“Investing” in real estate.
September 3, 2022 9:05 PM Subscribe
I am considering going in on a real estate deal with family. This is money I would give them as a gift, no strings attached if needed, and we have done deals together in the past so the emotional component is not my main concern. Learning the very basics and what to consider / what to offer as a fair deal is my priority.
Again, this is a relationship where money has flowed back and forth many times, and if I lost the whole investment I would not be furious. The amount is not enormous and it’s something I can afford. I’m not worried about ruining the relationship, I just want feedback on the logical / dollars and cents part of this. (I’m fine with feedback about how to manage the emotional side if it is proactive, I just don’t need dire warnings that it will destroy my family. Fine with dire warnings about the financial side of things.)
My relatives are buying a house on the lower end of market value from another family member. They are planning to fix it up as a rental, in an area where rentals are in high demand. The house is in good shape. I have multiple other family members who flip houses / buy rentals in this area, and make a good living that way. It’s not a major urban area, so we’re not talking huge gobs of cash flying around, but it’s still profitable.
They are looking for $10k toward the down payment. At least half the rental income would go to house payment + fixed costs, a percentage would be saved toward repairs, and then we would split the profit in such a way that I would make back the down payment + X amount. Maybe X amount (or X%) for Y years, or maybe indefinitely.
I have no idea what X amount should be. I’ve never bought a house (they have, and are contractors). They are setting up an LLC for the rental. Beyond that, I’m naive about most of this.
Any ideas on a good place to start, in terms of structuring the cash gift, the investments, etc.? If this is a good / bad idea (for me I mean, they are doing it with or without me)? Again, this $10k could honestly just go to them as a no-interest loan and I would be financially fine, but they would prefer if it was also a good deal for me so everyone could potentially benefit, outside of any disasters.
There is also a remote possibility of just flipping the house (they are buying for a low price from aforementioned family member). In that case, would also appreciate advice on how to structure the deal. If there are websites or books I should read, I would appreciate it.
For various reasons I consider this 10K money I have free for speculative investments / dubious causes so if it all completely disappeared I would chalk it up to a learning experience.
Again, this is a relationship where money has flowed back and forth many times, and if I lost the whole investment I would not be furious. The amount is not enormous and it’s something I can afford. I’m not worried about ruining the relationship, I just want feedback on the logical / dollars and cents part of this. (I’m fine with feedback about how to manage the emotional side if it is proactive, I just don’t need dire warnings that it will destroy my family. Fine with dire warnings about the financial side of things.)
My relatives are buying a house on the lower end of market value from another family member. They are planning to fix it up as a rental, in an area where rentals are in high demand. The house is in good shape. I have multiple other family members who flip houses / buy rentals in this area, and make a good living that way. It’s not a major urban area, so we’re not talking huge gobs of cash flying around, but it’s still profitable.
They are looking for $10k toward the down payment. At least half the rental income would go to house payment + fixed costs, a percentage would be saved toward repairs, and then we would split the profit in such a way that I would make back the down payment + X amount. Maybe X amount (or X%) for Y years, or maybe indefinitely.
I have no idea what X amount should be. I’ve never bought a house (they have, and are contractors). They are setting up an LLC for the rental. Beyond that, I’m naive about most of this.
Any ideas on a good place to start, in terms of structuring the cash gift, the investments, etc.? If this is a good / bad idea (for me I mean, they are doing it with or without me)? Again, this $10k could honestly just go to them as a no-interest loan and I would be financially fine, but they would prefer if it was also a good deal for me so everyone could potentially benefit, outside of any disasters.
There is also a remote possibility of just flipping the house (they are buying for a low price from aforementioned family member). In that case, would also appreciate advice on how to structure the deal. If there are websites or books I should read, I would appreciate it.
For various reasons I consider this 10K money I have free for speculative investments / dubious causes so if it all completely disappeared I would chalk it up to a learning experience.
Best answer: Seems to me that you should be a member of the LLC. There is depreciation and other deductions to reduce taxes. How much money are they putting up? Is it 50-50?
I have not done a real estate deal in this manner, but I have done many trading deals with other people investing.
Some general thoughts.
Is this equity with risk or a loan? Both are ok, but they would behave differently.
