As real estate investors we have had the opportunity to talk to and learn from many people. I know that I have spent my share of money on educating myself and the people in my office on investing and private lending.
I can tell you that I have picked up so many things that I took home and implemented only to have them fail miserably. I have taken and tweaked everything and through constant testing made it work in my market.
What have you found during your implementation that just plain didn’t work for you. Either because of the market, the material or there was a fatal flaw in the concept. Let me know what you tried that worked and what did not work.
I am working to finalize my new Private Lending Product “Cracking the Private Lending Vault” and want to answer as many questions as I can for you all. So share what you know. I will answer these questions on the blog as well so you will receive an answer quickly.
I get asked this all the time. People figure that private lenders are either optional or a luxury. In my opinion they are a necessity in the real estate investing business. Without private lenders you have either to use your own money, rely on banks or partner with other investors.
There are some real limitations to all of them. What do you think? What has been the biggest hurdle in your business without private lenders?
I have been talking to many investors over the past 8 to 12 months and they have shared many of their frustrations regarding Private Lenders. I want to hear more. Call me a glutton for punishment but the more I hear the better we can serve you.
Most of the frustrations have been along the lines of; how to find them or how to secure them. I am sure that there are many more out there that you can share. Let’s hear em. I will post my replys in each of the comments so take a look often.
As this weekend we take the time to celebrate our countries founding, I want to wish you all a happy and safe 4th of July.
This is one of my favorite times of the year. It will always bring back memories of sun and fun, parades and happy times with family and friends. Great times. But please remember that it is those people in the Armed Services that has made it so and has guaranteed it for so long.
20 Years ago on tomorrow, I remember having been out to sea for over 100 days. Our ship was sitting in the hot Persian Gulf off the coast of Iran waiting for things to happen. Here we are 20 years later; the fall of the Berlin Wall, collapse of the Soviet Union, 2 Gulf Wars, a war in Afghanistan and fighting of terrorists worldwide. The Navy is still sitting off the coast of Iran waiting for things to happen.
Even though America is going through some tough economic times, businesses are failing and homes are being foreclosed upon, we are still a great country. Specifically due to the valiant effort of those in are armed forces. So take the time to thank a Soldier, Sailor, Marine, Air Force & Coast Guard member this week end.
Remember that while we are here having hotdogs, hamburger steak and beer, there are hundreds of thousands of service members risking their lives for our freedom. 20 years ago, as I was looking at the coast of Iran wondering what was going to happen since the Ayatollah Khomeini just died, would we have a war or would things settle down a little. I would never have thought that I would be wondering the same thing 20 years later.
Have a great weekend and have a beer for me will ya,
Dedicated to Multiplying Your Successes!
Paul Galasso
“Freedom has its life in the hearts, the actions, the spirits of men and so it must be daily earned and refreshed-else like a flower cut from its life-giving roots, it will wither and die.” ~ Dwight D. Eisenhower
I hope your Memorial Day weekend was a great one. Most of us lose sight of the reason for this Holiday but I hope that you don’t. I want to thank all of those of you who are now or have served this country in any of the armed forces. I like to take this time to reflect on everything we would have missed out on if those in the military past present and future have not sacrificed for all of us.
From the time my daughter Rachel was little I emphasized what those who have gone before us sacrificed to achieve. We can show them our support in many different ways from picking up their dinner to buying them a drink or just an appreciative gesture.
Have a great day today, spend time with friends and relatives and hoist back a couple for me.
I asked my attorney a seemingly simple question: “Is A Private Mortgage Note Considered a Security and Is It subject To the Same Scrutiny by the SEC and the State?”
Seems like a pretty straight forward question and should be a straight forward answer right? Not even close. My regular attorney said that he would research it and get back to me. He said that yes according to the SEC and the “Howey” Test (SEC v. W.J. Howey Co. 1946) it met the definition of a security and that because of this it was regulated by the SEC and the State Department of Securities.
He also passed me on to another attorney who was better informed about the SEC and she proceeded to tell me the same thing and that we needed to be registered in the states that required such registration. She taught me everything I needed to know about putting together Private Placement Memorandums and how to find private lenders legally. Considering that you cannot make general solicitations to find investors. She emphasized using proper disclosures and risk assessments correctly. Basic “Cover Your Assets” disclosures for everything.
The end of last year my attorney decided to go “in-house” with a new startup company where she could take that company public. Great for her, not so good for me. Or was it?…
I spent the next couple of months looking for a new SEC attorney that could help us all out. So after finding and interviewing several I finally found one of the best in the Pacific Northwest. I made an appointment with him. Sent him a copy of my course Cracking the Private Lending Vault and proceeded to spend an afternoon and $5000 with him for consultation.
