How to raise funds from family and friends to invest in real estate
Investing in real estate is a great way to grow your wealth. The property tends to increase in value over time and has the potential to show great returns from future rental income and resale profits.
To start investing in real estate, you’ll need capital – and a lot of it. Obtaining financing is one of the most important steps in any real estate project. While most home buyers use traditional home loans to purchase a property, they have other financing options that residential and commercial real estate investors can explore.
Low interest FHA loans, which private lenders issue and then backed by the Federal Housing Authority, work very well for projects like home hacking. Veterans, active duty members and their surviving spouses can qualify for VA loans, which have competitive rates and terms.
If you already own a property, you may qualify for a HELOC or a home equity loan (or a “second mortgage”), which borrows against the equity in your home. And for fix-and-flips and the BRRRR method renovations, many investors are opting for hard money loans, using the property itself as collateral instead of credit.
Today, however, we’re going to focus on a more personal type of borrowing. Maybe you’ve tried the avenues above and received refusals, or maybe you just don’t like the risk associated with certain types of lenders.
While this is certainly a more socially risky proposition, this article will provide some tips on how to ask your family and friends to help you finance your real estate project. Involving money in any relationship can complicate matters and you should only pursue this opportunity if you operate with caution, verify your investments, be transparent, and carefully prepare your investment thesis.
Do your research
Before asking anyone for money, take the time to develop your ideas. Find the area in which you want to buy property and ask yourself questions such as:
• ● What is the asking price compared to the selling price of other properties in the area?
• ● What is the average monthly rental or seasonal rental income for similar properties in the area?
• ● Has the population increased in recent years? If yes, why?
• ● Has the local government made any major investments in the area recently? (for example, to infrastructure)
• ● What is the crime rate and quality of the school district like?
● • ● What types of businesses, retailers and entertainment centers are there already in the neighborhood? Are there any gaps your idea could fill?
You can find the answers to these questions and more by simply doing a little research on Google, driving around the area, taking a virtual walk with Google Maps Street View, checking public records, or asking a local real estate agent.
Prepare an investment plan
Once you’ve done your research and analysis with useful apps and software, make an investment plan for yourself. That way, when you start approaching your network, you can answer their questions and show you have a good idea.
Because you plan to apply for a loan from someone close to you, you don’t necessarily need to make an official appearance when pitching your idea. You can present your investment plan in writing, but you can also present it verbally to friends and family.
However, showing that you have taken the steps to validate this idea could serve as a powerful indicator of your seriousness in the project and the degree of due diligence that you have succeeded in carrying out.
It never hurts to go the extra mile and make a formal pitch with written investment research and supporting evidence for the claims you plan to make to friends and family.
Rehearse your presentation
While you don’t want to sound too contrived when introducing your friends and family, it’s still a good idea to rehearse your business idea out loud. This exercise can help you gain confidence and clear your nerves before approaching potential lenders.
It means practicing how you phrase certain pros and cons, often playing on the pros and minimizing concerns about the cons. But you don’t want to lie.
If there is anything that can really sink an investment, you have to honestly ask yourself if that investment is worth it. Don’t rush into investing with your loved ones’ money just to go bankrupt and create tension with those who love and support you. No risky real estate investment is worth anything next to this bet.
Define the potential return on investment
In addition to determining the income generated by these assets and the potential resale value, you should be aware of other costs that you, your friends, and your family should be aware of.
Show that you have thought through all the details and that you have taken into account the elements that could reduce your return on investment. For example, you might consider purchasing a home warranty 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 seller’s net record to compare the estimated selling price with the selling costs. These include costs such as renovation costs, loan repayment, property taxes, real estate commission, etc.
Also consider that you will need to pay capital gains taxes once you sell the property, unless you complete a 1031 swap transaction and reinvest the proceeds of the sale in a property. Similar of equal or greater value.
Discuss financing options
Once someone has signed up and is willing to provide you with funding, make sure you understand the terms and conditions of that funding. You have several different routes to take:
If a family member or friend “offers” you money, it means you don’t have to pay it back. You can also avoid paying taxes on the money offered. Currently, an individual can donate up to $ 15,000 tax-free per year, but they can also benefit from the tax exemption on lifetime donations valued at $ 11. , $ 58 million.
When you donate more than $ 15,000 to one person in a single year, you decrease both your lifetime gift tax exemption ($ 11.58 million) and the tax exemption. federal law on estates you receive on your death. It might not matter to most Americans because their domains won’t fall within that range.
Even if you land well below your lifetime donation tax exemption, you still have to report any donation in excess of the annual exclusion of $ 15,000. The IRS will want to keep track to make sure that you haven’t given away your wealth over time and that you haven’t paid the estate taxes.
Finally, a letter or signed document stating that the money was donated could come in handy down the line if your project is successful and the lender suddenly wants a share of the profits.
Loans allow the lender to set repayment terms, interest rates, etc. who will act as an intermediary.
Providing someone with equity means that you don’t have to pay off their loan until you make a profit. However, this will also make your friend or relative a business partner with partial ownership of your business, so be sure to consult a lawyer.
Establish a repayment schedule
Show the people you’re borrowing from that you’ve thought about how you’re going to pay them back. Will it be monthly? Annual? Once the property is sold? How much will you owe them for each payment? Will they charge you interest? Think about these things in advance.
Pro Tip: Before applying for personal loans from loved ones, it’s a good idea to make sure that your other debts like credit cards and student loans are paid off, or at least most of it paid off.
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 in casual conversations. Keeping your network up to date with your plans can make them feel invested in your goals and can also attract new investors.
Finding financing for your real estate project can be tricky. Asking friends and family for money can potentially strain relationships or cause them to end entirely if you don’t meet their repayment terms.
You can avoid this by being upfront about the risks, managing the project prudently, keeping people informed with regular updates, and providing 100% transparency. It means including both the good news and the bad news. Relatives are likely to be more forgiving of the ups and downs of your business plans.
Ultimately, putting the rules of the loan agreement in writing can set clear expectations early on and avoid drama down the line.
Riley Adams is a CPA and author of Young and committed website, which emphasizes financial independence and investing.