Here's my detailed creative financing plan: Why won't it work?

Question

I am looking for feedback on what holes/errors there are in my creative financing plan.

Backstory: I just moved to the Indianapolis area 4 months ago from Las Vegas and decided to give REI a shot. I have been immersing myself in the learning process as much as possible. I have already paid cash for my first property (20k) and I am almost done with the rehab (25k) on it. I hope to begin looking for a tenant within a couple of weeks. I plan to refinance it as soon as possible, but I have yet to begin looking for local lenders that will accommodate me. I hear that part is tough so my expectations are low for it happening too soon. However, I don't want to sit on the sidelines while I am figuring this part out. Half of a deal is better than none of a deal, right? I really want to make my friends money too.

I have friends that have money and trust me 100%. They are also motivated by my newfound passion for REI and are interested in being investors through my work. I am comfortable figuring it out as I go for investments involving only my money, but I want to get more of the details ironed out before taking on investors.

Here is my plan, tell me why I am wrong or what I could do to improve on my plan. Thanks.

1.Open an LLC in my name.
2.Have my friend (lets call him Blake) roll his IRA into a self-directed IRA using a custodian like Equity Trust.
3.Have Blake inform Equity Trust that he wants to make a real estate investment and to have them send my LLC $70k~.
4.I would then use that $70k to use the BRRRR strategy to buy a house, rehab, rent, and hopefully refinance the property using a conventional loan. If we were able to get this financing my LLC would send Equity Trust and his self-directed IRA the amount of his loan back.
5.If we didn’t get all of his investment back in the re-fi he would get repaid out of the cash flow from the rental income until he was made whole on his initial 70k investment.
6.Once his investment was made whole we would be splitting any profits on a 50/50 basis, including any appreciation and future profits on the sale of the house.
7.If we lose money, he will get 100% of the money we recoup.
8.I would be acting as the property manager and taking 10% of the rent for my duties no matter what. By that I mean, if we ended up breaking even on the deal as a whole I would still have made money from my property managing duties (if I weren’t doing this we’d have to be paying someone else to do it anyway).
9.If we are not able to get a conventional re-finance or are not happy with the terms we can get then the LLC would issue a mortgage to Blake's self-directed IRA and begin paying him the mortgage at an interest rate of 6% with a LTV of 80% of whatever the house appraises for. His investment would then be backed by the property and the equity we gained through the BRRRR. If the LLC defaults on the loan for some reason Blake would assume ownership of the property on his own.
10.In addition to paying Blake's IRA the mortgage each month the LLC would also be paying his IRA half of the surplus in the LLC's bank account that is exceeds the amount we have determined to leave in reserves for capital expenditures.
11.The other half of profit would be distributed to me once per year as well.

My understanding is that Blake would not owe any taxes on any of this money since all of his investing is done within the umbrella of his self-directed IRA. I would owe taxes on my half the profits in addition to the 10% property management fee I will have been getting each month.

Can someone that knows more than I do (all of you) tell me why this plan is foolish, won’t work, or how to make it better? And if you really want go ahead and tell me what a genius I am how this is a groundbreaking idea! I realize there is literally zero chance this is true, but I want to believe!

Jeff Rabinowitz · Answer

This is a great deal for you. You have very little risk with this arrangement (it doesn't appear that you are contributing any money) and have several profit points. It is a terrible deal for Blake. He risks losing all of his money for the opportunity to partner with an inexperienced rehabber/landlord. He will be taking the entire financial risk for 1/2 of any potential profit there might be while he absorbs all of the losses and has no control of the process. I wouldn't take Blake's position.

Joe Villeneuve · Answer

You're close. Don't bring on Blake as a partner though. That can get very messy using a SDIRA. If his money is coming from a SDIRA (I do it this way) have him write a business loan out of it instead. Notice I didn't say a mortgage. This is a much better setup for all. Some of the highlights for Blake:1 - He gets paid no matter what through loan payments2 - You can pay him higher interest because...Now some of your highlights:...(because)1 - You will only pay for these funds once, but you can use them as many times as you want2 - The properties you buy are all still 100% equity, so you can still refi, which is one way you can use the SDIRA Loan cash as many times as you want.

