Investing in real estate is a great way to get around Grow your wealth. Real estate tends to increase in value over time and has the potential to generate high returns through rental income and future resale profits.
To invest in real estate, you need capital – and lots of it. Securing financing is one of the biggest milestones in a real estate project. Although most home buyers use traditional home loans to purchase real estate, they have other financing options that residential and commercial property investors can consider.
Low-interest FHA loans, given by private lenders and then backed by the Federal Housing Agency, are great for projects like home hacking. Veterans, active duty members, and their surviving spouses can qualify for VA loans that have competitive rates and terms.
If you already own property, you can qualify for a HELOC or home loan (or “second mortgage”) that will borrow against your current home loan. And for Fix-and-flips and BRRRR method renovationsMany investors choose hard cash loans and use the property itself as collateral instead of loans.
Today, however, we’re going to focus on a more personal way of borrowing. Perhaps you’ve tried the routes above and you’ve received rejections, or you just don’t like the risk associated with certain types of lenders.
This article is certainly a socially riskier proposition. However, it does provide tips on how to ask your family and friends to fund your real estate project. Including money in a relationship can complicate matters. You should only take advantage of this opportunity if you act carefully, review your investments, create transparency and thoroughly prepare your investment thesis.
Do some research
Before you ask someone for money, it is a good idea to spend some time fleshing out your ideas. Research the area where you are looking to buy a property and ask yourself questions such as:
• ● How high is the asking price compared to the selling price of other properties in the neighborhood?
• ● What is the average monthly rental income or vacation rental income for similar properties in the region?
• ● Has the population increased in recent years? If yes why?
• Has the local government made major investments in the region recently? (e.g. about the infrastructure)
• What is the crime rate and the quality of the school district?
● • ● What types of businesses, retailers, and entertainment centers are already in the neighborhood? Are there any gaps your idea could fill?
You can find the answers to these questions and more by simply Googling, driving around, virtually “walking around” with Street View from Google Maps, checking public records, or asking a local real estate agent.
Prepare an investment plan
When you’ve done your research and analysis using useful apps and software, create an investment plan for yourself. That way, as you approach your network, you can answer their questions and show that you have a fully baked idea.
Since you are planning to apply for a loan from someone close to you, you don’t necessarily need to make a formal appearance when presenting your idea. You can put your investment plan out in writing, but you can also present your plan orally to your friends and family.
However, showing that you did the groundwork to validate this idea can be a good indicator of how serious you are on the project and how much due diligence you did.
It never hurts to go the extra mile and prepare a formal pitch with written investment research and supporting evidence for the claims you want to make to your friends and family.
Rehearse your pitch
While you don’t want to turn out to be too sophisticated when pitching your friends and family, it is still a good idea to repeat your business idea out loud. This exercise can help you build confidence and shake off your nerves before reaching out to potential lenders.
That means practicing how to express certain pros and cons, often by playing off the pros and cons and minimizing concerns about the cons. But you don’t want to lie.
If something can really sink an investment, you have to honestly ask yourself whether that investment is worth the risk. Don’t rush into investing with loved ones’ money just to go broke and cause tension with those you love and support. No risky property investment is worth anything near this gamble.
Determine the potential for ROI
In addition to determining the income from these assets and their potential resale value, you, your friends, and family will incur other costs.
Show that you thought through all the details and considered things that could decrease your return on investment. For example, you might consider purchasing a home guarantee in case something goes wrong with the property and you don’t want to risk paying for every repair yourself.
You can determine how much it will ultimately cost to sell the property by using a net sheet from the seller to compare the estimated selling price to the selling cost. This includes costs such as renovation fees, loan repayment, property taxes, real estate commission, etc.
Also take into account that unless you do, you will have to pay capital gains taxes after the property is sold 1031 exchange transaction and reinvest the sales proceeds in a similar property of equal or greater value.
Discuss the financing options
When you’ve signed someone up and are ready to provide funding for you, make sure you understand the terms and conditions associated with that funding. You have different options:
When a family member or friend “gives” you money, it means you don’t have to repay it. You can also avoid paying taxes on gifted money. Currently, an individual can give up to $ 15,000 tax-free annually, but they can also take advantage of the lifetime tax exemption on gifts worth $ 11.58 million.
Giving someone a gift of $ 15,000 in a single year reduces both your lifelong gift tax exemption ($ 11.58 million) and estate tax exemption after your death. This may not matter to most Americans as their lands will not fall anywhere near this area.
Even if you land well below your lifetime tax exemption, you’ll need to report every gift through the $ 15,000 annual exclusion. The IRS will want to keep track of them to make sure you haven’t given away your assets over time and skipped paying estate taxes.
Finally, a letter or signed document stating that the money was given can be helpful later if your project is successful and the lender suddenly wants some of the profit.
Loans allow the lender to set repayment terms, interest rates, etc. You can work with an attorney to create a “promissory note” that details the terms of the loan, or you can structure the loan through a peer-to-peer lending company that will act as an intermediary.
When you offer someone equity, you don’t have to pay back their loan until you make a profit. However, this also turns your friend or relative into a business partner who partially owns your business. So be sure to contact a lawyer.
Establish a repayment schedule
Show the people you borrow from that you have thought about how you are going to repay them. Will it be monthly? Yearly? As soon as the property is sold? How much do you owe them for each installment? Are they going to charge you interest? Think about these things in good time.
Pro Tip: Before asking for personal loans from loved ones, make sure that your other debts, such as credit cards and student loans, are being paid off, or at least substantially repaid.
Keep your network up to date
Let your friends and family know where you are on your investment journey. You can do this through social media, with an email newsletter, or during casual conversations. Keeping your network informed of your plans makes them feel invested in your goals and can attract new investors too.
Finding funding for your real estate project can be difficult. Asking for money from friends and family could potentially strain relationships or cause them to end altogether if you fail to meet the repayment terms.
You can avoid this by knowing the risks in advance, managing the project carefully, keeping staff regularly informed of updates, and providing 100% transparency. That means including both good and bad news. Loved ones are also likely to be forgiving of ups and downs in your business plans.
Ultimately, setting out the rules of the loan agreement in writing can set clear expectations early on and avoid any drama down the line.
Riley Adams is the CPA and author of the Young and the invested Website that focuses on financial independence and investing.