Here is where it gets tricky and it turns out that it was a very good thing for my other SEC attorney to have gone “in-house.”
My new SEC Attorney John said that even though the using the “Howey” test classified notes and debt as a security another test “Reves v Ernst & Young” (1990) further defined that a promissory note secured by real estate was not classified as a security and so therefore it was not subject to the SEC regulations as a security.
Great News right? Well maybe…
While that is the case without a couple of specific clauses written in specific ways the note could still be considered a security. Drat…
The two things are simple but not to be messed with. If you don’t have them in your promissory note then you could be in trouble when the state and federal regulators come knocking at your door.
I reveal both of them in the Cracking the Private Lending Vault course as well my complete promissory note that includes the proper clauses and disclaimers.
The one thing that John the SEC attorney said before we left was how impressed he was with the multistep marketing campaigns that I use to raise funds. Because they are designed with the SEC rules in mind he was blown away at how effective they were despite the regulations. It is a fine line but he was comfortable that it would withstand the scrutiny well.
Have a great weekend, go out and enjoy the fresh start of the new month!
I received an email from Tim Redding the other day. He bought a copy of my Private Lending Essentials CD set the about a week ago and just received them in the mail. Here is a copy of his email:
“Hey Paul, I got the CDs in the mail yesterday and I listened to the first two. I believe what you say about finding private lenders but I am having trouble getting my head wrapped around one thing. Why would someone want to lend money on real estate when the value of real estate is going down all over the country? How can I talk them into lending me money that is risky like that?”
Tim, thanks for sending in your question. I first want to address the underlying tone of the question okay? You seem to be thinking that all real estate is risky and that all real estate values are going down. I can see how you would be of that opinion based upon the overall negative attitude regarding the Economy and Real Estate in the news.
If you think this way then you will not be confident in your business or in the deal. That will show through to the potential lender as doubt and lack of confidence. You will not be successful finding lenders with this attitude.
First realize that real estate values are local not national. I know of specific areas that have increasing values right now this week in my target market. The increasing values have slowed down in these areas but not stopped inching upwards.
Another thing is that you cannot nor should you ever “Talk” anyone into anything. I explain the benefits and inform people what is in it for them. I let them determine whether or not they should invest based upon their own criteria and values.
I show them a professional credibility kit and a professional property package. The credibility kit shows them why work with me. The property package informs them of the pertinent deal information including the property value, loan to value and my intended exit strategy. It explains why this deal may be right for them.
You are really helping people by offering them the opportunity to earn a good rate of return on their money. If you look at it as an exercise in selling rather than assisting someone meet their goals then you are only looking at it from a selfish perspective and people won’t trust you.
I played racquetball with a friend the other day, he was planning on moving his IRAs over to a self-directed IRA last summer but he let it slide. I reminded him several times last summer but never pushed him. He was telling me that he lost several hundred thousand dollars last September and October.
Do you think he would have minded if I had been a little more aggressive in reminding him to switch to a self directed plan? Then he would have been a little ticked. But he would have been thanking me now. Instead he decided he can’t afford to take the money out of the market because he wants it to recover before he does.
Please remember that you are only helping them by getting their money working harder for them. By adjusting your attitude and mental thought you can do many people a lot of good. By working with them properly and utilizing the proper professionals you are the hero in today’s economic climate.
In last week’s eNewsletter, I described the SEC and their regulatory power over businesses and how they make money. I wrote about the exemptions that fall under Regulation D rules 504, 505 and 506. I mentioned that in many states, but not all, you can advertise for accredited investors.
I live in Washington State and this is one where you cannot advertise for lenders. I also explained that you will probably only get caught when things start to go horribly wrong and your lenders start to come after you, throwing complaint after complaint, desperately trying to get their money back. This can and will cause you and your business great harm.
What many investors don’t understand is that getting up in front of a room of people where you don’t know them and don’t have a relationship with everyone, can and will be classified as general solicitation. There really are better ways to find private lenders.
I always recommend Real Estate Investors to first begin looking for Private Lenders in their own back yards. I can hear you saying “But Paul, I don’t know anyone that has any money!” Most people have a much broader sphere of influence than they may realize.
Have you ever played the 6° of separation game? If I remember the game correctly, it was used to name actors that stated with one actor and within 6 names you have to touch Kevin Bacon. Something silly like that. Anyway, the point is that when you ask for referrals to someone who may know a private lender you are only 6 steps away from someone that knows the right people.