Patrick Cruse · Answer

Thomas S. I typed up this post in microsoft word and for some reason when I copied and pasted I left off the last paragraph. This is what it said."Disclaimer: Before I go through with any of this I will be meeting with a securities attorney to help me draft my agreement with Blake. I just want to know if I am missing obvious holes."Please don't mistake Blake for a fool. He is not. We both want to do things as responsible as possible. I don't intend for it to be an "arrangement". I want it to be as "iron clad" as possible.

Mike D'Arrigo · Answer

@Patrick Cruse the biggest obstacle I see to your plan is getting conventional financing in an LLC when you go to cash out. Conventional lenders won't lend to an LLC. I just recently had a lender on my podcast show who talked about that. You can find the podcast on my website.

Michael Lee · Answer

Hello and welcome to BP! The first thing you did wrong was not getting your financing figured out and settled before you started investing. Most conventional lenders will make you close on the property in your personal name and then you can transfer it into your company game. Your plan to use your friend as a Partner seems very fair. I would get advice from an experienced Attorney before you nail anything down with your Partner.Your agreement has to be in writing because there is money involved and that is just business. I think that Entrust is a good selection because of their experience on this type of investment and can act as a consultant. I agree that part of something can be better than nothing. I also think that he will have to pay taxes on any profit. I also think that unsecured loans are required by the self directed IRA but they can possibily help you on that with referrals.Good luck to you!

Joe Villeneuve · Answer

There are a whole new set of rules regarding SDIRA partners, as apposed tomaking/taking a loan. Property ownership (from within the SDIRA) takes on certain limitations with the responsibilities that you don't want the IRA to take.With a loan, it's just paper...just like an investment in a stock or bond. It's a little more detailed (not complex) than that, and probably too involved to use this format to explain. If you want more info, PM me...and not, I don't sell or represent any SDIRA's...LOL.

Patrick Cruse · Answer

@Joe Villeneuve Can you expand on this a bit more? Why is a business loan better than a mortgage? I believe you, I just want to understand it. Is a business loan still backed by the property?What do you mean by I will only pay for the funds once, but can use them many times? I am close to grasping what you are saying, but I don't have a full understanding. Thanks,Patrick

Thomas S. · Answer

Your friend Blake is a fool to invest his money based on trust. Trust may be a element of friendship but is misplaced in business. What he needs, and you, is a iron clad contract that protects both parties. What ever direction your "arrangement" takes it needs to be drawn up by a lawyer.

Jeff Rabinowitz · Answer

He is not guaranteed 6%. He will be paid only if you manage to find a property that you can operate at a profit after you take 10% for managing or mismanaging it and pay all the other expenses. If the property operates at a loss he eats all of it. This is a passive investment for him only if you manage to find a refi at terms you are happy with. If you cannot find that refi he may become an active investor with no desire to be for a property that you chose. If he is happy with a 6% return for the downside risk then guarantee him that return. (He could do much better with a simple note secured by the real estate at a higher rate that more accurately reflects the risk.) If you want to make him more secure, pay him before you take your management fee.

Patrick Cruse · Answer

Fair enough. Do you @Jeff Rabinowitz see any errors in the logic of the deal? Is it feasible to setup this way? Again, Blake trusts me 100%. I don't expect you to trust me at all so I understand why you wouldn't want to take his position. He knows that I will be completely honest with him and have his best interests take precedent over my interests. In my opinion (and his), the deal of acquiring 1/2 of a house + an investment that is paying a "guaranteed" 6% for being a totally passive investor with someone you trust is a pretty good deal. What type of deal would you expect him to want if you think this is a terrible deal from his POV?