Whether or Not to ask friends and family and if so how

[Dave P.]

As I continue my real estate investing journey, I am considering the option of turning to family and or friends for a down payment loan and in turn offering them something in return i.e. a fair interest rate. I have heard on their BP podcast, both Josh and Brandon express opposing views and comfort levels as far as whether or not to turn to family or friends. In order to help me and hopefully others reading this, I am asking the BP community to respond to the following questions; 

1) What are the pros and cons of asking for lending from family and or friends? 

2) What are some tips for how to identify a potential private money lender if he/she is a friend or family member?

3) What is the best written or verbal message to broach the subject?

Thanks.

[David Dey]

Dave that is a great question and one that doesn't get the respect it deserves.  Most people just go with the generic private money advice, "start by asking your friends and family for money to do your deals." 

(Sounds eerily like those MLM pitches)

More family and friend relationships have been bolstered or ruined over this very issue.

You've probably heard the old saying, never lend friends and family money if you want them to remain friends and family.

The truth is raising private capital, whether from family or standard private lender is very personal transaction and should be treated with respect and honor.

Think of it this way, if you borrow money from a bank and don't pay it back, do they take it personally?  No they don't.

They may sue you, may take your collateral, may even garnish your wages, but it's just business.. nothing personal.

On the other hand, if you borrow money from a friend or family member, or even a private lender that worked his/her entire life building this nest egg, and don't pay that money back, do you think they'll take it personally? Absolutely!!

That's why you need to treat this transaction with its proper respect.

1) Just because they are your friend or family, don't feel that they owe it to you to do this loan.

Approach the situation as a true business transaction and treat them with the respect you would give a standard private lender.

2) Ask yourself the question, "would I loan my hard earned money on this deal?"  

(Don't think of it from your view point of how much money YOU are going to make on the deal.  What would they do with the property if something happened to you?  What exit strategy is there available to them as the lender?)

3) Make sure that they are the right person for the deal.

(If the people have an absolutely low risk tolerance, or this is over extending their savings, credit etc.  this may not be the deal for them.)

4) For low hanging fruit, (easier success rate) 99% of all private lenders fall into 3 categories, business owners, professional licenses holders, (like doctors, lawyers, etc..) real estate professionals.

All three have something in common, they think differently than your average wage earner.  They think cash flow, multiple streams of income, predisposition towards increasing of assets.  With real estate professionals (i.e. Realtors, appraisers, surveyors, and good old fashion investors) having an additional understanding of the power of real estate.

5) every lender asks 2 questions, whether full scale bank, private lender, or friends and family, every one asks the same 2 questions... And if you answer both of them to THEIR satisfaction, they will fund your deal every time.  (On the other hand, if they didn't fund your deal, look at these 2 questions, this is where you blew it!!)

Question 1) What's my security?

Whether a bank asking for your 10-03 form listing your assets and liabilities, and asking to see your tax returns, or a private lender asking you how much skin you have in the game and what your track record is.  They are all asking the same question, "how am I not going to lose my money?"

You really need to be able to answer that question to your lenders satisfaction, not yours!!

Now, I have asked many real estate professionals this question.  

You're standing in front of MR Moneybags and asking him for money to do your deal.  He asks you the question, "what's my security?"  What's your answer?

99% answer, "the first mortgage on good property with at least 30% equity behind it."

Or they will simple answer, "the property."

99% answer this way, and 99%are wrong.  

The mortgage and the property are not the security, they are the collateral.

The security is YOU!!

If they like you, trust you, believe in you, honestly believe that you will take care of their money as if it is your own.. then 99% of the convincing is already done.  Now all you have to do is show them a good property and answer their second question.

Conversely, if they don't like you, trust you, believe in you, they're not gonna lend to you at 10%LTV.

So when you are presenting your opportunity, don't just pitch the property, pitch yourself.  Your track record, your exit strategy, their exit strategy and your commitment to making sure that their funds and returns are secured.

Question 2) What's my return?  

Make it fair!!  Look at it from their side. What will be a fair return for the risk they are taking?

In closing, make sure that you are clear with your explanation.  Just because, you "get it," don't automatically assume they get it.

A great strategy is to ask your friends and family to assist you in putting together a list of questions that a potential lender would ask that you can answer for that potential lender.  This will do a couple of things.

1)  it will get them to ask questions in a non threatening setting.

2) it may whet their appetite to either do something themselves or may inspire them to refer someone in their sphere of influence to you.

Hope this helps!!