If you belong to the online website www.linkedin.com/in/paulgalasso you know that this premise is the core reason behind this website. It allows you to reach not only people that you know but also people they know. There is a way for you to get in touch through recommendations to many people around the country.
There are other ways to find private lenders and I am a big proponent of doing just that. I believe in creating a group of potential private lenders that I call my lender coalition. Now a quick point of clarification about this, I am not having them throw their money in a pot for me to use at any time. This is just a group of individuals that are interested in becoming private lenders and have money to invest in the right deal.
This enables me to develop a relationship with them to see if the project that I am working on will be suitable for them. There are some guidelines that you need to follow to meet the letter of the law. These are not difficult to do, just a checklist that will keep you out of trouble.
Having a coalition of investors will enable you to take advantage of opportunities that arise, and will help you go forward faster than you could have ever done without having a cadre of lenders.
Quick note, I am hosting a webinar on Wednesday March 18th at 6:30pm talking about this very topic. I recommend that you attend. It will be an information filled 60 minutes that will help you accelerate your real estate investing business. Check it out at www.CrackingTheVault.com/webinars.php
I am amazed by the fact that more often than not I will attend a networking meeting or a REIA club meeting and always hear people stand up and say “I am a real estate investor and I am looking for private lenders on this property I am buying.”
I am amazed because in many states, and in most circumstances, doing just that is against the law. Now, I am not one of those hard nosed guys who think that everything is black and white. If you jay walk or speed you are a dirty rotten law breaker.
I was a cop while I was in the military, but I have been known to speed occasionally, to tip back a few too many beers at parties, and to walk across the street in the middle of the block. But overall I am a law abiding guy, especially when it comes to business and borrowing other peoples’ funds to do my business.
According to the SEC, if you raise money for your business by selling securities you need either to register your security or file an exemption. Typically, exemptions fall under Regulation D – rule 504, 505 or 506. Which one you file depends on how much money you raise.
Most small business people raise money using the 504 exemption, with which you can raise up to $1,000,000 in any 12 month period. Also, in some states you can advertise for investors provided that you only advertise for accredited investors.
An accredited investor is someone that meets the criteria defined in Regulation D Rule 501. They have a net worth greater than $1,000,000 or an income of $200,000 per year for the last two years as well as the expectation of the same income for the current year. If the investor is married then they and their partner need a combined income of $300,000 per year for the last two years, with the same expectation for the current year.
Many states do not allow advertising at all for a rule 504 exempt investment. When you ask for money in a meeting you violate that guideline.
Often I get asked if there are people around that are enforcing that law or if it is just some technicality that no one cares about? The answer depends upon your state. We have a section of Washington State where there are state employees that are actively looking for companies that violate this rule. Other states, no one really cares until it is brought to their attention.
Most often it is just used by the prosecution if something goes wrong. Let’s say that you borrow money from a lender and cannot pay it back on time. You get your property foreclosed on and the lender then sues you for fraud. The prosecutor will pile on charges to ensure that something sticks. Kind of like being called in front of congress on a political witch hunt. You have nothing to hide so you go there and tell them everything they want to know. But you miss something or you remember something wrong and then you are convicted of lying to congress. The first charge is thrown out but the others remain and you go to jail or get fined.
So I am telling you that before you advertise you need to be aware of what is legal in your state and then stay within the guidelines and rules. If you don’t you may pay for it in the future.
Besides, lenders who know about these rules will not work with someone that does not. If you don’t know this they will wonder what else you don’t know. The good thing is there are ways to advertise and still stay on the right side of the legal line. I will touch base about that next week.
Last week I was telling you about a “Fictional” story of Real Estate Investor James and his Private Lender Terry. James bought a house and borrowed money privately from Terry to buy, renovate and sell this investment. Things quickly went wrong.
I put “Fictional” in quotes because this is based in fact. Actually I put together a couple of worse case scenarios from actual lenders and investors. Nothing can ruin a relationship faster than money. Fortunately, it can be prevented with a little forethought and communication.
If you missed last week’s newsletter you can read it below.
James could have prevented this situation by finding another lender. Terry needed her money in 9 months because of a previous commitment with the money. James did not take into account that he may need to have more than one exit strategy. He didn’t take into account that things may not always go just right. He should have put a safety factor into the timeline. Unfortunately, it seems that things never go the way we plan.
Remember the old saying; “Man plans and God Laughs.”
Unfortunately, like most investors, James would rather have gotten the money right away so that he did not lose the deal and the potential profit. He saw close to $95,000 gross profit and he wanted to get started. Nothing wrong with being anxious to make money but you need to think ahead at what could go wrong as well as what could go right.
