Private Money Program Samples

By Susan Lassiter-Lyons | Real Estate

Last week we looked at the fundamentals of how, exactly, a private money program operates and how to determine, exactly, how much to pay invaluable private money partners. Now, it’s time to dig a little deeper into the setup of your investor relations division and create a specific (but flexible) private money program tailored to your business needs.

Let’s take a look at a few options and explore how they work in real world examples.

Ready?

Here we go!

Debt Investors

Example…

Let’s say you’re buying a 4-unit apartment building for $350,000. You’re getting seller financing for $250,000 and you’re getting a private money loan from your Aunt Sally for $100,000.

Seller financing means the seller of the property provides financing for you to buy their property, with the agreement you will be paying back the loan in installments plus interest.

In this debt-investor example, you keep 100 percent ownership. The net profits for that 4-unit apartment building go into your pocket.

How much do you pay your private money partner?

Aunt Sally gets an 8% return on her money (just simple interest) over a five-year term while you make monthly interest payments to her. You also make the installment payments to the seller.

Equity Investors

Example…

Again, you come across this 4-unit apartment building for $350,000, with seller financing of $250,000 and a private money loan from good ol’ Aunt Sally, but this time Sally says, “I think I want a bigger piece.” Now you decide to do it for a 50-50 split.

What you do is either form a limited liability company (LLC) with Aunt Sally and split the profits, or you can write Aunt Sally into the operating agreement for your existing LLC for that specific property and split the profits that way.

How much do you pay your private money partner?

If for some reason you don’t make any money with the building in the first six months, Sally doesn’t get any money. But, if your deal makes $1,000 each month, then she gets her $500 each month just like you.

Debt and Equity Hybrid Deals

Example…

That same 4-unit apartment building for $350,000. You get a private money loan from Aunt Sally for $360,500.

Why did she loan more than the purchase price?

She loaned the extra $10,500 because you’re charging a 3% acquisition fee up front for putting this deal together. You’re making three points cash right at the closing table, and Aunt Sally gets to make money on both ends.

How much do you pay your private money partner?

It’s a 75/25 split ownership with Sally. You will pay her 5% quarterly in simple interest as a debt investor, and a 25 percent ownership split as an equity investor. If that property makes $1,000 profit every month after you make Sally’s loan payment, you get $750 and Sally gets $250.

Residential Buy and Hold; Both Perspectives

Example…

Let’s say you have a residential buy and hold for which the purchase price is $137,900, and it needs $22,000 in repairs.

When it’s all fixed up it’s going to be worth $213,200.

You have two debt partners who are going to do the deal. You’re going to pay one of them 5.5% and the other one 6.5%. The loan is on a 5-year term and the rent on the house is $1,200 a month.

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Analyze this property two ways: one from your perspective to see how much you’re going to make on the deal, and another from your private money partners’ perspective to see what they’re going to make on the deal.

Here is an analysis from your perspective.

The potential rental income for year one is $14,400 less vacancy, $720 in credit loss, and $2,880 in operating expenses.

So your net operating income is going to be $10,800.

Subtract the annual debt service (the total mortgage payment that you’re going to pay out to your two debt investors) of $11,511.

So you’re losing $711 each year before taxes. Not so great.

In year two, you will lose $495; in year three $275; in year four $50. In year five, my goodness, you made a whopping $179 for the whole year.

Sweet! Is this a deal you would be interested in doing? Not likely!

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Now let’s look at the deal from your debt investment partners’ perspective.

Debt Partner One invests $79,900, and you’re paying him 5.5 percent. His monthly payment is $454, and his total return over the five-year term is $27,240.

His cash-on-cash return is 34 percent. It’s a great deal from his perspective.

Debt Partner Two is getting an even higher point value, and his cash-on-cash is 38 percent.

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I do this to illustrate a point because I see it happen all the time.

You get these investment partners, and you’re so freaking excited that somebody finally wants to invest with you that you run out and snag the next deal that comes down the pike.

