How To Protect Your Investors Interest In Real Estate

Question

I was wondering if anyone could offer advice/strategy on how to bring an investor on board and provide them with a guarantee on the secondary position of a financed deal on a property.  Basically I have identified a few properties and don’t have the cash position to make a down payment on an offer, hence the need for an investor.  I’m looking to bring in family/friends as investors but they need a “guarantee” that their dollars have secondary rights to the property in case of the deal going sideways (behind the bank).  Creating a LLC as partners has been discussed but I’m curious if anyone has experience as to how to bring on an outside investor and give them secondary position to the property (behind the bank and before my interest/ownership). It has been discussed to be be 50/50 in terms of LLC ownership. Also, other entity setup is welcomed.  Is this arrangement something that we can simply include in our operating agreement? Any suggestions would be appreciated.

Taylor L. · Answer

If you're raising money from a passive investor whose return is generated solely by their investment, and they do not have an active part in the deal, then you're in syndication territory. If you go the LLC route, make sure the other person has at least some active role in the deal.

Lots of folks use promissory notes for this type of a thing. You'd need to follow any requirements the primary loan has regarding secondary notes, but the legal paperwork for a note is far less pricey than a syndication.

This is definitely something worth discussing with a lawyer

Austin Elm · Answer

@Taylor L.  I did not even consider this being a syndication deal so thanks for bringing that up. That would introduce a whole new can of worms.

I think for my situation a promissory note or LLC would be the best route to go.  I will consult an attorney thanks for you response.

John Corey · Answer

Austin,

Two warnings.

1. Be careful about calling someone active when they are not. If they are not competent to be making the decisions, too busy to participate or similar, you are going to struggle to prove they are active. Window dressing will not stop fines or jail time. If the deal goes south, they might even be the ones who turn you in as a way to force you to give them their money back.

Are they going to co-sign for the loan?

2. Documentation. If you are claiming they are active, document the meetings, the decisions they made with you and similar. Having them listed on the loan and listed on anything else that makes sense will be another way to document what happened.

Assume that you are in front of a judge. Maybe you can not even speak because you were hurt in an accident. Will the information be so clear to the judge that they rule in your favor?

Nothing turns family and friends against you quicker than a deal gone south. Keep clear records of everything so no one can tear up and claim they did not know.

Austin Elm · Answer

@John Fortes, thanks for the tip as well.  As long as my investors are active participants in the company (LLC), then I should be clear of all SEC regulations.  Thank you.

John Fortes · Answer

Be careful how you are going about raising capital. Sounds like you will need active roles for each investor to stay clear of SEC guidelines.

Taylor L. · Answer

@Austin Elm Good luck. FYI, just having an LLC doesn't do anything regarding whether you're selling a security. All syndications I'm involved in are LLC structures.

Austin Elm · Answer

@Alina Trigub, thanks for your input. Seems like there’s a lot of different ways to set these investor relationships up.  I definitely want to avoid the securities setup for the investment. I think that every investing situation is unique, and it sounds like consulting an attorney and CPA needs to be the first step.

Alina Trigub · Answer

@Austin Elm

Welcome to BP!

As @Taylor L. mentioned, by bringing passive investors into a deal you're potentially selling a security. So definitely reach out to securities attorney. Consider giving your investors some roles, potentially small ones to refrain from selling a security and doing a pure JV. Again speaking with RE attorney will help you tremendously. The conversation should cover operating agreement terms as well.

How To Protect Your Investors Interest In Real Estate

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