Major burning question for real estate investors: how much of the deal should I give up when I bring private investors in?
First, why is this so important? Whats the big deal?
Well, I see way too many real estate investors who either want to give up too much of their deal and kill their own profits. Listen, if you find a deal, put it together manage it and see it through to a profitable result YOU DESERVE TO GET PAID! You dont have to give it all to the money person (even if its your first deal).
Remember that youre in business for one reason and one reason only: to make money. No ifs ands or buts.
Now the other side of the coin is not giving up enough of the deal. Being too greedy. This can happen a lot too, and often does with inexperienced investors. You cant keep everything for yourself, because youre not shouldering all the risk. There has to be a balance somewhere.
This question is easily answered when it comes to private money loans: the piece of the deal you give up is just the interest paid to the lender based on the agreed upon rate. For instance:
Private Money Loan: $150,000
Interest Rate: 10%
Term: 12 months
Amount Paid to Private Lender: $15,000
That one is pretty easy. However, if youve read any of my other stuff, you know that Im not very big on private lenders Id much rather you had equity investors in your business. But thats where part of the rub is how much of the deal do you give up to your equity investors?
Lets take a look-see:
Private Money Invested: $150,000
Projected Deal Profits (Best Case): $40,000
Projected Deal Profits (Worst Case): $20,000
Time Frame: 6 months
Lets say we elect to start at a 50/50 split. This gives the investor a max $20k profit or a min 10k profit on $150k in 6 months. This brings them a pre-tax annualized return of 26.6% and 13.3%, respectively. Not too bad. This looks reasonable. The investor brings the money and you bring the deal and manage the project.
But what if the investor wants more?
Back to the math: whats the minimum amount youd be willing to do the deal for? Say its $10,000. In this instance, youd look at your best and worst case profit scenarios, bake in your needed profit and work back to the investors number from there. Going back to our example, you might want to give the investor maximum of 60% of the deal, figuring that youll end up somewhere between your best case and worst case profit scenario. Still protecting your profits while making the investor happy thats the name of the game.
Im a huge advocate for real estate investors setting minimum profit numbers for themselves on deals. You just should not do deals unless youre going to make money. I hear a lot of whining on this subject that usually goes like this: but I need to prove myself to the investor first or I need to get a deal under my belt first.
Ok, great. Just find a deal where the investors and YOU can both make a nice profit. Never and I mean never work for free.
Bad precedent to set and bad business in general. Always lock in your profits. Contact TrueCapital to find out how you can get started with private equity.