When planning, I always have a contingency for both time and money. If something looks to take 6 months I will plan for 12. If I figure that I could sell retail I analyze what could happen if I need to discount or sell creatively.
In this story, James only planned on selling retail. He did not anticipate what would happen if he would need to sell on lease option or seller financing. If he had, he would never have promised to pay of the note in 9 months.
At month 9 he could not pay off the note. He was in default. What could he have done differently?
1. Talk to the lender, starting in month one. Give status reports and updates along the way. At least on a quarterly basis, preferably once per month.
2. At month four James should have been asking Terry if he could extend the loan term out because of the selling situation. Terry may say yes. Things could have changed in her life as well. If not James should start to look for another lender.
3. Once he finds a lender that will better match the loan he could then do a “refinance” closing, swapping out one loan for the other. I would be communicating with both lenders to ensure they understand what is going on.
That would have been the cleanest way out for both the lender and the investor. They would still have had a good relationship; James could have borrowed money from Terry in the future.
Due to these circumstances Terry was forced to foreclose on James. Terry was in second position and had to begin making payments on the first mortgage. Terry spent 150+ days foreclosing on the property and in the end had a property worth $325,000 but it cost her $245,000 + in legal costs. She ended up making about $80,000 because James couldn’t sell the property. She then had the option to sell it or to turn it into a rental.
At the end rather than have Terry foreclose, James could have given Terry the deed in lieu of foreclosure. James would have admitted his mistake and done everything he could have to mitigate the loss to Terry. Terry would have gotten the property, rather than go through the foreclosure process, and would have saved almost 5 months worth of hassles.
Either way, the foreclosure would have been prevented if James would have found a lender that was looking for a longer term investment rather than 6-9 months. There are plenty of people like that out there; you just need to find them. It would have been better for all involved.
By the way, James didn’t just mess up on the loan he ruined his real estate investing business. Terry would have spread the word and nobody would ever lend money to James again, and they shouldn’t.
This is why I advocate protecting your private lenders above all others. It can ruin you and your business. Whether intentional or not, you can really harm people and their lively hood. This is why there are tough securities laws. If this is done intentionally, it can be determined to be fraud and you can be prosecuted.
This can easily be prevented by being realistic going into your transactions and with continual communication.
There are so many issues with the real estate market in 2009. First there is the foreclosure mess and the resulting banks tightening their guidelines. There are seller’s that have unreasonable expectations about housing values. There are buyers with unreasonable expectations about housing prices. As an investor we are stuck in the middle.
Another thing that has been happening as a result are that real estate investors who have been utilizing private lenders have been making compromises in their policies and taking the first Lender with money that comes along. Franticly worrying about the money and not caring where the money comes from.
This is Bad Business! Bad for the lender because they are expecting an opportunity to be a specific type of transaction and they may receive what ever the investor had on hand. The Investor may be anticipating a particular exit strategy but may not find a buyer in time. This could be a conflict between the two.
I will use the following example, (this situation is hypothetical and is not based on any one investment.) Real Estate Investor James puts a property under contract to purchase for $200,000. His exit strategy was to rehab and resell quickly. He determined the after repaired value to be $325,000 after $20,000 in rehab.
He was buying the property Subject To the existing 1st mortgage of $180,000 and needed to give the seller $20,000 for their equity. James will then pay the monthly payments of $1500 per month on the first mortgage until he sells the property. He was planning on being in an out of the property in 6 months.
James finds Terry, who had some money in her home equity line of credit that she would like to earn a good return on investment. Terry borrows $75,000 from her HELOC, She puts $10,000 in her savings account to make the payments on the HELOC until is it paid off and then lends $65,000 to James on a 9 month promissory note secured by a second deed of trust.
Terry figured that she was safe because the ARV was $325,000 and the total loans would be $245,000 which is 75% of ARV. She figured that having $80,000 in equity would be good enough. The note was structured as a balloon payment of principal and interest when the house sold. This also gave James 1.5 times the length of time than he figured it would take to rehab and sell.
Terry told James that 9 months was the longest she could lend the money out because she was going to be doing some remodeling on her house next summer and would need the money then. James was comfortable with 9 months as he had completed a similar project and it only took 10 weeks from start to finish because the house was put under contract to sell before it was finished.
Things went down hill from there…
James had to find a new contractor because the one he had used on the last project moved away. The contracting bids came back much higher than anticipated. James had done carpentry in the past so he decided to rehab the property himself.
The rehab took twice as long. It was completed in 20 weeks instead of the 10 weeks he planned. It also cost $35,000 instead of the expected $20,000 and because he did the work himself it wasn’t the same quality of work that a contractor would have done.
