Many investors have run into problems trying to find money for commercial real estate deals. Typically a real estate investor will find a great 36 unit apartment building that cash flows $5,000 per month only to soon realize that they will need $200,000 to close the deal. Guess what comes next? They realize they just don’t have the funds to bring to the closing table.
Sounds like something you have experience before? I would very much like to show you how to raise capital from private investors using creative investing strategies, self directed IRAs, crowdfunding, peer-to-peer lending, and use commercial wholesaling for your commercial real estate investing deals.
How Do I Know if My Deal is Good Enough to Attract Investors?
Good deals attract money. A good deal will attract interest and this is exactly what I preach to others and beleive for my very own deals. Here are five good elements of a good deal:
Five Good Elements of a Good Deal
===> #1 Your deal must be priced under market
You don’t want to bring an overpriced deal to your investors. People like good deals.
===> #2 You want your deal to have income upside.
In other words, you want the rental income to be capable of going up over time instead of down. As the net operating income of a commercial property goes up, so does the value. You need to show your investor that you have a plan and that the property is fully capable of increasing income, therefore increasing in value.
===> #3 Your deal must have excellent cash and cash return.
Let me ask you this, what’s your 401K, your IRA getting these days? 2, 3, to 4%, right? If I can stretch it a bit, and say you’re getting 4 1/2 to 5% return on investment on your IRA that would mean it’s going to take 16 years for your investment to double. That’s a very long time and you could be way past retirement by then.
===> #4 The market must be a good one capable of sustaining your investment for years to come.
You must know all of the market demographics; the economic trends, the vacancy trends, population, and migration.
===> #5 You must have a razor sharp exit strategy that’s realistic and conservative
An exit strategy is a design that you have in place to return the investor’s money plus more.
Six Ways to Raise Capital for Your Commercial Deal
1. Raising Capital From Private Investors.
There are two reasons why you need to learn how to raise capital:
- You're eventually going to run out of your own money
- It’s the best way to leverage your limited resources to do larger deals.
When you are driving down the street and see a brand new commercial building being built, it is most likely not just one rich individual paying to finance the property. It’s most likely a group of people pooling their money together to finance the larger project. What you want to do is be the leader of that pool. You want to be the person that knows how to raise the money.
How Do You Structure a Deal With Private Investors?
If you have one or two investors whom you know very well, and they put in all the money, and have an active role in the investment, it can be as simple as using an LLC. Your attorney can establish the LLC and write up an operating agreement to spell out what your role is and what their role is. You will be the managing member of the LLC and they will just be members with a title. That’s as simple as it gets and it’s probably the most common structure out there when dealing with investors.
If you have two or more investors and they are passive; meaning they’re not active, then things change quite a bit. This is called, “Real Estate Syndication” and there is a lot more paperwork and disclosures involved. You will actually need an attorney with SEC experience to help you. SEC stands for the Security Exchange Commission which is the branch of government that monitors fraud and scams when dealing with raising capital and the financial market.
2. Raising Money Using Creative Financing
There are four different methods for raising money using creative financing. They are the master lease agreement, the seller carry first mortgage, seller carry second mortgage, and then finally, the hard money loan.
Check out these three other commercial training resourses on these other creative financing methods:
- A video on the master lease agreement
- A blog buying commercial real estate without banks using seller carry.
- A video on commercial hard money loans
So exactly how do investors like you use creative financing to help raise capital or at least structure a deal where the capital requirement is very small? (See example below)
Creative Financing Deal Example:
This is an actual deal from one of our students. It’s a three-story office building, but it’s 40% vacant, meaning it’s only 60% occupied. A typical bank will not lend on this type of property, because it’s considered a high risk. The property does not generate enough money to pay for the loan, due to its high vacancy levels. Now, even though a typical bank wouldn’t loan on this property, a hard money lender would. The seller was willing to sell for $1 million, but if the property goes from 60% occupied to 90% occupied, it would be worth $1.6 million.
