Private Lending-Expectations vs Reality
I got an email from a subscriber that asked: “If a investor can give you 100% money to invest in real estate. What is the best JV arrangement you can offer him to have a workable and sweet agreement acceptable to both parties? (investor is sophisticated accredited investor).”
This is a great question, and there are 2 issues you need to address to raach an answer:
1. What are the expectations of the lender?
2. What can your deal afford to offer?
The first question is easy. Just ask the lender! They’ll usually tell you. Find out what kinds of returns they’ve gotten on other investments they’ve made. Also, establish their risk level. For example, someone who invests in start ups may have made a killing on one particular company, but other companies may have been a total bust.
It’s not likely you can offer 10 fold returns on a real estate investment if your investor is funding the total acquisition cost. This is why it is important to establish with your investor, what their return and risk balance is. Real estate has less risk and more security (when you know what your doing), than most other investments. (Return OF investment is important to all investors). And you can add an ”equity kicker” to your offer to increase the return for the investor.
However, how high you can go, or how much you can sweeten the pot depends on your deal.
To decide this question you need to consider:
1. The cashflow and profit generated by your transaction projected over the time until you pay off the investor.
2. The financial risk - that is, in the worst case scenario, you should be able to still pay your investor what you promise. This is critical, because losing money for an investor is going to put a mighty big dent in your ability to raise money from other investors.
This is not a trivial exercise. To project your return from the deal, you have to factor in rental increases, expense inflation, all the operational costs including managing the property, appreciation rates, carrying costs, selling or refinance costs, etc. And you should make conservative assumptions.
The second and more difficult challenge is factoring in the financial consequences of what happens when things don’t go according to plan. Like, what if you have to evict a tenant(s)? What if the renovation takes longer and costs more than you predicted? What if the property doesn’t appreciate as much as you’d hoped?
You cannot afford to look at your deal through “rose-colored” glasses. You need to have a “Show Me the Money” attitude. In other words, what do the numbers show when the deal is subjected to various “worst case” scenarios.
And, finally, once all the numbers are in front of you, you have to decide how much you’re going to want to take away for yourself. Once you have your bottom line, you can calculate the maximum amount the deal can pay your investor.
Now, all these analyses and calculations are probably daunting to most investors. Especially the work of making the risk analysis. However, there is one piece of software that can reduce this entire task to a 5 min exercise. Just plug in the numbers and read off the results.
It is an expert system we’ve developed, called the Deal Evaluation Tool. It is the result of our 10 years experience doing all types of real estated deals, and conversations with many experts.
I use it for every opportunity that comes across my desk. After fine tuning it with a nice return for us and our investors, and taking account of the risks, I use to to make offers, and negotiate deals. With it, I am always in a strong negotiating position, because I know my bottomline and when to say “Deal or No Deal”.
Richard Odessey has been investing in Real Estate since 1999 and have bought, managed and sold over $5MM in assets over that time period. He has created a national network of RE investors that are a source of continual on-the-ground intelligence. Richard has also developed unique and proprietary tools to zero in on only high profit-low risk transactions.
