Tips on Raising Private Money for Big Projects
By Adam Davis
It’s one thing to talk about getting private money for single family house flips…raising $50k, $100k…up to the $250k range.
But it’s quite another to raise capital for bigger deals, like apartment buildings or commercial real estate.
The reason I focus much attention on raising money for house flips is because this is where I get most of my questions from readers and it’s also where the majority of my own business in real estate comes from.
However, over the past 2.5 years I have increasingly pursued commercial real estate opportunities and it now represents about 45% of my total real estate portfolio.
Since there are quite a few real estate investors who also bridge the residential/commercial gap I want to go over some tips on getting money for bigger projects. For all intents and purposes, “bigger projects” mean over $1,000,000. Could be multi-family, office, strip mall, medical, etc.
The first thing you really have to think about when raising private money for commercial deals is……the minimum amount of private money you need. A big mistake I made with one of my first projects was not raising enough money in the beginning, then having to go back to the investors for additional funds to cover working capital short fall.
Think this is a no-brainer? Think again.
You see, just about every number you get from a seller of commercial real estate must be taken at face value as a complete lie. Yes, you read correctly. If I get a rent roll from a seller of an apartment building, I assume it’s a lie. When I get into diligence after PA has been signed, I look to the bank statements to cross-reference deposits, etc. But still, there’s a large amount of leeway in between numbers presented by seller and what is actually going on.
You’d be amazed at how may ways there are to manipulate financial numbers (remember those Enron guys?).
So, what happened on my deal was, based on diligence, I thought we needed $350k for a purchase. Turns out we needed $400k. Had to go back to the private investors to pony up more dough. This was not fun. Made me look amateurish. Better to always raise more than you need and give some back at the 6 month mark (even if you have to pay extra for it in terms of cost of capital) then to be forced to get additional funds.
This brings me to my next tip for raising big money, which is to carefully select the private investor prospects you will market and present your deal to.
In residential real estate, if you are getting $100k in private money, you can easily give a mortgage (or trust deed) to provide collateral for the loan. But in with a commercial deal, if you are getting any type of institutional financial for part of the purchase price (like a bank loan), then the bank will be in first position and they will often require you to not have any other debt on the property (which could impede cash flow).
Yes, this means you’ll have to raise equity capital for the portion of the purchase price (and purchase costs/fees/working capital/reserves).
What is equity capital?
It’s where you give an ownership interest to your private investors instead of a promissory note.
Your private investors will share in the profits and capital gains on the deal instead of receiving a fixed interest payment.
Personally, this is my preferred way to finance most projects, as the capital is more flexible and I can do more things with it. It’s also easy to present this concept to accredited investors, who are usually familiar with the terms of how such deals operate.
Your private investor prospects for bigger deals should be accredited (read: relatively wealthy) investors who have a time horizon for a minimum of 3 years. They can lock up their funds without needing them for 3 years or longer. This is critically important because redemptions of private money can be a killer. You don’t need people calling you in 6 months wanting their investment money back to go on vacation.
Another important tip is to make sure your deal has sex appeal. If it doesn’t, create some.
There is a certain segment of private investors who are attracted to the ‘bond-like’ investment of steady returns provided by a promissory note. Then, there is another contingent of investors who will be bored with this and your message will bounce off. When you raise bigger money, you must make your deal exciting. You must show how the investors stand to make bigger money than normal. You must show how your project has a true unique selling proposition.
One thing that has been a total flop for me is: raising private money from accredited investors to acquire stabilized, performing apartment projects in good areas. Since the project is stable, the rents are almost maxed out, the seller is not desperate, the area is not really on the upswing. If the purchase play is to simply buy performing cash flows, the private investors wont stand to make much money when they are riding along with you. Plus, there is not much sex appeal with this type of deal…outside of a large building structure bringing pride and a little bit of an ego trip.
And there’s another one…big money investors-at least many of them-really dig the ego trip of investing in real estate. There’s a little bit of “look what I got” factor at play. This is why I encourage regular communication with your lists of prospective and current investors, where you show pictures of the projects you are working on and (hopefully) pictures of other investors with YOU at these projects.
It makes everything more real and tangible.
Quite a few of my current private money lenders still call me and tell me they “just drove by that house we did last year…that was so nice!”
The pride of ownership factor is a big deal.
When you go after projects that are just a simple purchase, buy and hold, then it’s harder to sell the “upside” of the investment. And savvy investors – those with money – know there must be a value-add in order to maximize returns. You must be prepared to answer this question. If you don’t have a strong value-add, re-think the project.
Principally, raising money for bigger projects is all about these basic things:
1. Credibility (of you)
2. Believability (of project and plan)
3. Execution
4. Timing
If you line these up properly, you won’t have any problems raising capital for your deals. Keep in mind, raising private money is an ongoing process and must be part of your business.
Real estate investors who treat funding as a “part of the time” sort of thing will get “part of the time” sort of results.
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