Why 10% is the Magic Number for Private Money Investment

It seems just about every time a real estate investor talks about offering a return on private money investment, 10% is the starting point. Upon closer examination, 10% seems to be some kind of unspoken benchmark for investments of all kinds. "Can I get at least 10% per year on this?" is a question often asked by both novice and experienced investors across all asset classes.

The 10% benchmark can be quite a sticking point. It's more a part of business vernacular than it is a guide as to the potential success or failure of an investment. If you take a closer look at it, you might discover two big reasons why 10% is stuck in your head:

1. It is the purported average annual rate of return of the U.S. stock market. The financial services industry goes to great lengths to show their clients that the stock market, "on average" goes up 10% per year. There are all kinds of studies and data that both refute and support this, but once thousands and thousand of people talk about it to thousands and thousands of people every day, it's bound to stick in the reaches of someone's psyche. Typically, your private investors have invested in other vehicles prior to your private placement. They've been pitched by the stock market sales people before and have heard the 10% mantra quite a few times.

Since many people perceive the stock market to achieve returns of 10% per year, they might expect any comparable investments to get the same or better. After all, why switch if the return is the same? You'll either have to show how your investment is very different (and highly favorable) to the stock market or you'll have to pay comparable (or higher) returns. And, sometimes you'll have to do both.

2. It's the first double digit number. Someone may not be happy with 9.9%, but give them a 10% rate of return and they're happy. It's a funny psychology, but most people will take the bigger number if given a choice. The thought of single digit versus double digit returns is enough to entice an investor. On a more practical level, investors may be aware of the long term effect of compounding that even a small annual difference in rate of return will bring. Psychology is the most important factor in consumer investment decisions.

Most people would like to believe that they make rational decisions with their money all the time, but academic studies have proved this to be untrue. Fear and greed govern most investment decisions - for real estate private money placements and otherwise. If an investor has two choices, where investment A will yield them 10% and investment B will yield them 8%, even though investment A may be much riskier, the investor often chooses A anyway. The extra 2% per year makes a big difference.

For your real estate investment project, you may not be able to pay 10%. Don't worry! There are times where you'll raise private money and the returns you pay will be less than 10% and your investors will be OK with this.  "How is that possible?" you may be wondering, "won't private investors run the other way if I don't give them 10%, 12% or more on their money?"

While it is true that private investors want to make good returns, they also don't want to jeopardize their principal or possibly eliminate themselves from participating in your investment projects. People also like to do business with those they like and trust. If your investor likes and trusts you because you take care of their investment dollars, you'll be able to pay returns of less than 10% (sometimes perpetually) and you'll still have investors that are happy as clams.

It's important for you not to get caught up on the 10% return number. Run your business plan and project proformas with different rates of return for your private investors built in. If you can pay less than 10% but you can afford to pay more, you are in the best position to raise money.