structuring private loans as JV....what!?!?!

[AndyLuchies]

Thanks for coming out to hear this question, any and all ideas welcome.
Here`s the deal:

A) I have access to lots money from people that want decent returns on money, but not interested in real estate JVs.
B) I think getting long term loans from them at a decent rate, e.g. 10%, will satisfy their tastes and my needs.
c) I`ll be using the loan money as downpayments on properties.

Problem: if I simply add loans to my net worth, I am essentially buying properties 100% financed and banks don`t like that, so I will rapidly run out of grace with the lenders. I need a way to prevent that.
SO
is there a way to attach the loan as a JV interest in a property (e.g. on one I already own), and register on title somehow so that if i get a $10,000 loan, instead of it registering as debt, I register it on an existing property as a JV interest (worth $10,000).
OR
what about having my wife get the loans in her name from these partners, then if I apply for properties alone, the loans aren`t included in my networth statement.

Let me know what you think about my ideas or give some of your own.

At this point, please don`t suggest something that does not include me applying for financing, as that`s really the only way to access this money. I also don`t want to do anything under the table, I want to play by the banks` rules, but am unsure what is smart structuring and what is illegal.

 

[Thomas Beyer]

A 10% ROI fixed is too high in the current environment and will likely get you in trouble.

You could have a corporation that issues loans @ X %. The corporation buys it, with your personal guarantee.

Run this by a bank / mortgage broker for the first deal and see where it goes. Then do a 2nd, 3rd ..

a 2nd option is that YOU buy asset with your own cash. Then, 2-3 months after the deal closes you add a 2nd mortgage @ X%.

Be aware that 10% FIXED is a VERY HIGH return and as such lower leverage is required .. or a reserve for 2-3 years of interest payments.

 

[housingrental]

Hi Andy

I take issue re 10% high on Thomas`s post above
This will depend on the specific risk of your project.
I`ve taken $$ in loans at exactly that, 10% interest, and its worked out well...
And if Thomas would like to extend loans to me or you at less I welcome it.... Do you have anything you want me to put to use at 8% Thomas ?

 

[Thomas Beyer]

QUOTE (housingrental @ Dec 15 2009, 10:06 PM) ..
I`ve taken $$ in loans at exactly that, 10% interest, and its worked out well... And if Thomas would like to extend loans to me or you at less I welcome it.... Do you have anything you want me to put to use at 8% Thomas ?
I am not saying that 10% is not good for the investor. It is excellent ! I am saying IT MAY BE TOO EXPENSIVE FOR THE BORROWER, especially in a flattish real estate market with tight cash-flow.

 

[housingrental]

Yes I understand....
But can be hard to find lenders at lower rates.. and can be well worth 10% on small portion to get deal done...

QUOTE (ThomasBeyer @ Dec 16 2009, 11:20 AM) I am not saying that 10% is not good for the investor. It is excellent ! I am saying IT MAY BE TOO EXPENSIVE FOR THE BORROWER, especially in a flattish real estate market with tight cash-flow.

 

[bizaro86]

Hello,

One option would be to hold the subject property in a corporation. Then, have the corporation issue two classes of stock. A common stock, which has voting control and 100% of the equity in the corporation, and a preferred stock, with a fixed, redeemable value of whatever amount the investor is putting in. The preferred stock gets paid their dividend first, but doesn`t share in the upside, so the mechanism is similar to a loan.

Also, there are some tax advantages to your investors for receiving their income as dividends and not as interest, which could potentially allow you to offer them a lower interest rate. Of course, the downside is the payments are then no longer tax deductible to your corporation.

Michael

 

[Thomas Beyer]

QUOTE (bizaro86 @ Dec 16 2009, 02:22 PM) Hello,

One option would be to hold the subject property in a corporation. Then, have the corporation issue two classes of stock. A common stock, which has voting control and 100% of the equity in the corporation, and a preferred stock, with a fixed, redeemable value of whatever amount the investor is putting in. The preferred stock gets paid their dividend first, but doesn`t share in the upside, so the mechanism is similar to a loan.

Also, there are some tax advantages to your investors for receiving their income as dividends and not as interest, which could potentially allow you to offer them a lower interest rate. Of course, the downside is the payments are then no longer tax deductible to your corporation.

Michael
yes an option .. IF the deal makes sense still ..

and you are now selling securities .. and as such add`l documents for accredited investors or friends/family/close business associates should be filled in ..

 

[Nir]

QUOTE (housingrental @ Dec 15 2009, 10:06 PM) Hi Andy

I take issue re 10% high on Thomas`s post above
This will depend on the specific risk of your project.
I`ve taken $$ in loans at exactly that, 10% interest, and its worked out well...
And if Thomas would like to extend loans to me or you at less I welcome it.... Do you have anything you want me to put to use at 8% Thomas ?
I have to agree with Adam because of the following real life example:

I recently purchased a plex with JV partner. we share property 50/50 and net income 50/50.
his 50% net income ALONE is significantly higher than paying 10% interest would be!

