How does it REALLY work when you use someone else's money?

Question

Hi everyone!

I have a question that I haven't seen specifically answered in the forums.

How does it REALLY work when you use someone else's money for a down payment? I guess this is a good problem to have, but I have a few friends who have approached me about investing in real estate with me. My goal is to obtain financial freedom through buy-and-hold 2+ unit buildings. However, I am concerned about sharing profit with another party for a buy and hold investment. If I have a unit that is providing $300 in cash flow (after all expenses) per month, it seems a little silly for my investor to put down $20-30,000 (if they split the downpayment and I live in an expensive area) to receive $150 in cash flow per month.

I currently have been "house-hacking" a tri-plex for the past year. I saved my own money for that and have done all the work myself so the idea of partnering is new to me.

Have you all had success stories with splitting the profits with someone else? Buy and hold real estate doesn't have massive immediate returns, so am I ruining my ROI by splitting it? Is it better to wait another year until I can afford my own property with my own money? I'm feeling confused as to what the next step should be and I would love some ideas from those who have been there before!

-Erin

Yousif Abudra · Answer

@Erin Caldwell  It is a bit unclear exactly which type of situation you are asking about, but I will address the two options that I believe you might be considering:

Option 1: Buying an Investment Property (Not living in it) & Splitting the Down Payment with your friend

In this option, you can both be on the title as Tenants in Common, each with a specific % ownership.  Or, you can form an entity such as an LLC which would be on the title - within the LLC, you can each have a % ownership but you can also identify a % profit split, which may be different than % ownership.

The distinctions between ownership and profit/loss distributions are important.  Because you may be doing all/most of the work and providing capital while they may be providing only capital.  In that case, it does not make sense to split profits evenly.

Another factor to consider is who is taking out the loan.  If you are taking out the loan, and you are doing the work, and you are committing capital, then you are clearly taking much more risk and putting in much more investment to making the endeavor successful.  So an equal profit split makes much less sense.

Option 2: You will house hack the new property (live in it) & Split the Down Payment with your friend

See the last paragraph in Option 1 above.

Parting thoughts:

I VERY briefly covered a number of complex topics above.  If you have clarifying questions, feel free to ask.  Remember, capital is cheap and relatively easy to come by.

Most everyone has some money laying around to "invest in real estate."  The real work comes from finding the deals, making them cash flow, improving the value, and delivering a successful outcome.  On top of that, merely accepting capital from others can put YOU on the hook for ensuring compliance with both state and federal securities laws if you are not careful and understand the requirements.  So don't give away your hard-earned profits so easily.

Daniel Dietz · Answer

@Erin Caldwell as others have said it depends what both your and the potential investors goals are.

I am in a very similar situation right now. The plan I am working on with a couple different potential investors is this: They would bring the entire down payment - 20-25% depending on what type of loan we do. We would form LLC  if doing  commercial loan or TIC if doing conventional loan as 50-50 partners. I would do all the acquisition, purchase, management etc.... The investors would only see a cash on cash return of 4-5%, but an overall IRR of about 10-15% when figuring loan paydown and appreciation also. I would be getting a return equal in dollars to them even though I had no dollars into it.

We see it as a win-win. They get a good steady return that in our opinion is safer than stocks without having to do any management, and I get to make income/wealth by using my knowledge and skill instead of my cash.

Dan Dietz

John Thedford · Answer

Terms are what you can negotiate. Typically friends or family is cheaper than borrowing from strangers. I currently pay around 7% for private money. Hard money (strangers) is typically going to cost at least 10% but probably higher.

Mora Clark · Answer

@John Thedford what is the typical interest and term for that? I’m on the same boat. I can get the loan under my name to acquire a small multi but don’t have enough down payment and looking to borrow money from friends or family or other hard money lender so I can acquire more properties.

John Thedford · Answer

You can use OPM to purchase and they give you a mortgage, or you can take their money as an equity partner. I prefer using their money without the partnership arrangement. I make monthly payments, but all profits on the property are/will be mine. If I lose money, they still get paid. How many marriages fail? Those are partnerships that didn't work out. Same thing with RE. So, to answer your question, OPM has worked very well for me. It has allowed me to obtain several properties I didn't have all the cash to acquire. They love the interest. They are very happy because I pay them on time every month. I appreciate them giving me the opportunity to acquire more properties. Win-win.

Jay Helms · Answer

@Erin Caldwell - I recently had a similar discussion about this. My vision of what success looks like and my goals are not necessarily how others see opportunities. And what may seem silly to you or I shouldn't be a barrier for other people to invest. Different people have different reasons to invest, different criteria they want to meet, and different goals they want to accomplish. IDEALLY you find someone who has similar goals but what's the harm in helping your friends achieve what they consider success too?

To answer your question, you create partnerships that make it work for both of you. For example, instead of splitting the down payment, maybe you pull the deal together, they provide all the down payment and you guys split the profits 70/30. Most capital investors have an idea of what they want to see for projected returns for CoC and annualized IRR. Figuring out that part of the deal is the art to "No money down".

Brent Coombs · Answer

@Erin Caldwell, is it time to apply for another owner-occupied (low deposit, low interest rate, 30 yr) loan, for your next 3-4plex?

ie. Keep the additional profits you'd be getting out of your triplex, all to yourself!

[Have you built up enough equity yet, to refi out of your current mortgage?] All the best...

Joe Villeneuve · Answer

Not all $20k are equal.

How does it REALLY work when you use someone else's money?

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