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Using Other People's Money Responsibly When Investing In Real Estate

Forbes Biz Council
POST WRITTEN BY
Ali Jamal

As investors, when we hear about self-made millionaires making it all on their own, it’s important to understand the extent of the term "self-made." Building wealth on a million or billion-dollar scale is typically not something any one person can accomplish by themselves.

Independence is always ideal, however, while building a real estate portfolio worth $35 million in the last eight years, I’ve learned these ventures won’t always work when we try to do them solo, saving up for one large down payment at a time. We need to use other people’s money (OPM) and become comfortable with walking away from a portion of the profit.

Banks have made an industry out of using OPM to raise capital, lend money and reinvest. As sophisticated investors who have a good performance record, we need to look beyond a bank’s ability to lend to us and, instead, learn from their long history of how to raise capital responsibly.

Starting A Private Equity Real Estate Fund

Put simply, banks first started raising capital by reaching out to a pool of investors and enticing them to trust the bank with their funds to raise more money. In return, investors could look forward to the safekeeping of their cash and interest payments.

Similarly, investors can take on the role of a fund manager once they find contributors for a blind pool fund, also known as a blank check offering.

Real estate investment funds are like mutual funds, except the majority of the inventory is commercial and residential properties. These funds gain value through appreciation, property improvements and rental income. Customers who buy shares would receive the same portfolio management support they would receive with any other mutual fund.

As their fund manager, you have the flexibility to use their investment to raise more capital however you see fit, as long as you fulfill the obligations of your agreement with them. Typically, this obligation includes regular interest payments and sending out a quarterly report or facilitating regular conference calls to provide a breakdown of investment activity.

To create the fund structure, hire an attorney who specializes in asset management and investment funds. These are the experts who can ensure your fund complies with all the necessary security regulations.

Seller Financing 

Some investors may not have the performance record or experience that a group of fund contributors require to trust the investor with managing their hard-earned money. That’s when investors need to narrow down on fewer candidates.

With seller financing, for example, when you’re buying real estate already owned outright by the seller, you only need to earn one person’s trust — the seller.

What is attractive to a seller about this type of financing is they can earn a higher sale price for their home without having to fork out any capital of their own. The terms of the arrangement are usually laid out in a promissory note that, in exchange for a transfer of ownership, allows the buyer to make regular payments toward the loan until they can fully pay it off with a larger, lump sum amount.

Even when the seller decides to increase the sales price, the buyer still benefits from less overhead costs compared to what they would be charged by a bank for underwriting, appraisals or legal clearing of an application. The buyer is also granted an opportunity they otherwise may not have had, albeit at a higher cost.

Sellers should consult a real estate lawyer to ensure they are protected from fraud and they hold the first lien on the asset.

Joint Ventures 

The fewer people investors need to help them raise capital, the easier it is to do. What makes it even easier is a strong track record in real estate investing with outstanding returns or equity ownership as solid proof.

Once investors have enough experience and evidence of their success, they can raise capital through joint ventures. In my experience, this has been the easiest and most effective way to build wealth for each partner.

What partners like about this type of setup is they have more control over how the investment is managed and, if they choose, can actively take part in investment activities. Alternatively, they can be silent partners and still be shareholders with a stake in ownership.

Regardless of which channel one chooses to raise OPM, the pitfalls to success remain the same. Ensure every investor is on the same page and each other’s objectives are clearly communicated from the beginning. Try to bring different areas and levels of expertise to the venture; however, avoid bringing completely different leadership styles together as it can easily result in little or no cooperation.

Finding OPM can be a challenge for investors, especially if they don’t have the track record they need to showcase their potential. If they do have success raising OPM, however, the benefits are boundless. Investors can grow their portfolio exponentially in a way they would never be able to do by working a 9-to-5 job. Once they can prove their ability to manage OPM and provide the returns their partners require, they can also charge the appropriate fees. When OPM is raised the right way, avoiding common pitfalls and using the correct legal framework, it becomes a win-win for everyone who takes part in the venture.

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