Today, I’m replaying an interview with someone who deals with a very unique aspect of real estate–private investing. Private investors rarely talk on podcasts because they don’t want to be inundated with calls or emails from new investors who want money. That’s why I’m only using this investor’s first name in the interview, and I’m so glad I got him to share his unique perspective with the listeners of Just Start Real Estate.
In this episode, I talk to a friend of mine, and someone who I admire quite a bit. He is a private investor here in my local real estate investing community. Larry has been involved in real estate since 2007. He and I have worked together on deals in the past and he currently is a private investor for several real estate investors locally. He has a lot of insight and experience that he shares with us in this episode. It was definitely packed with good information. This is one you should definitely check out!
Larry has been an IT professional for over 35 years, and currently works full-time at a large computer software development corporation. Larry has always loved anything to do with home construction and is a serious do-it-yourselfer. He did his first residential property flip in 2007, and has since either partnered or funded about 20 more flips.
Larry’s dad was a builder and built over 250 homes over the course of his career. He was able to retire in his early forties when Larry was only 10 years old. Larry has always loved real estate, but since his father retired at a young age, Larry was not able to take over the family business. That did not stop him from getting involved in real estate! He was also able to work with his father on one spec build.
Larry officially became a real estate investor in 2007 when he purchased his first residential property flip. In Larry’s words, “that first flip nearly killed me“. One of the reasons why it was such a difficult experience was that Larry was working full-time. Full-time for Larry often is 8 AM to 8 PM. He would then go out to his flip and work until midnight. Because he is good at building, he would do a lot of the construction himself. This was a bad idea, which he certainly learned. It was that experience that led him to realize that doing flips on his own was not going to be a good fit. He then partnered up with a another real estate investor and did a few deals. After doing about five deals with his business partner, Larry decided to become a private lenderexclusively. He has not done any more deals himself, but he lends his funds to other real estate investors. In his current deals, he is essentially a silent partner whocontributes all of the funds but does not do any of the work himself.
Larry currently invests with a handful of investors that live locally and do deals in Southeast Michigan. He only invests with people who he knows personally and has developed a relationship with prior to lending money. Any additional investors that he would take in the future would have to have a portfolio of their past deals and show agood track record of performance.
I asked Larry what his criteria was for deciding whether or not he would fund a deal. He told me that he does not require a specific profit amount, or a specific rate of return. Larry looks at each deal individually, and if it is a deal that he would do himselfif he had the time to flip the house, he will consider funding it. There has to be a good spread and plenty of money in the deal for any miscalculations in the rehab. To give you some idea, Larry typically lends around $125,000 to purchase the house and then that house will typically sell for around $175,000. That is a fairly standard deal for him and his real estate investor partners.
Larry typically uses two documents on each deal – a private mortgage document, and a promissory note. The private mortgage gets recorded the day of closing, and the promissory note spells out the terms of the agreement. He typically only spends a couple of hours at the beginning of each deal evaluating the deal and creating the documentation.
I had a great time interviewing Larry and I know you will get a ton of value out of this episode. I highly encourage you to listen to it in its entirety!
After the interview concluded, we had a short discussion about a point that he felt he might not have made clear. He sent me a short email outlining what he would like to clarify. This is what Larry would like to make clear regarding his profit split deals:
When someone hears that they are giving up 40% of the profit it “sounds” like a lot. I think subconsciously people equate or compare it to an interest rate. Why would I pay 40% when I can borrow money at 10%?
Let’s look at the numbers:
If I loan $100,000 at 10% for eight months (a typical flip) you would pay a guaranteed $6,667.
Take the exact same loan with the agreement that you pay. 40% of the profits. If the Net profit to be split is $16,667, the 40% payout would be $6,667.
The real difference is in the risk the private investor is taking. I would actually prefer to receive a guaranteed interest rate because there is no guarantee that there will be any profit to split. 40-50% of nothing is nothing.
Unrelated Business Income Tax (UBIT) – Larry Brought this up during the interview. He wanted to caution private investors about this tax. If you don’t know what it is click the link and read more.