How can I raise private money for my real estate investments?
Conventional loans, hard money, seller financing — sometimes none of them are a good fit to your deal. So, you create your own real estate financing. The savviest dealmakers raise money from friends and investors to create their own fund of available capital. Because the capital is set aside exclusively for you, most people call it private money. It’s a powerful form of leverage, and this post is going to give you the basics for raising it.
For information on the advantages and disadvantages of private money, see:
What kind of financing works best for different types of real
estate investments?
Step 1: Prepare the Proper Legal Framework
When you’re dealing with other people’s money, you need to make sure setup correctly. A misstep can land you in court and possibly in jail. Start by registering an LLC in your state and drafting an operating agreement for governing your activities. The LLC will allow you to sell ownership to other members and organize them into a legal entity. Once you’ve put your group together, a detailed operating agreement will serve as a guideline for what you can and cannot do with the private money. It’s a point of agreement between you and your investors about how the fund will operate.
Most investors stop here, but to stay completely legal, you also need to mind Securities Law. When one or more people buy into your LLC, you are selling what the government calls "securities" and they have a huge document called the Securities Act that you should follow. You can decide to ignore it, but if you end up in court with your investors, their attorneys can eat you alive for not completing the correct paperwork. The Securities and Exchange Commission (SEC) will also start paying attention to your activities once you pass a few million dollars in private equity. Ignore their laws at your own risk.
It sounds scary, but if you follow the rules from the beginning, it’s not that bad. Generally, your fund will fall under "Regulation D," which gives exemptions to small operations like yours. Consult an attorney on the specifics, but to qualify for the exemption, you should:
- Try to Partner only with Accredited Investors — people with gross annual incomes over $200,000 or a net worth exceeding $1 million
- Keep your offering private, never blatantly advertising to the public
- Raise no more than $5 million
- Require your investors to sign a Subscription Agreement, detailing their purchase of securities
Step 2: Raise the Money from Private Investors
Once the framework is in place, the real fun begins. Accredited Investors are one of the most sought after groups in the country — everyone wants their money. Your job is to convince them to choose you. It’s difficult, but don’t get intimidated yet. You have several important advantages over most of the people that approach them:
- Security: You can secure their money on valuable real estate with a first mortgage. If you screw up, they don’t necessarily lose money; they can foreclose on your property.
- Return on Investment: Most companies offer accredited investors less than 10% per year. If you know what you’re doing, you can offer at least 15% per year.
- Service: Unless they have millions of dollars, accredited investors are typically ignored by large financial institutions. You can offer a personal touch that will make them feel valued.
Accredited Investors are also easy to find. According to Merrill Lynch, we have over 8.3 million in the United States alone. The best way to get in contact with them is to explore your own network. Call the wealthiest people you know and ask them to introduce you to their friends. If you have a respectable image and approach, you should find them eager to look at your opportunities and invest with you. I have several friends that have raised several hundred thousand dollars cash in only a few months.
The key to convincing them to invest is preparation. Create a short proposal (no more than 10 pages) that describes your track record, the structure of your LLC, and the opportunities you have available. Make sure you explain how you’ll safeguard their money and the returns they can expect. Stay honest, never inflating your figures or hiding any information. Avoid pressuring them for commitment, but politely follow-up every few days until they give you a definite answer. You’ll be surprised how much private money you can raise for your own real estate investments.