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Private Lenders = Cash Flow Now + Infinite Returns

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Did you catch the first two articles in this series about investing without needing bank financing?  The first one was titled, Fire The Bank and was all about the reasons you should invest in real estate today without relying on bank financing.

The follow-up article was Show Me The Money, and it includes methods for you to find your own private lenders who can replace your bank financing.  Now that you know the “why” and the “how,” I want to show the benefit of buying and holding real estate using private lenders.

When you eliminate the bank from your investing equation, there are only two relevant parties in the transaction–the investor and the private lender. The real estate investor is the “catalyst” who does all of the work for the investment including:

  • Find the property and negotiate the sale at a great price
  • Manages the closing
  • Completes the property fix-up to make it “rent ready”
  • Manages the property (landlording)

The private lender is completely passive and does no work, but supplies all of the funding for the investment up-front at closing for the catalyst.  The funding includes all closing costs, all repair costs, and all funds required for the acquisition, so the catalyst has no money out of his own pocket.

When the catalyst works directly with private lenders,you have a winning combination for cash flow using a joint venture arrangement.  The best part of this joint venture is that both parties are critical to the overall success of the investment.

A Case Study for Cash Flow & Infinite Returns

The catalyst markets and finds a great deal on a 3 bedroom, 2 bath home at a 40% discount price point (60% loan-to-value ratio).  What that means is the purchase price and all fix-up costs will not exceed a total of 60% of the after-repair-value of the home.

Purchase price: (includes closing costs) $ 40,000
Fix-up costs: $ 20,000
Total investment required: $ 60,000
After repair value: $ 100,000

The total investment required is $60,000 and the after repair value of the property is $100,000, which leaves $40,000 of equity once the fix-up is completed on the property. The catalyst found the deal, negotiated it, and performed the fix-up, while the private lender funds the entire transaction expense of $60,000.

In my market here in Richmond, VA, a house like this one will be a typical 3 bedroom, 2 bath house in a working class neighborhood. This house in Richmond will rent for $950 per month creating a nice income stream for the joint venture investment.

The catalyst used none of his own money to get monthly cash flow and an infinite return.

The primary on-going expenses associated with holding real estate are taxes and insurance. In Richmond, the taxes and insurance combined will be about $150 per month for the house in this example which leaves $800 net rental for the on-going monthly income stream for the joint venture.

The $60,000 investment has now been used to pick up $40,000 of gross equity and a $800 monthly income stream. I hope you are wondering how this gets applied back to the members of the joint venture because the answer is… any way that the Private Lender and Real Estate Catalyst come to terms.

For simplicity sake, let’s assume that the two joint venture members agree to a 50/50 split in this venture.

With a 50/50 split, the $800 monthly income stream is split so that both members receive $400 each month; along with this monthly income stream both members also will share the upside equity at some point in the future.

What Did Each Member Earn?

Let’s make one last assumption to show how the ultimate return can be easily calculated for both members of this joint venture.

Let’s assume that both members hold onto this investment property for five years then sell it for $100,000, which is today’s value of the house. What did both members earn on this joint venture?

Private Lender earnings:
$400 per month for 60 months: $ 24,000
Upside equity split of the total $40,000: $ 20,000
Total return over the five years: $ 44,000
Total investment made: $ 60,000
Annualized return for private lender: 14.66%
Real Estate Catalyst earnings:
$400 per month for 60 months: $ 24,000
Upside equity split of the total $40,000: $ 20,000
Total return over the five years: $ 44,000
Total investment made: $ 0
Annualized return on investment: Infinite

Everyone Is Happy

The private lender made a very strong return of 14.66% annually and his $60,000 investment turned into a $104,000 at the end of the five years.

The real estate investor (catalyst) used none of his own money, enjoyed $400 per month in cash flow and an overall return of $44,000 over the five years. The catalyst enjoyed an infinite return because he used none of his own money in the investment.

How many houses would you want to buy and hold this year and earn $400 per month on each house? I challenge you to establish a plan and invest in yourself, so you can easily structure investments similar to this one.

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About the Author...

Jim Ingersoll is a real estate entrepreneur who has bought and sold hundreds of homes. He is the author of Investing Now and Cash Flow Now (both available at Amazon.com), and enjoys speaking and coaching others on how to obtain their financial freedom.

Jim is Head Real Estate Coach and Trainer at: Coaching.CREonline.com

His website is InvestingNowNetwork.com

You can find Jim on Facebook and Twitter.

Comments

  1. James Plischke says:

    This is great Jim. I’ve been racking my brains looking at creative financing and seller financing trying to figure out a way to cash flow future investment properties and your ideas are the only ones that make sense. I have a little more to do and learn before I begin investing but your article put me more at ease in terms of financing my deals.
    James

  2. Jim Ingersoll says:

    James

    Thanks for leaving this comment. I am happy that you are thinking about how to capitalize without using your own money this year. This is a 3 part series so go back and review the other articles as well. I have a private lending report I can send you as well, just email me jim@investingnownetwork.com

    Enjoy your journey to private lending & cash flow in 2012
    Jim

  3. Christopher Smith says:

    What are your thoughts on offering the private investor a 10% rate of return as a lender only? Have the investor be the mortgagee?

