolio gives me better returns because I accept the risk of having some deals give me marginal returns to be able to get the massive returns from the home runs.