How To Pitch Private Funding *OR* How To Put $30k to work in RE

A recently closed transaction that I did the 30YF mortgage for has had me giving thought to how to secure access to short-term funding under terms and conditions better than hard money.

And, implicitly, about how someone with only a few tens of thousands can start getting their feet wet in expensive (Bay Area, Los Angeles, San Diego, etc) markets. It's really not necessarily easy or obvious how to get into coastal market real estate investing with only $10k or $30k, so most of these folks are stuck being Wall Street Investors earning 5% or so if they are lucky.

Let me summarize the needs and wants of two parties, a Real Estate Investor (REI) and a Wall Street Investor (WSI).

A few possible WSI wants and needs:

• Better than 5% returns, please!
• Get into being more on the REI side.
• Recourse. If a fund manager screws up and the WSI earns less than the S&P 500, the WSI has zero recourse.
• Learning opportunity, so when they've grown their nest egg to down-payment size, they know what they are doing.

A few possible REI wants and needs:

• Better than a 14% interest rate with 4 points upfront, please!
• Access to capital, possibly enough to purchase a home all-cash because it's not a home that can get a traditional mortgage, though I have a plan to fix that relatively quickly.
• Like every other REI, I'd like to put as little down as possible of my own money, and preserve liquidity. 

There is a very big difference between 5%, and 14% with 4 points up front, and our good friend arbitrage dictates that there's a chance for a win-win opportunity here. There are many folks that fall into one of the two above categories. A few times a week we see "I have $10k, how do I get started?"

So I think the conversation might go like this.

REI: "How much do you have in Wall Street, currently?"

WSI: "$30k."

REI: "And how much is that earning you?"

WSI: "Let's see, last year... 5%."

REI: "And if the fund manager doesn't do his job well, what recourse do you have?"

WSI: "Well, none. I can take my business elsewhere in the future, but otherwise I have no recourse."

REI: "I see. What if I offer you 8%, and if I don't deliver then you can foreclose on me. In addition, I'll take you to the project site and teach you about value-add real estate investing. Is your stock broker or money manager ever going to offer you 8%, ability to foreclose if they don't deliver, and to teach you how the firm you are investing in adds value?"

WSI: "Well, no. Of course not. That just isn't how it's done."

REI: "You're right, it's usually not. But that's what I'm offering you. I've got a three month project over on 123 Main Street (or, Address TBD) that I'll be closing on soon. If I spend my capital on the purchase, I will not have necessary renovation funds. So I'd like you to invest in my business. I'll let you secure the funds as a 4th mortgage on 456 Main Street. You can sell those stocks earning 5%, invest with me for three months earning 8%, I'll show you the work we are doing, and at the end of it when I pay you back you can put that money right back on Wall Street if you wish."

WSI: "4th mortgage? You're crazy. In 4th position, there wouldn't be any equity left if I were to foreclose."

REI: "You're not going to foreclose. Unlike Wall Street, I'm actually offering you recourse if I don't do what I say I will do. So that isn't going to happen. Even if it did, you still have that property to hold hostage. You can trash my business if I don't pay you back in full, or at least keep making payments at 8%. It's a hostage situation. I'm offering up a hostage, something that no one on Wall Street would ever offer you because they generally have no idea what the heck they are doing with your money, unlike me."

WSI: "That's a good point. But if I'm taking this risk on, I want 12%."

REI: "That's more than double what Wall Street is paying you to use your money, and they don't even offer any recourse for when they screw up! But I see where you are coming from. How about I merely double your ROI and offer you 10%?"

WSI: "Done."

If it were me, I'd give higher placement to whoever was investing the most. If it's a $400k project, the person fronting $200k gets 2nd position on that other property I own, and the $50k investor gets 4th or 5th position, until I've got my funding goals achieved. The REI has this conversation with multiple Wall Street Investors, from the big fish with a quarter million to the smaller WSI with only $15k to bring to the table. I'm not a lawyer. There may be requirements that the WSI are already in your existing network prior to you identifying this specific property, or if you do this more than a certain number of times per year. I'd suggest checking with a lawyer on that part.

Those promises to the Wall Street Investor above weren't false, by the way. Our REI here can in fact have their business trashed, so she or he had better know just what the heck they are doing! But that is always true with secured leverage. What the REI is getting out of this, of course, is basically zero points upfront hard money for the full purchase price (100% LTV) of the property.

Assuming his ducks are in a row with the various WSI, the REI can be writing cash offers that close in a week in a half, regardless of property condition. This is BRRRR friendly: Provided these private subordinate mortgages are notarized, recorded, official, etc, this is Fannie Mae Friendly and the exit from the WSI hard money can be the famous Delayed Financing Exception right up to the original purchase price (assuming the appraisal comes in where needed, we're talking 100% purchase price LTV financing here) without any 6-12 month seasoning. You would only be out the expense of the renovations.

If you want to do this with the Agency 30YF permanent financing as the exit plan, I'd strongly suggest you get very tight with your lender about what overlays they have, and ensure they understand it. No one can execute something they do not have a strong understanding of! Also keep in mind that this is as of the date of this blog post, no one can guarantee that mortgage guidelines will not change tomorrow, or will not have changed in the time between me writing this and you reading it.

Good Hunting.

NMLS 1220177