I tend to use cash when I expect a short hold time (less than 90 days) and financing when I expect a longer hold time (more than 90 days). Also, if I believe I’ll be doing a lot of buying in the near future, I’ll use financing as much as possible just to keep cash available for more projects.

I don’t have any contracts that I can send you and given that I’m not an attorney or contracts expert, please take anything I suggest and check with an attorney before you do anything…

That said, there are a couple issues to consider:

1. First, you should probably ensure that any money you lend is actually secured by the asset (the property) that the money is used to purchase. While this might not be necessary if it were just your son you were working with, the introduction of a non-relative probably makes this a good idea. In essence, this means that you should either hold a mortgage on the property (you’d be just like a bank lending on the property and could foreclose if you don’t get paid) or you should be put on the title of the property, either by yourself or jointly with your son and his friend. That way, you can be guaranteed that your money is secured by something physical that you get ownership of if your son and his friend don’t live up to their end of the bargain.

2. Second, you will need some kind of contract with your son and his friend that lays out (in detail) the roles and responsibilities of each of the parties involved in the deal. The contract can be a Partnership Agreement between you and them, or, if you think this will be a longer-term relationship, you might consider setting up a business entity (LLC, corporation, etc) that is jointly owned by the three of you. If you set of a business entity, there will be business documents (Operating Agreement, Bylaws, etc) that would need to lay out these roles and responsibilities that I mentioned above. Additionally, it would be in the contract or business documents how specifically the profits (and/or losses) would be split among you and the other two.

Those are the two basic things you need to consider, and I would highly recommend consulting an attorney who specializes in contracts to help you figure out the details.

Is it common for an equity partner to have a sliding scale as to what percentage of the profit they will receive based on the length of time the money is in use? In my mind, if I loan $70,000 and it generates a $20,000 profit in 90 days, I should receive less of the profit than if the same numbers happen after 6 months?

Thanks in advance,
Dave H.

I just found your site a week ago and find it very informative. Any help you can give would be greatly appreciated.

Dave

There’s really no hard-and-fast answer to your question…the big boys have many different options for financing, and depending on their situation, they can sometimes get very creative.

As you pointed out, traditional financing is the worst choice. It takes a lot of time to get the loans, the number of loans is limited, and traditional lenders don’t like to lend against run-down houses.

Certainly, the most common financing method for the big players is to bring in a number of investors, pool their investments, and use that as a cash pool for whatever they are trying to do. For example, they may find 5 investors each with $200K to invest, and they immediately have access to $1M for investment. And if you’re looking to buy relatively low-end houses, $1M can go a long way, especially if you have an exit strategy that gets you out of the deals quickly.

My strategy (which is also pretty common) is that I work with small, local banks that lend their own money. They can underwrite any deals they want, and don’t have to follow any specific guidelines. So, they can lend against a thinner deal if they know you have experience, or can lend to you on a great deal even if you have no experience. They make their own rules, so all you have to do is convince them that their money is safe with you, and you can often get financing.

While you may be able to get loans in your business name early on, you’re going to have to personally guarantee the loans. This means you’ll need at least decent credit or some assets to secure the loan. I’ve heard of people buying shell companies to have immediate credit, but lenders will recognize that and will likely ask for personal guarantees to go along with the loan.

As for refinancing many rentals, what you’ll want there is a commercial blanket loan. Basically, one loan that covers all the properties into one bundle. Many small banks will do this, as well as many traditional lenders, assuming you have decent equity to support the loan valuation.

Hope that answers some of your questions!

Thank you for putting this info online – this is very helpful.

In order to build a scalable business model around deeply discounted residential REOs and to limit personal liability on the other end makes me a bit wary of the traditional financing option. The other options appear to eat up profit margins unless you can flip rather quickly.

There are real estate companies that are active in residential housing – and not just apartment complexes. How do these guys finance ?

Generally speaking, is it possible to get a mortgage as a corporation or LLC with/without a credit history if you can show them the equity created after rehabbing in a spreadsheet with a comps analysis attached ? For other businesses outside of real estate, I heard of people buying shell companies with a good credit history in order to qualify for business loans. Would this be feasible in your opinion for REO mortages ?

How to the big real estate players finance and for what terms ? Can’t imagine there rates are much higher than personal mortgages- but I do imagine there is a size treshold and certain limitations.

After accumlating a portfolio of a number of rented, income-creating REOs, are there opportunities to refinance with a commercial mortgage in a LLC/company name that surpass a certain treshold ?

If you know the answers to my questions or have any resources to point me to, I would greatly appreciate it.

Yes, we were lucky to have the cash available to boot-strap our investing. That said, if someone doesn’t have the cash, but does have good credit and/or reliable income, they should be able to figure out a financing solution that will work for them. The key to financing is to constantly be looking for money, whether you need it or not.