In trading, when one person puts up the cash with which to trade and the other does the work (trading), it usually starts out as a 50-50 split of the profits. Losses obviously go to the cash partner, but they get 100% of the losses AND profits below zero or some pre-determined level.
What are the estimated returns? Will the annual returns be $5,000, $10,000,or what? If you get say a 10% return or interest of 10% what percentage of the annual returns will that be?
What is the value of the house? Market value, not sale price. If it is $100,000, and you want to keep it simple and just do them a solid yet still participate, you could just take 10% equity in the LLC. Straight equity seems to be a good path in that your interests are aligned with your relative's interests. It makes all the accounting cleaner, etc. If they end up flipping, you get your money back and presumably profits.
A straight loan with a fixed interest rate would also be simple from an accounting standpoint.
To me, taking some equity, to be negotiated between you and your family, aligns all party's interests. You could just be a minority partner. If you really want to help them, you could agree to be bought out at a set price or cost anytime after some time or some return has been made. That way if the investment is going well or they have the cash, they can pay you out and get 100% of the business for themselves.
If your financial interests are aligned and you intend to not be involved in the day-to-day decision making, you should have no issues with this being business with family.
The more I think about it, the more I think you should just be a 10 or 20% or whatever number partner or just lend them the money for a fixed interest rate. You could consider with the loan that they can defer payments for 6 months or a year so they can start to get cash flow.
Keep it simple and keep your interests aligned with theirs. Good luck.
posted by JohnnyGunn at 10:04 PM on September 3, 2022 [1 favorite]
I have not done a real estate deal in this manner, but I have done many trading deals with other people investing.
Some general thoughts.
Is this equity with risk or a loan? Both are ok, but they would behave differently.
In trading, when one person puts up the cash with which to trade and the other does the work (trading), it usually starts out as a 50-50 split of the profits. Losses obviously go to the cash partner, but they get 100% of the losses AND profits below zero or some pre-determined level.
What are the estimated returns? Will the annual returns be $5,000, $10,000,or what? If you get say a 10% return or interest of 10% what percentage of the annual returns will that be?
What is the value of the house? Market value, not sale price. If it is $100,000, and you want to keep it simple and just do them a solid yet still participate, you could just take 10% equity in the LLC. Straight equity seems to be a good path in that your interests are aligned with your relative's interests. It makes all the accounting cleaner, etc. If they end up flipping, you get your money back and presumably profits.
A straight loan with a fixed interest rate would also be simple from an accounting standpoint.
To me, taking some equity, to be negotiated between you and your family, aligns all party's interests. You could just be a minority partner. If you really want to help them, you could agree to be bought out at a set price or cost anytime after some time or some return has been made. That way if the investment is going well or they have the cash, they can pay you out and get 100% of the business for themselves.
If your financial interests are aligned and you intend to not be involved in the day-to-day decision making, you should have no issues with this being business with family.
The more I think about it, the more I think you should just be a 10 or 20% or whatever number partner or just lend them the money for a fixed interest rate. You could consider with the loan that they can defer payments for 6 months or a year so they can start to get cash flow.
Keep it simple and keep your interests aligned with theirs. Good luck.
posted by JohnnyGunn at 10:04 PM on September 3, 2022 [1 favorite]
Best answer: Logically it should be equal to your share of the equity. So if the whole downpayment is 40K, you get 25% of annual net revenue (rental income less mortgage repayment and other costs including money put away for maintenance), and when the house is sold, again you get 25% of profit (sale price less balance of mortgage, sales costs etc). This is complicated a bit more if your relative is covering the renovations up front as well - the easiest way there would be to treat that as "extra equity" for them so if they pour 10K into renovations, total equity is 50K and your stake and profit share is down to 20%.
It does depend on the active party keeping decent track of costs, so you need to decide if you trust them on big numbers or if you'd feel better with seeing the invoices yourself.
posted by I claim sanctuary at 10:12 PM on September 3, 2022 [1 favorite]
It does depend on the active party keeping decent track of costs, so you need to decide if you trust them on big numbers or if you'd feel better with seeing the invoices yourself.
posted by I claim sanctuary at 10:12 PM on September 3, 2022 [1 favorite]
Best answer: What would your estimated rate of return be if you had the money in the same place as your other savings? Ask for that percentage, or slightly higher if your family really wants this to BENEFIT you, or slightly lower if you want to give your family slack.