If partner got 10% it would be MUCH LESS than in current situation which includes net income (already higher than 10% as mentioned) + principal payments + any future appreciation.

Conclusion: since 50/50 in everything is COMMON, paying a JV partner 10% interest ONLY is apparently NOT too much based on the above real life example AND current economic situation.

Thomas, since I know you too support the 50/50 net income and ownership approach, it is surprising you think offering 10% interest without any additional benefit, is too much.
Yes, with 10% interest paid to the passive investor there is higher risk (because it is fixed) BUT lower expected payment than the other common method above. Therefore, for consistency, preferring variable rate mortgage should go together with preferring to pay 10% fixed interest. In BOTH cases you the active investor are expected to pay LESS but take higher risk! I know you too prefer variable rate mortgage - another good reason (I thought)
to actually prefer the 10% deal.

Remember: with 8% CAP, 25% down and 4% mortgage interest, paying the passive partner 10% interest is LESS than what you pay the passive partner with 50/50 net income and 50/50 ownership even with annual appreciation of only 2%(!) higher appreciation ---> gap only increases.

Regards,
Neil

 

[AndyLuchies]

These are some great ideas. I will start with a lower interest rate in my JV presentation then.
Anyone know of options that don`t require setting up a corporation? Right now that seems like a lot of time and expense for less properties (I only own 2 currently).

"a 2nd option is that YOU buy asset with your own cash. Then, 2-3 months after the deal closes you add a 2nd mortgage @ X%."

This is exactly what I was thinking initially, but then my properties will be leveraged too high for banks to keep give me financing, so I`d like to stay away from 2nd mortgages.

Does anyone see problems with me putting these loans in my wife`s name? Can I still register them on a property title as a simple caution/caveat to give the lender some security?

E.g. my wife gets 8% loan of $20,000 which is used to buy real estate in my name. We write off interest as business expense in our sole proprietor business, but I don`t have to declare it on my net worth statement as its in my wife`s name.
However, how do I give the lender security on that loan? Even though being in my wife`s name, can I simply put something on a property title saying "sale subject to Joe`s promissary note" or however you might word that? (so lender has assurance that their money won`t just walk away).

Andy

 

[Thomas Beyer]

QUOTE (investmart @ Dec 16 2009, 09:36 PM) ..

Remember: with 8% CAP, 25% down and 4% mortgage interest, paying the passive partner 10% interest is LESS than what you pay the passive partner with 50/50 net income and 50/50 ownership even with annual appreciation of only 2%(!) higher appreciation ---> gap only increases.

.
yes .. in theory i.e. on a spreadsheet this is true ..

but with 25% down-payment borrowed @ 10% AND necessary R&M you will likely have no cash-flow ..

I also have been unable to find properties at an 8% CAP rate that are in decent condition or in decent areas with upside. Loads of "pro-forma 8% CAP" but once you factor in real vacancies, true upgrade expenses and cash required it is more like a 5% CAP rate .. and then 10% debt becomes expensive very quickly unless you can get rents up, and re-finance within a year or so.

keep in mind that 50/50 is equity and usually better for cash-flow .. but 10% "guaranteed" loan is a debt that could bite you in a flattish real estate world.

Example:

$1,000,000 property with an 8% CAP rate woudl yiled $80,000 Cash-flow (in theory).

Add a $750,000 mortgage @ 4% and you pay $48,000/year with a 25 year amortization. Leaves $32,000 in cash-flow.

Deduct 10% on that $250,000 loan or $25,000 leaves you with $7,000 .. essentially NEGATIVE cash-flow as you will usually spend FAR MORE than that on R&M, vacancy loss, annual accounting etc.

Thus: a 10% "guaranteed" payment will put you as the operator at risk to be unable to hold property for 5 or more years !

Yes, you will get 100% of any upside .. if you can get there.

Thus: more cash down or more reserves or less than 75% mortgage is required !!!

10% loan = HIGH RISK.

50/50 may cost you more but lowers your risk !

 

[bizaro86]

QUOTE (ThomasBeyer @ Dec 16 2009, 04:17 PM) yes an option .. IF the deal makes sense still ..

and you are now selling securities .. and as such add`l documents for accredited investors or friends/family/close business associates should be filled in ..

My understanding was that the family/friends/close business associates exemption, as well as the private issuer exemption could be used so that registration and a prospectus were not required. If that is the case, and the issuer is not registered, what documentation would be required. Is support of the exemption necessary?