Then you find yourself in trouble by investing in a bad deal because you focused on what your private money partner can make, but you neglected to see how you’re getting screwed.

Repeat after me…

It’s not worth doing a deal if you’re only going to make $179 in five years! Even if the property appreciates in that time, appreciation doesn’t pay the bills.

Residential Fix and Flip; Both Perspectives

Example…

The purchase price is $67,900, and repairs will cost you $43,000. Your as-repaired-value (ARV) will be $148,000. You have one equity partner on a six-month term, and the price when you flip it is going to be $144,000.

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Here’s what it looks like from your perspective.

The selling expenses are going to be $8,880, and the cumulative rehab and holding expenses are going to be $945. Don’t forget that, rehabbers. You will need to pay the light bill, the water bill, and all that stuff. Initial purchase price: $113,400.

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If you sell by the end of month one, the profit is $24,775. If you hang on until month two, it goes down to $23,830. If you sell it in month three, it’s $22,885. In month four, $21,940. In month five, $20,995. So if it takes you five months to sell the thing, you’re making about $21,000. Is it worth doing?

I think that’s worth doing!

Here’s what it looks like from the perspective of your equity partner.

We’ll call him Jim Smith for fun.

You have a partner profit share, so your projected cash (before tax) if you sell in month one is $24,775. The managing partner’s (that’s you) profit share is $12,388, and Jim Smith’s share of the profit is $12,388. If it takes you six months to sell, he gets $10,025.

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Let’s see about his cash-on-cash return.

If you sell it in month one, his cash-on-cash return is 10.9%.

Not bad.

The worst-case scenario…

If it takes you six months, his cash-on-cash return goes down to 8.8%. Could you sell that to an equity partner?

It’s a better return than the banks would give him, so the point I really want to drive home to you is that just because a deal is great for your investment partner doesn’t mean it’s a slam-dunk for you, and vice-versa.

You have to run it from both perspectives for the deal to make sense.

Need some help running these numbers? I use and recommend RentalSoftware.com's Landlord and Flippers Cash Flow Analyzer software with the Partner Analysis module. That's the software that made the charts above and you can get it here.

The Extension Clause; Your Safety Net

What happens when your short-term investment turns into a long-term marathon?

There are lots of reasons for this:

  • Your flip doesn’t flip
  • Market conditions do crazy things
  • You have a fire
  • Let your imagination go nuts

How do you think the conversation with your investor might go if you knew there was no way the deal would close by the term date?

“I know I was supposed to pay you back in six months but the project’s taken us longer than we thought. We’re going to need another two months. Is that okay?”

The answer: “No, that’s not okay. I want my money back now according to the term we set.” Now you’re in deep doo-doo.

The best thing to do is plan for this in advance with something called an extension clause.

Write a contingency in the promissory note as the deal is being forged in case stuff happens. Say to your debt investor, “This is a six-month term, but just in case we go over, let’s plan for automatic extensions. If I don’t pay it back by the six months, let’s say that my four percent interest rate will jump to 6 percent every month I am over the six-month term. We can cap it there until the note is paid in full. What do you say?”

I’ve had that exact conversation with investors and they’ve remarked to me, “Yay! I sure hope your project gets blown so I can make more money.” I laughed, but thought how they’d be whistling a completely different tune if there was no extension clause and I couldn’t pay them back by term end. Have these conversations up front and plan for the imperfect.

Hungry for More Ideas?

I have gazillions of ideas and examples on how to tailor an individual plan if you are hungry for more, I encourage you to check out my Getting the Money self study course where we explore how to raise private money from individuals so that YOU control the funding.

I’ll even give you a free private money calculator to see how much you need to raise for any project just for checking out the program. Now, that’s satisfying!

have fun and create value!

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(2) comments

Lisa

Thank you for the great information.

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    Susan Lassiter-Lyons

    You bet, Lisa!

    Reply
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