  4. Jim Ingersoll says:

    I think 10% works well for short-term loans, but for long-term buy and hold I would avoid 10% as it will take a big chunk of your cash flow away. Glad you are thinking!

    Jim

  5. Myk Brown says:

    Is 50 50 a typical situation? Do you always try and find 1 lender per deal to keep it simple, or is there a way to set up an LLC that buys and manages the properties for multiple investors and pays out a set percentage and maybe a dividend whenever a property is sold?

  6. Jim Ingersoll says:

    Hi Myk

    50/50 makes it easy for this case study and easier to attract equity funding, but you could go 60/40, 70/30 or whatever works for you and the investor/lender.

    You can also combine sources of funding as needed, though it is simpler to have one source for a transaction.

    Jim

  7. Michelle says:

    In this example is the private lender also funding the money needed for repairs as well. IMO being that he/she is funding all the cash 50/50 seems like the best option doing anything else like 60/40 or 70/30 if I were the lender I would want the higher percentage since the lender is taking all of the risk. Me as the catalyst loses nothing but time. 50/50 is generous I would jump on that.

    Michelle

  8. Jim Ingersoll says:

    Michelle

    You are seeing the win-win benefits of joint venture investing – congrats. Yes, the private lender can supply the funds for acquisition + renovation expenses. There are very few investment vehicles that can offer equity participation and this is an easy way to find the funds for real estate investing.

    Thanks
    Jim

  9. Daniel says:

    Chicken or Egg?

    I think what’s holding me back from pursuing this model is not knowing what to go after first, the chicken or the egg, or, in our case, the deal or the money.

    If I go after the investors first, I imagine being asked for more information about the “deal”, which I don’ t yet have. On the other hand, if I go after the deal first, I’m afraid I won’t have enough time to find an investor!

    What to do????

  10. Jim Ingersoll says:

    Daniel

    That is a great point. Many people say that IF the deal is good enough you can ALWAYS find the money. There is a lot of truth in that perspective.

    I do think it is good to begin telling your real estate story, goals and plans with people on a regular basis. At the end of the conversation just ask if they know anyone who would want to joint venture and work together. Start with your inner circle of relationships first (family, friends and colleagues). As you get more comfortable you can begin stretching out. For instance if you are speaking to your dentist, just ask how the stock market is treating his returns. Ask financial type questions and you will have doors start to open up.

    For most people the deal is easier to find then the first investor, but that is not always the case. You may want to go after the chicken and the egg at the same time and the deal will be ready for you

    Jim

    • Faraz Khan says:

      Jim,

      Thanks for posting this. This is the exact process I’ve done for the last 3 years, and now I have 30 units (8 properties), with only one deal using my own cash, and I’m only 25 yrs old. It really does work if you pitch yourself well, and it all starts with just one deal and one investor.

      In terms of the ‘chicken or egg’ (deal or investor), it’s really both. You can’t get the investor to write you a check without the deal, and you can’t close a deal without the money in the bank. As Jim said, you can to go do both.

      Here is my method:
      1. Get interest from potential investors & get their email
      2. Meet with them to show example properties & pro formas, figure out their Time & Budget requirements (1-2 years or 3-5 yrs is what I do).
      3. Ask them for $150 to setup a new LLC so you know they are serious (get them to have a vested interest)
      4. Start sending them real deals and ask for the money
      5. If they don’t give you money, send them the results of other deals / deals they’ve missed

      Eventually you will find 3-5 investors who will continue to do deals with you and you won’t be able to keep up with the dealflow because you’ll be busy managing your previous deals! (that’s where I am!).

      - Faraz

  11. Sophia says:

    Jim,

    Great blog article. However, one issue I am not clear is how to account for the expenses related to holding the rental for the first 5 years. I see people usually count about 40% of the rent as the expenses, including vacancy and necessary repairs, and this is not including property management fees. So in your example, the net operating income really is 950*0.6-150=420. Split it 50/50, the investor is only getting 210 a month, 12600 for five years. Annual return is about 10.87%. Please let me know your thoughts!

    Thanks,
    Sophia

  12. Jim Ingersoll says:

    Sophia

    Thanks, glad you are soaking in the concept.

    I write that info into the joint venture up-front and only react to actual expenses occurred rather than trying to project. If you do a good renovation when purchased you should not have many repairs in the first couple years and if you are careful with screening tenants you can cut the vacancy expense, but every situation is different.

    The private lender and real estate catalyst get paid the same amount either way. Personally I would not nickel and dime the private lender and work to cover anything minor so they can stay completely passive and enjoy the joint venture as much as I do.

    Jim

  13. richard says:

    Your blogs are very helpful. Please keep writing.
    What kind of written document should the two joint venture investors use describe the terms of their agreement? Can you refer me to examples?

  14. Hello,

    I am not getting my math correct. Please show me the formula used to get the annualized return for private lender. Thanks.

  15. I’m confused. I’ve never seen a typical 3 bdrm home go for anything close to 40K, even taking into account a 40% discount/LTV ratio. Can anyone show me any real or similar examples?

What do you think? We would love to hear your opinion.

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