Quick: Somebody Call 9-1-1... Private Money Emergency

 

Holy smokes I have to get this off my chest before I check myself into the hospital to have a stent put in a rapidly clogging artery....

I wish I had a "bat phone" to all real estate investors where they could tie into this one message: Please, Please, Please don't overpay for your private money!

Remember how I always talk about not being 'needy' when it comes to private money? You remember the old adage: "bankers only lend money to those that don't need it?" Pay close attention 'cause this is important stuff.  It could mean the difference between $200k and more per year in income to you.

Here's what I'm talking about...

Let's say you have a deal and it's a good one. You're locked in on a nice bank-owned property that you can buy for $100k, put $10k rehab into it and sell for $150k. I'm getting excited - after taking commissions and other selling costs into consideration that's a (conservative) $35k profit for those with no abacus, slide rule, calculator, spreadsheet or little Capuchin monkey on your shoulder. You plan on no more than 60 days from start to finish.

Juicy.

Great, so now you go to your private investor who has already committed funds to you and they like the deal. They can invest the entire $110k + a little "slop money" for holding costs. (You should always have "slop money" for every deal - it's like the old American Express Card commercials - don't leave the closing table without it). Probably $5k in slop money is OK for this deal.

Sweet.

Now we're really cook in' with gas. Big payday just around the corner. But, quick snag in the line...

Private investor wants to talk to you. Seems that you told them they'd be getting a 10% return on their money. You did tell them that. What's the big deal? Well, Mr. /Ms. Investor are under the impression that they're going to be making $11,500 on this deal ($115k x 10%). You're under the impression that they're going to be making $1,916 ($115k x 10% per year = $958/mo. $958 x 2 = $1,916).

 Uh oh. You are now staring down the barrel of being $9,584 poorer if you go through with this transaction in the manner in which the private investor wants to.

Yikes. Better get out of the way before the gun goes off.

First, what went wrong?

For starters, your investor is thinking in terms of what is called absolute returns on their money versus annual returns on their money. There is a wide chasm between these two.

The rate of return you offer your private investor should be on an annualized basis - be clear about that at all times. When you tell somebody: I'll give you 10% on your money - make sure it's clear that their percentage return is on an annual basis.

Here's another example to give you a better feel:

Amount invested: $100,000

Time invested: 3 months

Rate of return offered: 10%

Amount paid (annualized): $2,500 (100k x .10 = $10k, 10k/12 = 833.33, 833.33 x 3 = 2,500)

Amount paid (absolute): $10,000

**Note- the closer the holding time is to 1 year, the close the absolute and annualized returns come together. At the one year mark, they're both the same. Going back to our deal where we were going to make $35k but now stand to make just over $25, what should be done? Should we walk away from the deal?

No. Why? Because there is always a middle ground. Always a way to make the deal work (that's what being a real estate investor is all about, right?).

So, we go back to the investor and try to clear up the misunderstanding. Hopefully, everything is Ok (this may require you to be firm and dig in your heels - but in a nice way). You tell them how great this deal is and how many more you have coming up just like it. You tell them that investing with you makes the most sense compared to anything else and why stop now when they are so close to a major investment home run ("just think of how jealous your friends are going to be, Mr./Ms. Investor"...)

Worst case, you negotiate a higher annualized rate on the investor’s money. Say you move from 10% to 12%. Maybe you have to nudge up higher. But, don't go too high. You don't want to feed the bears at Jelly stone. Or...here's something even better you can do......

You can offer to pay the investor the amount they have stuck in their head ($11,500 in this case) IF they agree to commit the funds to you for at least a 12 month (preferably longer) time period. That way you have the money for more deals locked up, the investor makes what they want to make - quite possibly more - and you win. You can even look at it in the way that just this one deal covers the cost of funds for the year, so the next deal profits are all yours. Maybe you have to throw in a little extra incentive -but that's what this whole dance is all about.

***If the telecommunication overlords are listening, please at least set up some bat phones so real estate investors can make more money.***

You are only handicapping yourself and your profits by paying more than you need to be for private funding. It's something you can clear up quick if you want to.

Now, go forth and profit - handsomely, mind you - and don't forget me in your will (I should at least get a spot above your annoying nephew, right?)