What to offer private passive investor who gives down payment?

Question

I am preapproved for a loan for a rehab that includes rehab funds.  I need to bring 20% to put down which we have, but I have a private investor willing to put in the 20%.  I initially thought to pay him 1 pt per month for each month, but then thought a 80/20% profit split should be sufficient.
Here is an example:

Purchase price as is $110,000
Rehab costs $50,000 per contractor
Total loan amount $160,000*
Projected resale amount - $230,000 ARV
 
*20% down $32,000

Purchase to closing estimate 3-4 months
 
Estimated resale PROFIT is $50,000 after holding costs, fees, commission to agent etc
Private investor 20% which is $10,000
Balance to our firm $40,000
I would set it up as trust with me as Sole Trustee and then beneficial interests 80% Me and 20% passive investor

Is this a fair deal?  What do you offer a down payment passive investor?  What would you offer a down payment ACTIVE investor?  1 pt per month?
 
New rehabber looking for advice TX gang!

Brian Burke · Answer

William Donaldson, here are some links to some threads I found on the topic:
http://www.biggerpockets.com/forums/51/topics/76494-equity-partners-vs-pooling-investors-under-reg-d
http://www.biggerpockets.com/forums/49/topics/62274-what-are-the-sec-requirements-for-soliciting-private-money-?page=1
http://www.biggerpockets.com/forums/50/topics/55532-please-be-careful-when-raising-funds-sec-cease-and-desist-letter-

Maryann L., Ann Bellamy is right, it's not a reflection of character just a business risk to be undertaken by the person providing capital.  They will want to make sure that the deal is lucrative enough for them to accept the risk, that will be the defining factor in how they set the "price" for their money.

Ann Bellamy · Answer

Maryann L., the reason Jon Holdman was so adamant is this:

(And you need to look at this strictly from a business view point, don't take it personally)

You may be doing all the work, but if the price drops, or there are unexpected issues, and you get a lot less than you expect, all his money may be gone and he may make no profit at all.  You have no money at risk.   Yes, all your time may be for nothing if the deal goes bad, but you haven't come out of pocket and you money is not going up in a puff of smoke.  You just get up, dust off, and start over.  He on the other hand, has lost his money, and to get you to make it good, he has to spend considerable time, effort and money to sue you.  He can't even step in and take over the project, because he can't foreclose, and you are the trustee.  So he's up a creek, and dependent on your integrity.

Which is considerable, but that's not the point, I'm approaching this explanation simply from the structure of the deal, not from a personal perspective.

William Donaldson · Answer

Not to hijack the thread, but Brian Burke can you post a link to an in-depth explanation of your last paragraph pertaining to the SEC regulations?  This may help out the OP as well.

Maryann L. · Answer

Tom Wilhelm - I do like that option of splitting the DP.  
I met with the person Friday.  They are completely comfortable with the entire DP and taking 20-30% of the profit.

I don't need this person for a deal, but I DO want to grow and there is no way I could take on more than one project at a time without them so obviously I want to make it worth everyone's investment. So Joel Owens is right.  I have had a business relationship with this person since 2004. We have both invested in rentals and both aren't in love with renting.

We both have a relationship with the board member of the bank that has pre-approved me for the loan.

Nothing is set in stone at this point and we aren't actively looking at properties so this is definitely a situation I'm exploring further.

Ann Bellamy · Answer

Providing the downpayment money is actually more risky than providing all the money.   Because the downpayment is at the mercy of the first position lender.

Also,  if a lender is a part owner, they can't foreclose and are behind the first position lender.  So while you feel that this structure is less risky because he's not in second position, but is a part owner, it's actually more risky, because in a foreclosure or liquidation, the mortgagees are paid before the owners.

Having you, the borrower, but $ in the deal does several things:
1.  Shows you are willing to put your money where you mouth is
2.  Ensures that you will work harder to make the deal work so as not to lose your investment.

So that answers Tom Wilhelm's question, I think.

As to your question, Maryann L., I would never go behind a first position, and especially never behind a first position hard money lender.  Downpayment money is sometimes called gap funding, to make it sound less risky, butI'm pretty conservative and can't imagine any circumstances in which I would do that.  I think the more you see from the inside, the more you realize just how risky this type of funding is for the lender.

I have, however, provided 100% funding under very few circumstances.  Those include having done multiple deals with the borrower and having a high degree of confidence in their ability and integrity.  The borrower also would have cash reserves and experience.  It speaks to relationship lending.  And you presumably are trying to build a relationship with this person providing the downpayment money.

I know you are looking for an answer on what to offer him, but I would still ask him what he wants and negotiate from there. In the end result, building the relationship is priceless.

Joel Owens · Answer

Maybe you don't NEED this person at all on THIS deal but what happens if this investor likes how you worked this deal and then a bigger deal comes along??

This investor then is comfortable doing a much larger deal with you or has a personal friend who has 10 times or more the money than they do.

I don't look at things one dimensional as you never know when that contact might work for another deal you are possibly doing.

It's not better to use OPM if you have a really good deal and are 
giving away too much in the deal when you have your own cash.

So again find out what the investor wants and negotiate and then decide if it is worth the cost to use the money.

Tom Wilhelm · Answer

Would it make a difference to potential investors if Maryann DID have skin in the game? My thinking is that if her goal is to limit her money invested, but the investor wants assurance that they won't be the only one holding the bag, why not split the DP (16k each) and offer 10-15% equity? More hassle than it's worth at that point?

Maryann L. · Answer

Ok, I will agree second position is risky, although I guess I'm not looking at it necessarily like second position, but if that's too much for most of the seasoned investors here if you were partner on a rehab project like this, in what capacity would you participate?  I really don't NEED this person at all, but if there is one thing I've learned it's better to use others money rather than my own if I have the opportunity.

Ann Bellamy · Answer

Maryann L., I don't think the original question was lost.  I think that most of us are explaining that since we think the position is very high risk, we each would require far more than the 20% equity you are considering offering, and in fact would not probably consider it at all.

Therefore, the question of what to offer that is fair, is difficult to answer.

I think Joel Owens is right:  let the investor state what he wants, and go from there.  You can then evaluate whether it is worth it to you to use his money rather than your own.

Paul Crowson · Answer

If it were me as an investor in this deal Maryann, I wouldn't do it, I would want 1st lien position, or at least to know of a lot of success you have already that is verifiable with references...

What to offer private passive investor who gives down payment?

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