Obviously, I`m not a securities lawyer (or any type of lawyer at all) so I`m interested in hearing from those who have gone down this path.

Michael

PS. For those interested, a law firm has a summary page here:
http://www.heenanblaikie.com/fr/publications/item?id=576

 

[Nir]

QUOTE (ThomasBeyer @ Dec 17 2009, 10:43 AM) 50/50 may cost you more but lowers your risk !

why do you prefer a VRM then? Fixed mortgage rate may also cost you more but lowers your risk!

 

[Thomas Beyer]

QUOTE (investmart @ Dec 17 2009, 02:00 PM) why do you prefer a VRM then? Fixed mortgage rate may also cost you more but lowers your risk!
both are good options. I am just poiting out the facts of poor to negative cash-flow if you promise a fixed % on a deal with essentially 100% leverage.

You decide what is right for you.

VRM with a % equity participation is an option ..

 

[markbrad]

What if you could get a loan 8-10% without payments for 2,3, 5 yrs? THat could allow you the cash flow you are looking for. Think about it, a lot of people invest in mutuals, stocks etc., and leave it there for long lengths of time. Why should a private loan be any different? Maybe you could structure payments half and half. Half monthly, half baloon payment?

Any thoughts on this?

Mark

 

[Thomas Beyer]

QUOTE (markbrad @ Dec 17 2009, 06:17 PM) What if you could get a loan 8-10% without payments for 2,3, 5 yrs? THat could allow you the cash flow you are looking for. Think about it, a lot of people invest in mutuals, stocks etc., and leave it there for long lengths of time. Why should a private loan be any different? Maybe you could structure payments half and half. Half monthly, half baloon payment?

Any thoughts on this?

Mark
sure .. that is better .. for two reasons:
a) 10%/year paid in 5 years is less than 10%/year paid monthly, and
b) it improves your own cash-flow, thus improves the chance to hold 5+ years

again, as a real estate investor you lever other people`s money for your (and their) gain. Thus, the real estate underlying the venture hs to be able to deliver returns far above the fixed/"guaranteed" money you borrow. The more you borrow they higher the risk to you, the operator.

10%/year guaranteed can be better for you in 5 years than 50/50 .. but not necessarily. It depends on you, the asset and the economy.

 

[Nir]

QUOTE (ThomasBeyer @ Dec 17 2009, 04:32 PM) both are good options. I am just poiting out the facts of poor to negative cash-flow if you promise a fixed % on a deal with essentially 100% leverage.You decide what is right for you.

VRM with a % equity participation is an option ..

As usual you raised good points Thomas and offering 8% interest for example is more reasonable than 10%.

However, the point I tried to explain Thomas, is that you partially contradict yourself by preferring a variable rate mortgage but not paying 10% (or 8% interest) to a passive investor, although both are expected to cost you less and increase your risk.

In other words, you explained above that you prefer the 50/50 approach because "50/50 may cost you more but lowers your risk !". ok fine but why then, for the same reason, don`t you prefer fixed mortgage rate when taking a new mortgage? It also "costs you more but lowers your risk !" relative to variable rate mortgage (VRM).

Hope my point is more clear now.

Regards,
Neil

 

[Thomas Beyer]

QUOTE (investmart @ Dec 18 2009, 11:41 AM) In other words, you explained above that you prefer the 50/50 approach because "50/50 may cost you more but lowers your risk !". ok fine but why then, for the same reason, don`t you prefer fixed mortgage rate when taking a new mortgage? It also "costs you more but lowers your risk !" relative to variable rate mortgage (VRM).
Hope my point is more clear now.
10% FIXED on money from 80% LTV to 100% is FAR HIGHER RISK than taking a fixed or variable rate mortgage @ 2.25% or 4% for the first 80% !!

I didn`t say I`d prefer 50/50 .. I say "it is lower risk" as real estate does not always go up. Plus, using my example earlier is not great for cash flow ! 10% MIGT be better for some folks and is better in rising markets if payments are post-poned as a balloon !

see here:

Example:

$1,000,000 property with an 8% CAP rate would yield $80,000 Cash-flow (in theory).

Add a $750,000 mortgage @ 4% and you pay $48,000/year with a 25 year amortization. Leaves $32,000 in cash-flow.

Deduct 10% on that $250,000 loan or $25,000 leaves you with $7,000 .. essentially NEGATIVE cash-flow as you will usually spend FAR MORE than that on R&M, vacancy loss, annual accounting etc.

Thus: a 10% "guaranteed" payment will put you as the operator at risk to be unable to hold property for 5 or more years !

Yes, you will get 100% of any upside .. if you can get there.

Thus: more cash down or more reserves or less than 75% mortgage is required !!!

10% loan = HIGH RISK.

50/50 may cost you more but lowers your risk !