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Hi July,
I’ve been doing a little bit of investing, but now I’ve hit a road block: I’ve maxed-out on being able to buy property all by myself and now I’d like to know, how can I buy real estate using other people’s money?
Thanks In Advance July!
Teresa H.
Thanks for asking, this is the #1 question posed by most real estate investors. The first thing to be aware of is that TRUST = MONEY. People will only give money to people they trust. You build trust by creating long term RELATIONSHIPS. It is through the sincerity and authenticity of your connections, that attract investors that align with your values and philosophy. In today’s world, you need a system to be high touch and top of mind so that your network connects to you on a regular basis. You accomplish this through a monthly newsletter. Staying connected is so important to your real estate business and yet most real estate investors simply don’t do it. This is the first thing I reach potential real estate investors. It’s not finding the deal or analyzing the deal. It’s how to connect and stay connected. Because you will find real estate deals all day long. Attracting the money takes time. Your newsletter should be education-based and give your readers value. This is what keeps them coming back for more. You can find out more about how to create your newsletter at http://www.YourMillionDollarNetworkBook.com.
Credibility is in the eye of the beholder. You may know you are credible but how does your potential investor know you are. You have to show them. You show up every month with your newsletter. You show up at seminars, workshops, meetings (early). You have your real estate play book with you to share as needed. What is a play book? It is as simple as a wire-bound note book. Put a number at the top of the page, such as #1. Clip out the newspaper ad or print off the MLS listing and glue, tape, staple it onto page #1, of the property that you decide to pursue. Beneath the ad or on the next page, write down all the particulars for this property such as listing price, location, amenities, square footage, contact information, break down of rental income, break down of expenses. This is your summary page where you compile your initial research notes. Log your phone calls (date, time, who, what) so you can keep track of the deal’s progress. If you can’t get it to the 1% Solution, then move on to deal #2 and so on.
I use the 1% Solution to help me quickly evaluate if a property will cash flow based on the list price as it relates to the rental income. If you are looking at a property listed for $300,000 then multiply that by 1%, and you get $3,000 per month of rental income that you need to adequately cash flow this property. If this property is a house with the upstairs renting for $1,800 and the downstairs renting for $1,000, that’s $2,800 per month and worth pursuing. If the rent is $1,500 per month then you can see right away there’s going to be a problem with cash flow. This is a rule-of-thumb that I use to quickly analyze properties. It saves me time because my criteria is to look only for properties that cash flow. The 1% Solution is not for everyone.
You can also use this in reverse, or the Reverse 1% Solution. You know the gross rental income of a property is $3,000 per month. Divide this by 1%, you get $300,000 or your buy price. I know this is not very scientific. It’s a rule-of-thumb to weed out the properties that don’t match my criteria. When I do find something that qualifies, I take it to the next level and enter the information into the Cash Flow Analyzer. You can get the software at http://www.onthebeacheducation.com/2008/12/05/cash-flow-analyzer/ or go to my website at http://www.OnTheBeachEducation.com, go to Resources and scroll down.
Dolf de Roos, a very successful New Zealand real estate investor, says to analyze 100 deals before you find 3 that you may put an offer on. That’s why you number the deals. It’s to keep going until you hit #100. I found my deal-of-the-decade at #68, a 4-plex in Fort St. John that produced $3,000 gross rental income per month, after expenses, mortgage and taxes, it produced $2,000 per month positive net cash flow. That was a few years back in the early 2000′s but this one deal produced $34,000 equity gain on completion.
Next, you need to learn how to explain the 7 Profit Centers In Real Estate to everyone. You need to be passionate about real estate, so much so that you can’t help but teach it. You are compelled to share – to people who want to hear your message of course. You also need to learn how to filter people who aren’t interested. The ones who are interested will keep asking for more. There are several videos at http://www.OnTheBeachEducation.com under the Media tab where I am teaching the 7 Profit Centers, and another video where I am giving this seminar to a room full of financial advisors/planners. Model what I am doing until you become familiar with the numbers.