There’s a $650,000 upside if we can buy the property, fix it up, and get it at least 90% occupied. A typical hard money lender will lend about 70% of those million dollars on the deal. In other words, they gave us a loan for $700,000, so the down payment would be $300,000. Here’s the problem, you don’t have the $300,000, and so what do you do? In this example, we negotiated with the seller for the seller to carry a second mortgage in the amount of $250,000. So my student’s down payment was only $50,000.
Now, some of you are wondering why the seller would be in second position for so much money. Why would he allow that? It’s because his property’s distressed and if he would just put it on the market and sell it as is, he’d most likely get half of the million dollars that he wants. We’re going to give him a million dollars, but he has to hold a second mortgage for us to get the deal done.
So my student got the deal financed and closed, and over the next year he was able to secure a 90% occupancy. The hard money loan was only good for one year so at this point my student went to a local lender and put a long-term loan on the property to pay off the hard money loan, and just let it cash flow.
The exit strategy is to get out of the hard money loan by putting long-term permanent financing on the property and cash flowing from there on out. That’s using creative financing to create a win-win-win situation for all. Win for you, win for the seller, because he gets a million dollars, and a win for the lender who gets their equity requirements taken care of.
3. Raising Money Using Self-Directed IRAs.
In this case you can use your own self-directed IRA or someone else’s to fund your down payment. You can partner with someone that has a self directed IRA and they can help you fund the deal. Did you know that there’s close to 8 trillion dollars sitting in IRA accounts today?
What did you earn last year in your IRA, or perhaps in your 401K account? Returns of 3, or 4, or 5% sound about right? Well, that’s not going to get you anywhere close to retiring at all. I personally work closely with syndicators and their goal is to double their investors' money in five years. That means a good 20% return over the next five consecutive years. It’s doable and it’s being done.
Common Ways to Invest in Real Estate Through a Self-Directed IRA
- Direct Purchase: Where the IRA buys the entire property outright using funds in the accounts.
- Partnerships: You can use partnerships and combine IRA funds with other people’s IRA funds in conjunction with your funds, even non-IRA funds to do a deal like this. With the right company and the right structure, you can fund all of your deals using self-directed IRAs. You just have to Google self-directed IRA real estate and a few companies will pop up
- Mortgaged Backed Purchase: Basically you would use an IRA as a down payment against a mortgage to buy the property.
- LLC, a limited liability corporation: In this case, the IRA holds an interest in the LLC, rather than title to the investment.
4 Important Things to Know When Using Self-Directed IRAs
===> #1 The property’s buyer is the IRA, not you.
===> #2 All of the expenses and income must go through the IRA.
Expenses must be paid directly by the IRA and any income must remain in the IRA.
===> #3 You cannot use the property for personal reasons.
The property must be treated as an investment, not for your immediate benefit or your family’s benefit. It’s for the IRA’s benefit only.
===> #4 All of your maintenance repairs on the property must be done by a third-party.
If the IRA owner provides any sweat equity like changing a light bulb in the property, there could be significant penalties.
4. Raising Money Using Crowdfunding
Crowdfunding is a method of raising capital through the collective efforts of friends, family, and individual investors. This approach taps into a larger pool of people in an online platform called a crowdfunding platform, and it leverages their networks for greater outreach and exposure. Let me put it in layman’s terms for you, you have an internet company that goes out and recruits rich people to put money into their company. Then the company goes out and recruits you, the person needing the down payment, to input your deals into the system to see if it will be approved to use those investor’s monies. It’s done 100% online.
Popular Crowdfunding Websites
Getting Your Crowdfunding Deal Approved
Go to a crowdfunding platform like Realty Mogul or Realty Share and submit an application. You’re going to put in your deal information and put in everything you need. Once the deal is approved and they go into an approval process where they’re going to need additional information about your background, a credit check, things like that. If that’s approved, they’re going to send your deal out to their platform’s investors to gain attention and to get money to be used for the project. Then once the money comes in, once the capital goal is reached, it can take 24 hours to a month to get the whole thing funded.
Now once you’re approved, the money’s dispersed right away. The drawback to this is you can spend a month trying to get your deal funded through crowdfunding, but if you only reach 90% of your goal, you get none of it after it expires.
