Making Money by Spreading the Wealth

“Money is like manure; it’s not worth a thing unless it’s spread around encouraging young things to grow.” – Thornton Wilder

I just wrote a check to a doctor friend of mine for $54,073. Thankfully, it wasn’t for a medical procedure. I was returning his $30,000 investment and distributing a $24,073 profit to him – in just over a year.

My oldest sister has worked most of her life in theater, and her primary interests have been family, friends, the arts, and her animals. She is not particularly educated about – or interested in – investments. Yet she realizes she now has to make progress on building up a nest egg.

Last month, I was able to write her two checks totaling about $37,000 – almost doubling her investment in about 14 months’ time.

My mother-in-law has turned $50,000 into over $105,000 with me in three years. A friend turned $28,500 into $60,000. I soon expect to write $98,000 in checks to three business associates. A brother has made roughly $117,500 on a single property with me.

And the list goes on…

As a real estate investor, the more investors you have willing to help fund your investments, the more quickly you can act on those rare deals that truly represent exceptional value. And that means more money for you and your investors. And it’s not hard to build and gradually expand your own reliable group of friends, family, and associates who invest in your deals – as equity investors or private lenders – once you learn a few fundamental principles for putting together a successful partnership.

You have to put together a clear, accurate, and compelling presentation. You must make sure the partnership is structured so that your investors’ interests and yours are 100 percent aligned. And you have to make sure that all transactions are transparent and that you have regular reporting to your investors.

Learn to do these few things, and you’ll be ready for a much higher level of investing.

Give Money, Get Money

Whether it’s a payout to an equity investor or a high-yield quarterly payment to a private lender, I love to write each one of these checks. It’s like financial karma.

The money goes out to investors in the form of very good returns on their investment … then it comes right back to me, as new capital for new investments. And since their investments with me have grown their wealth, the amount these investors are willing and able to invest grows at the same time.

These friends, family members, and associates have made returns far greater than they would have in the stock market, and with far less volatility. Yet, for all intents and purposes, with just as passive an investment. That’s important to bring out in your own investment offerings.

My investors write a check to become a limited partner in one of my real estate partnerships. They receive documentation securing their investment – then they ultimately get a bigger check back. That’s the extent of their “work.”

They do NOT have to…

• Identify the best property markets to invest in…
• Search for the best deals in that market…
• Negotiate and conduct due diligence once a good deal is found…
• Sign the purchase contract…
• Seek the best mortgage, sign for it, or have any liability at all for it…
• Handle marketing, leasing, and renewals…
• Handle property management or have any general liability for the property…
• Oversee rehabs, additions, or any other strategy to increase the value of the property…
• Take care of the distribution of dividends to the partners…
• See to the bookkeeping and regular reporting…
• Handle the cash-out refinancing for a rapid return of investors’ capital…
• Handle the final sale and distribution of capital and profits to investors…

As the general manager, all these things are handled by my office. The limited partners have no more management responsibility or liability than they would have from owning shares in a public company.

Give Your Debt Investors a High Yield and a High Level of Professionalism

In case you’re not familiar with the terms, you’ll basically deal with two types of investors in your real estate partnerships: private lenders and equity investors.

For private lenders, it’s pretty straightforward. They lend you money for the purchase, rehab, or development of a property. You give them a mortgage (a recorded lien against the property) and other important docs (such as beneficiary status on title and property insurance policies). You then pay according to the agreed-upon schedule.

I currently offer my private lenders rates of 9 percent to 11 percent, secured by cash-flow-producing real estate that typically has equity 30 percent or greater than the loan. I also provide my lenders with an amortization and payment schedule and a statement with each payment, so they know exactly what they’re getting and when. Finally, I pay them compound interest, not just simple interest.

They get, in effect, the professional treatment and reporting they would get if they bought a CD at a major financial institution. But they’re getting collateralized returns of two to three times the amount they’d get with a CD.

For Equity Investors in Partnerships, Try to Under-Promise and Over-Deliver

Passive equity investors in real estate partnerships take more risk than private lenders. Because they’re limited partners, they have no personal liability (their risk is strictly limited to the amount of their investment) – yet, they get paid after lenders do.

If, for instance, a property had to be liquidated, the private lenders would have to be paid in full before equity investors would get a single dollar of their capital back. Equity investors accept that position because they can make much higher returns.

The investors I’ve mentioned, for instance, have made annual returns of 25 percent, 50 percent, and more on investments with me. Yet, even though they’ve done very well, I never project these kinds of results in my offerings to them. I prefer to under-promise and over-deliver.

My friend the doctor, for instance, just made 80 percent in just over a year. Yet in my original offering, I listed prospective returns of 10 percent to 30 percent a year.

Those were not random projections. They were based on comparable values and the discount at which we were buying the property, on the income the property would produce once we rehabbed and repositioned it, and on a range of projections of appreciation for the overall local market. (This was a value market with solid cash-flow fundamentals, and it was a market that was experiencing growing demand – not a bubble market heading for a peak.)

In my projections today, in fact, my typical projections for market appreciation in value markets range from 0 percent to 5 percent a year over three to five years. I don’t look out only one or two years, and I don’t project the heated appreciations of the recent past into the near future. This more conservative approach tends to result in projected returns for my passive equity investors of 10 percent to 30 percent a year, with the most likely outcome expected to be somewhere in the middle – in the high teens to low 20 percent range.

And since we look to buy value-added plays, we can make investors good returns even should markets turn flat. Purchase a property, reposition it and increase its income by 40 percent, and you can increase its market value by about 40 percent. And since you’re using leverage to buy it, the returns for your passive investors can be even greater.

Let me not digress into strategy. The point is, when you make your investment offering, show the key numbers: purchase price, current market value, the discount you’re getting, the after-repair value, and future values (based on various modest market scenarios). Then lay out a strategy for creating additional value in the property. And make your projections for investment returns realistic, not pie-in-the-sky promises.

Then, execute your plan. And when the day comes to pay your investors, chances are good that you’ll surprise them on the upside.

Good Partnerships Are Formed When Interests Are Fully Aligned

A final point for good partnerships; Structure your deals so your interests as the general manager and the interests of your equity investors are 100 percent aligned.

For instance…

• I invest my own capital in every deal I offer to investors. If it’s good enough for their money, it’s good enough for mine.
• Investors’ capital comes out first. I don’t get a dollar’s worth of dividends, capital gains, or refinancing proceeds until my investors do.
• If I’m going to a financial institution for financing and the mortgage requires “recourse” (i.e., a personal guarantee), that comes only from me. That means I will pledge my net assets if necessary to secure the best loan for the partnership. (So I never just do a deal because investors are throwing money at me.)
• I provide regular reporting, with P&L, balance sheet, and general ledger – as well as a plain-English review of what’s going on with the property, including photos.

I didn’t always handle things this formally, of course. Initially, friends and family put money with me because they saw the success I was having and they knew I don’t take speculative risks. (I only buy under-market-value, cash-flow properties.) But, as more investors became interested in my deals, it simplified my life and theirs to formalize the initial offer and subsequent reporting process.

[Ed. Note: Justin Ford is the editor of Main Street Millionaire, a deep-value real estate investment home-study program. This November 16-18, he will be hosting the Real Estate Wealth Builders Summit at the 5-star Doral Golf Resort and Spa in Coral Gables, FL. Justin will be joined by private-money expert Alan Cowgill, commercial-property expert Toby Unwin, short-sale “queen” Dwan-Bent Twyford, and six other nationally known real estate investment experts.]