To recap: (a) start your monthly newsletter, (b) start your play book, (c) learn to teach the 7 Profit Centers in Real Estate.
When you find the deal that you want to acquire, make sure your Offer To Purchase has at least these two subject clauses: (1) subject to financing that is satisfactory to the buyer and (2) subject to inspections that are satisfactory to the buyer. You can include other subjects such as subject to review of operating statements, rent roll, utility statements, etc. Give yourself a minimum of 3 months to close the deal if it’s qualifies for residential mortgage. It takes on average between 6 months to 8 months to close on an apartment building using commercial financing.
Once you have the accepted offer in place, that’s when you start doing your due diligence on the building and getting your investors in place. Remember, you have the subject to financing clause in place to protect you.
Hold meetings with family, friends and business associates. Explain that you are looking for investors in your upcoming deal and use the 7 Profit Center model to break down the return on investment for each profit center.
Going back to my 4-plex purchase, the 1st Profit Center is Buy Equity Day One. We acquired the 4-plex with $34,000 equity on Day One. Divide this by 2 and you have $17,000 per person. The investor put up $48,000 using line of credit. I put no money in the deal. Calculate $17,000 divided by $48,000 = 35.42% return on the equity portion. The investor wasn’t even using the line of credit and the interest rate was somewhere between 4% to 6% at the time. The investor gets to write off the interest payments as the cost of doing business, and is making money with the bank’s money. This is the game of making money from nothing.
By the time you get down to Profit Center #7, Reinvesting Equity, your education session will have a room full of hands going up, wanting to invest with you. Remember – you are not selling, you are educating people on the value of real estate.
Your exit strategy should be well thought out. My original plan was hold the property for 5 years or 25% appreciation, whichever came first, would generate a conversation on these options: (1) sell the property, (2) have the property re-appraised and take the equity out and pay out the investor, (3) have the property re-appraised and take the equity out and invest in another property, (4) leave as is and continue holding.
Ah, but before I conclude my comment, I make extra sure that my investors are aligned with my values. You may have heard horror stories of partnership clashes. That’s a values misalignment in action.
Make sure you have a written joint venture agreement. I use a simple subscription agreement form along with a Risk Acknowledgement Form when collecting the deposit and all stakeholders sign the agreement and collect the balance of funds.
I hope this helps.
July Ono
Wow! Thanks so much July, I really do appreciate you sharing your knowledge with me (and the world!) I think that is truly awesome. Could you please let me know how you did your first joint venture deal? How did you structure it? Thank you again for being so helpful!
I sourced a 4-plex for a closing price of $186,000. I then sourced an investor who put up $48,000. We agreed to a 50/50 split of the cash flow and the equity value above the purchase price. The investor’s original investment of $48,000 belongs to the investor. This money included the down payment, closing costs and contingency reserve fund (emergency money for unexpected expenses). The property generated $3,000 per month rental income, after expenses, management fees, taxes and mortgage payment, this left just under $2,000 per month positive net cash flow. I left the cash in the bank for the first half year to top up the emergency fund. After that you can pay out a cash distribution either every month, every 2 months, every 3 months, or whatever you decide. Our written agreement stipulated that if the property appreciated 25% or 5 years (which was refinance time), this would initiate a conversation on whether to (1) keep the property and continue as is, (2) refinance the property and reinvest the money in another rental property, (3) refinance the property and distribute to both investors or the equity partner, (4) sell the property. Two years later, I received an unsolicited offer to purchase the building for $344,000. We agreed to sell. Paid off the mortgage, paid off the investor’s $48,000, paid the selling costs, and the remaining capital gains was split 50/50. I hope this answers your question.