You can have interest-only payments start right away, with principal payments after it's fully rented (or after it's flipped).
posted by metasarah at 4:48 AM on September 4, 2022
You can have interest-only payments start right away, with principal payments after it's fully rented (or after it's flipped).
posted by metasarah at 4:48 AM on September 4, 2022
Best answer: I have done real estate in the past. With the right attitude by the managing members, it is an excellent way to invest. Making a capital contribution as a member of an LLC carries with it the risk that the project may start to lose money and require additional capital contributions from each of the members.
The number 1 question in any business endeavor is - do you trust your partners? not just to be honest, but also to know what they are doing?
posted by yclipse at 4:55 AM on September 4, 2022
The number 1 question in any business endeavor is - do you trust your partners? not just to be honest, but also to know what they are doing?
posted by yclipse at 4:55 AM on September 4, 2022
Best answer: if I lost the whole investment I would not be furious
If you are taking equity, do consider the possibility that the value may fall below your investment. So the house is sold at a loss you not only lose the $10K but are still on the hook for some share of those losses.
You can avoid that risk by only taking an equity stake equal to the money you put in e.g. house valued at 200K and for your 10K you only take 5% equity.
posted by Lanark at 5:55 AM on September 4, 2022
If you are taking equity, do consider the possibility that the value may fall below your investment. So the house is sold at a loss you not only lose the $10K but are still on the hook for some share of those losses.
You can avoid that risk by only taking an equity stake equal to the money you put in e.g. house valued at 200K and for your 10K you only take 5% equity.
posted by Lanark at 5:55 AM on September 4, 2022
Best answer: Again, this $10k could honestly just go to them as a no-interest loan and I would be financially fine, but they would prefer if it was also a good deal for me so everyone could potentially benefit, outside of any disasters.
The way I've always done this kind of thing, for both friends and family, is to offer the asked amount as an interest-bearing loan. I pay them the money and give them a link to a shared spreadsheet based on this template that tracks payments and repayments, calculates interest daily, and compounds it monthly just like a bank would do for a savings account.
I never impose any kind of repayment schedule. I'm always very clear that they can pay me back, or not, as and when it suits them.
This is not any kind of business arrangement and my willingness to help in this way depends mainly on the extent to which I think it could be win-win - which requires only that (a) the interest rate we agree would be reasonable is higher than my bank would give me on that amount of savings and lower than they'd get for a commercial unsecured personal loan (b) paying me back as and when they can won't cause them more stress than having the money now will save them.
I value simplicity and am not even slightly attracted to the idea of mixing business relationships with friendship and family relationships, so what they do with the money they get from me is none of my concern and that's exactly how I like it. So I don't do equity in businesses or any other kind of formal, enforceable contract.
For what it's worth, if I was running this scheme as some kind of business it would be a shitty one - after about a dozen of these there's around thirty thou that I'm pretty sure I'll never see again. But when it does turn out win-win it feels good all round.
posted by flabdablet at 7:09 AM on September 4, 2022
The way I've always done this kind of thing, for both friends and family, is to offer the asked amount as an interest-bearing loan. I pay them the money and give them a link to a shared spreadsheet based on this template that tracks payments and repayments, calculates interest daily, and compounds it monthly just like a bank would do for a savings account.
I never impose any kind of repayment schedule. I'm always very clear that they can pay me back, or not, as and when it suits them.
This is not any kind of business arrangement and my willingness to help in this way depends mainly on the extent to which I think it could be win-win - which requires only that (a) the interest rate we agree would be reasonable is higher than my bank would give me on that amount of savings and lower than they'd get for a commercial unsecured personal loan (b) paying me back as and when they can won't cause them more stress than having the money now will save them.
I value simplicity and am not even slightly attracted to the idea of mixing business relationships with friendship and family relationships, so what they do with the money they get from me is none of my concern and that's exactly how I like it. So I don't do equity in businesses or any other kind of formal, enforceable contract.
For what it's worth, if I was running this scheme as some kind of business it would be a shitty one - after about a dozen of these there's around thirty thou that I'm pretty sure I'll never see again. But when it does turn out win-win it feels good all round.
posted by flabdablet at 7:09 AM on September 4, 2022
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