Probably the most important thing I don’t want to leave out about getting approved for a crowdfunding down payment is you have to be experienced, you have to have a track record, and you have to bring some money to the table. If you’re brand new, if you’re a beginner, crowdfunding is not for you.
5. Raising Money Using Peer-to-Peer Lending
Peer-to-peer lending is peer-to-peer. The first peer is internet portal that rich investors put their money into for return on investment and then it goes out the portal to you, all right. The first peer in peer-to-peer is the investor, the second peer in peer-to-peer is you, and in between that is an online platform that makes sure the investor’s needs are met, along with qualifying you as a borrower. Have you heard of companies like Lending Club, or SoFi, or Prosper? Those are peer-to-peer lenders. It’s an online platform that gathers people to invest in each other.
We only use this for small deals requiring between $25,000 and $100,000. Now, we had a student that needed $60,000 to close a small commercial property deal. He had a good job, good credit, decent income, and he was able to borrow the entire down payment at 7% for five years through peer to peer lending. With peer-to-peer lending is that the better your income and credit is, the lower the interest rate is.
You are also going to have to factor that loan into your overall returns. If you look at a simple analysis of commercial property, we have income minus expenses minus the mortgage equals cash flow, right? If you use peer-to-peer lending, you have your income minus expenses minus your mortgage minus your peer-to-peer loan equals your cash flow. In other words, make sure your peer-to-peer, whatever you borrow using peer-to-peer lending, that your deal can afford it.
6. Raising Money Using Wholesaling
A lot of our students don’t have a lot of money to invest in commercial real estate, just a great desire, and that’s okay. What we instruct them to do, and we have a whole program for this, is to show them how to wholesale their deal to buyers to create capital for themselves. If they do this multiple times, they can stack up and raise their capital so they have enough money to do their own deals. Basically, what they do is find a deal, get the deal under contract, and then flip it to a buyer for a fee. You can do this several times and the goal there is to build up your own down payment. It’s very doable, so if you don’t have a whole lot of money, you can wholesale your deal to raise your down payment.
My First Experience Raising Money For Commercial Deals
I had run out of money and I was in kind of a mastermind buddy group and nearly all of us had exhausted our personal money. We were forced to go out and raise the money. I found an investor who was actually a coworker of mine. I found a small deal and actually, if you’re raising money for the first time, I recommend making it a small deal. Small deal equals small mistakes, and small deal equals small amount of money to raise, which this was the case. It was an 11-unit apartment rehab project. It was very light rehab; I’m talking just paint and get rid of a few bad tenants. As your first deal, you do not want to do extensive rehab, or do a whole bunch of evictions; You just want to keep it nice and simple.
After I negotiated and got the property under contract we flew down to the property together. I wanted him and I to both be convinced that the deal was very doable. My investor put up the entire $66,000 down payment, so you can see it wasn’t a whole lot of money. We also both applied for the loan, so we were both on the loan, which means both of us would have skin in the game. I wanted him to know that even though he’s putting money into the deal, I’m committed too, because my credit and my other properties are at risk if this loan fails. We were personally guaranteeing this loan. My attorney drafted up the LLC and we closed on our project. I did all of the asset management. For example, I oversaw the manager, I made sure the bills were paid, I took care of the taxes at the end of the year, any small accounting, –I did all that. Guess what? I also collected an asset management fee for overseeing all that every month.
After about 18 months we sold the property and we split the profits 75/25. 75 to him, 25% to me. You’re probably wondering, “Why did I give him so much?” Well, here are two reasons:
Number one, I wanted to get a track record and experience of raising capital, right? I needed that so that I can continue to do more. I can go out there after this deal and show people, “Hey, I already raised money and the project was successful. Now, please invest with me,” right?
Number two, I wanted my investor to reinvest with me, so that was my goal of why giving away profit with the 75/25 split. You will find out that in this industry that’s more a norm than not, a 75/25 split. As you get into syndication and learn more about it, you’ll see that that split is quite normal.
I hope this helps all of your investors obstain or figure out a way to use creative financing for funding your commerical investments deals.