There are many ways to structure a joint venture deal. If you’re just starting out and need experience, taking a 10% share and giving 90% to your investor is an attractive offer. It’ll give you much needed experience in managing a deal, get your reporting systems in order and build confidence in your next venture eventually working your way up to a 50/50 split. A lot of investors may wince at this and wonder why my share is so much. When you take into consideration the amount of work involved in sourcing the deal (6 months), then negotiating the price to create $34,000 equity (another 6 months), and the management of the property, the financial reporting, it becomes obvious why you are worth it.
Hi July – 3 years ago my husband and I bought 2 rental properties in Winnipeg (we live in Surrey BC), which are managed by a Property Manager. At tax time can we charge the management fees as part of our expenses?
Yes, you certainly may deduct management fees as part of your expenses. You can also deduct the interest payments you make on the borrowed funds because it is the cost of doing business. Unfortunately, there is no GST recapture permitted for real estate businesses. One of the most trusted advisors on my Power Team is my Chartered Accountant. We work with them to understand our tax liabilities and how to mitigate our tax consequences.
Hi July,
I am novice Real Estate investor and just barely starting on residential properties. I have heard your amazing stories through Dave DeBeau audio interviews. I was inspired and able to relate to your story because I am doing this with a sense or urgency to support my aging parents back in my home country. My question is if you know a good source of contract templates or forms (i.e Purchase and Sale, Whosale agreemenent, Lease to Own, Memorandum of option, Joint venture agreement, Risk Acknowledgement Form, and other useful forms). We will have them still review by a Lawyer, however if we will have the template, since we are just starting, it will be less expensive. Lastly, if you can provide good advice for us beginners. Appreciate your help and continuing support to educate other people.
You can find many of the forms you seek on the internet. I typed in “purchase and sale agreement” into Google just now and forms from several provinces popped up. Or you can attend REIN (the Real Estate Investment Network), they have weekend workshops geared for the novice investor and provide templates. The obvious problem with templates is that if used incorrectly, a template can be incomplete and give you a false sense of confidence. I encountered this on one of my first deals. I neglected to insert any subject clauses into the template. I became very good at understanding contracts after that.
As for joint venture agreements, each one is different and unique depending on how you are structuring the deal. It is unwise to use a template from another investor unless you understand exactly how they structure their deal because that particular template will force you into that structure. The reason why you can’t find a template anywhere is that every lawyer has their own different interpretation and version of how deals are structured. And because real estate falls under exempt market securities, there is no standard template. I still draft up my own agreements and work with my lawyer to tweak it according to the financial and legal parameters of that deal. And because these are legal documents that you wish to use, there is a liability issue here. You can sue a lawyer for E&OE under their insurance policy (that stands for errors and omitted errors) but no one is going to hand you over a legal document to be copied and set themselves up for a potential lawsuit down the road.
There are other liability issues around the marketing of securities including real estate which is why you cannot promote to the general public. If you are buying real estate outside of a public structure (eg. using a prospectus or offering memorandum), then you are considered private equity. As such, you are permitted to accept money only from close family members, close friends, close business associates or accredited investors. Only from these 4 categories. To pass the “close” test, just imagine the Securities Commission asking you for the birthdates of your investors, their children and the last time you exchanged Christmas gifts. In order to ascertain whether an investor is accredited, you can find the National Instrument NI 45-106 on Google.
It’s important to find a lawyer who has experience doing the types of deals you are interested in. If not, take the time to educate the lawyer. Do not assume they know.
Surround yourself with like-minded people who will support you in your journey. Make sure you have mentors that can guide you along the way. A good mentor will not just give you answers. The best mentors will help you ask better questions so you can get better answers.
For all beginners, I insist on getting your Relationships established. This is far more important than finding a deal. Relationships create rapport creates trust equals money. Get a newsletter started and start educating people. And be very clear on your 10-Year Plan, then work backwards from 10 years out to Today. What are 3 action steps you can take today (and every day) that will take you one step closer to your ultimate goal? The cumulative effects of these 3 action steps will amount to 1,095 actions taken in one year. The key is to keep going, keep learning, keep networking and the success you seek will find you.