In order to meet their loan to value ratios (LTVs), nearly all lenders require borrowers to have some "skin in the game" or equity in each fix and flip project. How does a real estate investor who is just starting in the business or is tied up in another project obtain the down payment necessary to qualify for a hard money loan?
Friends and Family: A Logical Start
Friends and family are a great place to start when looking for help with money down. You know them, have a track record with them, may have worked with them before on other types of projects, and you have access to them to propose your deal.
Laying out your Proposal: Risks and Rewards
Before you approach friends and family, prepare a detailed analysis about the specific investment opportunity. Research the project thoroughly, and be very clear and honest about the pros, cons, and associated risks.
Next, devise a business plan that clearly articulates the timeline, projected milestones, and budget of the project as well as the terms of the proposed partnership, joint venture or investor relationship you wish to enter into with them. Approach the entire process like the business relationship that it is.
Real estate partnerships offer your chosen family and friends the chance to invest money into your fix and flip project(s) in exchange for a designated ownership percentage. As equity partners or investors, your family and friends will have an opportunity to receive money that the property generates at closing. So, while they will be taking an investment risk, they will also be in a position to benefit from the sale of the property.
Legalize your arrangement. This is a business partnership and should be structured as such. The most common way to structure these partnerships is as general partnerships, limited liability companies (LLC), limited partnerships or corporations. Consulting with an attorney who specializes in real estate partnerships can provide valuable information about the process and the best type of agreement for your situation.
Clearly, establish the role of each partner or investor. For example, your friend or family member might contribute the cash needed to make the initial down payment and closing costs, while you will be responsible for securing the remaining funding, buying the property, and managing all of the construction. Alternatively, your partner may want to take a more active role in the day to day operations of the renovation. Spell this out clearly ahead of time.
If you choose to set up a partnership, determine the aspects of the deal that will be included in the partnership and split. As partners, your family and friends will be able to participate in all aspects of real estate property ownership. This will allow them to receive a designated ROI percentage that might include: property appreciation, loan paydown, cash flow, and monies from the sale of the property. Remember that the addition of your partner’s funds reduces the number of your construction loans so that should be taken into account as well when determining what is included in the profit split.
Decide how the NET (profit or loss) will be split. Remember to include all costs when determining the profit (or loss): fees, refinancing costs and any appreciation. There are many different ways to split the profits, and not one right way. It all depends on how much money each party brings to the deal, how the work is divided, who takes the most risk, etc. Splits range from 50/50 to 80/20 based on the above factors and what the two parties agree to. The key is to decide and formalize the split ahead of time.
Outline terms of reporting the income (or loss) for tax purposes for each party
Following the steps above gives your partnership the highest chance of success, which can be a foundation for many future successful real estate deals.