Raising Private Capital

Matt Faircloth

Overview: 

Rick Carabba
Not much new info, very fluffy. If you're looking to raise private capital you're better off subscribing to LegalZoom for $40/month and using the unlimited 30 minute phone consultations to talk to attorneys who specialize in raising private capital.
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Updated On: 
Oct 16, 2020
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Book Note

Chapter 1: Intro to Private Capital

  • Private capital: money from an individual in return for equity or interest
  • mortgage agreement (deed of trust) and promissory note define the details and ownership structure between money provider and deal provider
  • overview of private capital sources and uses, mostly common sense

Chapter 2: Prerequisites before you start raising money

  1. Get educated - (real estate transactions, negotiation, accounting and finance)
  2. Develop a track record 
  3. Take personal inventory - (time, money, skills, goals, your "why")
  4. create a business plan- (strategy, market analysis, team)

Chapter 3: The Deal Provider

fluff - common sense

Chapter 4: The cash provider

Cash source 1: Self-Directed IRA

  • Personal IRA opened and managed by the individual. 
  • The owner of the IRA can lend to a deal provider from their IRA
  • The owner of the IRA can't have any personal benefit from the activities of the money, can't own any piece of the investment, can't take a fee or in any way benefit from the IRA's activities. 
  • The owners kids/grandkids/parents/grandparents can't be the receivers of the money for investment in anyway. 
  • Account holder can't touch the money, so all principal repayments & interest need to be paid from the deal provider to the 3rd party that holds the individuals IRA. 
  • Account holders do not need to pay a tax on the profit they make every year and can compound their returns/ roll them into the next round of investment. 
  • 401(k) not eligible unless they left the company they had the 401k with.
  • regular IRAS that are managed by financial planners or retirement specialists cannot be used to invest in real estate. 

**CALLED FIDELITY (my broker): not available at fidelity. need to go to a 3rd party administrator that does this specific type of IRA. It's more than likely going to be something that you need to go to a smaller IRA administrator. CPA/tax advisor will be able to do that. Not as easy as he makes it out to be. Cash source 2: Real Estate Equity

  • If cash provider's mortgage balance is less than 50% of his home value then there's opportunity for them to use that equity to invest.
  • Method 1:New mortgage- for this to work the return on their new refinanced mortgage needs to be higher than the interest that they're paying the bank. 
  • This creates another positive cash-flow for them without doing anything
  • Method 2: HELOC/BELOC 

Cash source 3: Cash

  • liquid savings, high income earners, inheritance. 
  • educate on capital gains tax, short term is same tax bracket as ordinary income, long term is between 15-20%. 

Chapter 5: Where to find cash providers

fluff - common sense

Chapter 6: How to turn potential into reality

Most common cash provider questions:

  1. How/when am I going to get my money back? - (SDIRA - will be deposited into your SDIRA at end of term, with interest. Reg loan - in bank account with interest. at end of term defined)
  2. What are the risks? housing crash (we use 75% before ARV rule to value deals). tenant not paying (experienced property manager, share screens that we use to screen tenants and a track record. Also a worst case scenario plan)
  3. How much of your own money are you putting in? 
  4. What if I need my money back? - real estate isn't liquid, define loan terms in the promissory note, when the term is up. alternatively they can have someone else buy their note. Make sure they aren't investing every last dime they own. 
  5. How does this affect my income taxes? - they will get 1099 from us for the interest on the loan, and a K-1 for a partnership deal. Educate on capital gains, find ways for them to beat taxes.

Chapter 7: How to structure the private loan deal

Deciding the terms of the loan: 

  1. Who is lending the money and where is it coming from?
  2. What's the deal? - 
  3. How quickly do I need to close? 
  4. How much construction is involves? - need timeline, want to negotiate a construction draw program with lender to lower interest.

Construction draw program: 

  • Basically just a tiered investment based on milestones reached on the project vs just 1 big lump sum in the beginning. 
  • money should be available on short notice, within a week. 
  • mitigates risk for the cash provider 

Private loan pitfalls:

  1. loan origination points and fees for renewal - 1 point = 1% of loan principal. renewal fee is usually .5-1% if you don't pay back on time. 
  2. monthly payments on fix and flips - eat into cash flow, avoid
  3. prepayment penalties and guaranteed minimums - fee if you sell or refinance a property before a certain date, always avoid. Guaranteed minimum returns aren't bad idea to sweeten deal for investors & give them a floor. 

Documents for setting up a private loan:

  1. Promissory Note - defines interest, maturity date, alt fees, etc. Defines what happens if late repayment, default. Original copy held by cash provider, copy held by deal provider. Collect original copy at the end with the words "paid in full" on it. 
  2. Mortgage security document (deed of trust) - Document creates a lien (investor claim) on the property. Means that property owner cannot resell or refinance property without lenders permission. Lender can begin foreclosure if promissory note loan defaults. 
  3. Personal Guarantee - holds borrower personally liable for loan. 
  4. Deed in lieu of foreclosure - Means that ownership of the property immediately goes to lender if the loan goes into default. 

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Rick Carabba is the Author.