Archive for Deal Structuring for Private Lenders

When you are in the process of networking -- that is meeting people and mutually evaluating whether you and they would be a good match for an investment opportunity, specific terms need not come up.  In fact, your first goal should be to get someone  to like, respect and trust you, before mentioning anything about an investment.  Secondly, when you are promoting your investment opportunity to a private investor, your goal is to paint a picture of a highly profitable, low risk investment.

Once the investor expresses some interest in the investment, then you can arrange a separate meeting where you can discuss the details, including specific terms.

You can find out more details by reviewing the training sessions listed in the "Events" tab.

Private Lenders as with most other investors, invest their money in businesses.  Having a business entity builds credibility with a private investor and provides other benefits such as liability protection, tax advantages, etc.  So, before one begins raising provide money for any kind of investment, it is highly recommended you incorporate in the state in which your business is located, so that you are a legally recognized corporate entity: Corporation, LLC, Partnership... A sole proprietor or DBA (doing business as), marks you as an amateur, and an investment risk.

When you are doing leveraged financing, where an institution (like a bank) lends money on the property and creates a mortgage lien in the first (senior position).  That means in case of default, the institution gets fully paid back the principal and it's collection costs before any other lien holder gets paid.

Other lien holders (e.g. you investor) are in the 2nd position--holding a junior lien.  In case of default it is unlikely that little or any of their investment will be repaid.  This risk can be unacceptable to many private lenders.

First, use  the MAO (Maximum Allowable Offer) rule.

MAO =  70% of the after repair market value - the costs of repairs.

AND Market value is not what the RE Agents say, but what it would actually sell for these days

You don't want to just ask for the "exact" (e.g. estimated ) cost of a rehab project.  Often costs will increase due higher material costs, unexpected repairs, and time delays.  The professor's rule of thumb is to add an additional 10% for minor rehab (<= $5,000), and higher percentages as the rehab becomes more extensive.

The professor as created a useful algorithm for this in his Deal Evaluation Tool.  This is an excel spreadsheet you can use to generate all your financial information for you and your investors for any type of real estate deal.  You can check it out at:

The valuation of a quad is based on comps (sales of similar properties in the last 3-6 mos), just like single family homes.

For multi-family, the valuation is generally based on the NOI "net operating income" which is defined as the total actual annual income from the property minus the total actual annual expenses.  Then the formula for the Estimated value is:

Estimated Value = NOI/(cap rate)

Thus if the cap rate is 10% and the NOI is $50,000, then the estimated value is $500,000.

The cap rate will depend on the class of the apartment (from "A" - high end living space & amenities, to "C" - working class functional, to "D" - livable but not nice.)  and the economy.  "A" has the lowest cap rate (5-6%), B (6-8%), C (9-11%), D (12% or greater).  A bad economy tends to increase the cap rate.

Private Investors are very concerned about how much risk you are exposing their money to.  Obviously, renting to a poorly qualified tenant is going to risk eviction costs and cause other problems which could cause a loss of investment or return.  So, even if the investor doesn't ask you, your failure to address that will diminish you chances of getting an investment.

With rentals, you have to address 2 issues for the investor:
1) What is your exit strategy:  When and how are you going to pay the investor back his principal?
2) How are you going to pay the return on his investment. With rentals that return is usually paid out of the cash flow from the rents.  That cashflow should be at least 25% more that the payment you are making to your investor.

Private investors are most definitely interested in wholesale deals.  A quick turn over of their money with a high profit is actually the best scenario, especially when the risk is low.  If for example an invest lends you $50K, and you flip the property for a profit of $20K in 2 months, and lets say you agreed to pay you investor a fixed 5% of his investment.  Then the investor would recieve $105,000 in 2 months.  That's a 30% annualized return.  Your investor would be delighted.

Question: "- - - I don't see being able to pay them monthly, and I am not sure I want to share in the equity - - - what is your take on it?"

Investors can be your most valuable asset, and the cost of what you pay them is always worth it.  So if you can't make monthly payments out of the cash flow from your project then you have 2 choices:

1) Reward investors with equity--a percent of your profit.  If the investor puts up all the money, giving them a minimum of 50% of the profit is pretty standard, and you may want to give them even more to get them on board for your first deal.

2) Offer deferred interest - that is, all the interest due and the principal owed will be paid when you exit from the deal (usually by selling the property).