The market had slowed dramatically and all properties were taking much longer to sell. James was between a rock and a hard place. The property wasn’t selling. The 9 month note was coming due in the next couple of weeks. What could he do?
Many things went wrong. Let’s address the point of this article: Matching the loan with the lender. James should have found another lender with a longer term. You should always build in multiple exit strategies into the equation. If he would have found a lender that would be willing to have their money working for 2 years James could have sold with seller financing or Lease option.
He could have gotten a tenant buyer in the property quickly that had a sizable down payment. Instead he was forced to sell for full retail in a declining market. Obviously this is not a good situation.
How does he get out of this situation? Or Does He? We will pick this up where we left off next week.
According to Dictionary.com a Coalition is a temporary alliance between persons, factions or states into one body or mass.
A Private Lender Coalition is when you assemble a group of potential private lenders so that when you need to borrow money on a project you have a ready pool to tap into instead of running around searching for someone to lend on a property.
I advocate creating a coalition for several good reasons:
Having the money available when you need it.
Different Lenders have different criteria and you need to mix and match them to meet your criteria
According to the SEC you need to have a prior relationship with the private lender before you can offer them any securities.
There are a few more reasons than that but these are the most important ones.
Most people don’t understand that the main issue that gets people into trouble with the SEC is that they don’t have a prior business relationship to the lender. The State Department of Securities and the SEC have created most of the exemptions specifically around that one condition. They target and go after businesses that violate this in order to protect their constituents.
Matching the lender with the type of investment you are making. You would not want to place a private lender that wants monthly principal and interest payments on a house that you are going to Flip. Ideally you would want a lender that is looking for compound interest with no payments until the project is complete. Otherwise you may put yourself in a precarious situation that will not work for you or your business.
Many potential private lenders are looking to get and have their money working for them as quickly as they can. They also are looking for a good interest rate and having their money secured by either the government or real estate.
Because this is their goal they will not necessarily wait around for you to have an investment opportunity. They will balance the time they need to wait with their other opportunities. They may decide that the best thing for them to do is to put their money in another investment that they may not be able to liquidate to invest with you.
The moral of the story is that you need to get their money working quickly and keep it working so that it meets their goals. This is why you need to create a coalition of as many investors as you can. But keep in mind that some states place limits on how many lenders or investors you can have.
For more information watch the third video about “Keeping it Legal” on www.crackingthevault.com.
I have spent the last several weeks sending out a survey to tens of thousands of investors. I have been reading the results and modifying my new product “Cracking the Private Lending Vault.” I was actually surprised at the questions that came in. There were some very insightful questions, but unfortunately there were a tremendous amount of miss-understandings about private lenders.
They were 5 big myths that need to be laid to rest. Unfortunately many of them were promulgated by many Real Estate Professionals or some “Gurus” that were using this as a way to sell their courses and training.
I will go ahead and do this David Letterman Style.
The TOP 5 Private Lender Myths
# 5 – Private Lenders charge high interest and upfront points
# 4 – Private Lenders have money just sitting around waiting for you to “Borrow It”
# 3 – You can only borrow money short term (for between 6 – 9 Months)
# 2 – All Lenders need to be Accredited Investors (Rich People)
# 1 – Private Lenders are like Unicorns – You hear tales of them, they sound cool, but there are just not any around!
Here is my reply to these myths that surfaced from the survey.
Many people confuse Private Lenders with Hard Money Lenders. I go in detail about the differences in these videos. Private lenders are regular people that have money they don’t want just sitting around. Most have their money sitting in the stock market or a mutual fund earning something for them. Others are more active and are lending it out to real estate investors on their projects. If you happen to come along and have a project when they have money available then perfect. Otherwise you will miss the opportunity of putting that particular lender’s money to work.
When you are working with individuals each will set their own terms for their loans. If you need a long term loan find a lender that is just looking to earn interest for a long time and will not need a more liquid investment. You can set the length of the loan in that regard. As far as only finding Rich People goes you need to read the book Millionaire Next Door. You will be surprised at who really are accredited investors. They are easier to find than you think. BUT, you can borrow money from people that are not accredited. You just need to have a prior relationship with them and understand what their requirements are or should be. There are also guidelines about how much you should borrow based upon thier net worth and income level.
The # 1 Myth is the most often problem. People have this expectation that they can make a phone call or look in a directory and find a listing for private lenders. When they realize that there is not and that they need to make a concerted effort to build that part of the business they are at a loss on how to proceed. This is such a big topic I feel that the best way to help with that is to get on a webinar to get into some detail on how to find the lenders. I am going to do the webinar tomorrow night. You can find out more about it and to register for it by visiting our webinar reservation page.
