Raising Private Capital To Purchase Real Estate

Getting started in rental real estate is rather simple at a high level:

1. Find a property that provides a "good" return.
2. Fund the purchase, and sometimes rehab, of the property.
3. Rent it out by screening for "good" tenants.
4. Keep up with regular maintenance, rent collection, bookkeeping.

Of course, there's lots of nuance to each step, but that's it in general. And lots of people are able to buy one rental every couple of years following this simple formula:

1. Spend less than you earn and save some cash for a down payment.
2. Find a property on the MLS to buy.
3. Purchase the property using your cash for the down payment, and finance the rest through a bank by leveraging the property as collateral and your job for reassurance of payments.
4. Rent it out
5. Either manage it yourself or hire someone else to do it.
6. Plus an optional step at retirement: drop your lowest performing asset(s) and use the proceeds to pay down debt on higher performing assets. Or, trade up to a larger property someone else manages.

Depending on how fast you save, you could buy a property every 2 to 3 years and at the end of a career have a nice rental portfolio for retirement. Lots of people do this, and you can too!

But what if you want to grow your rental portfolio faster?

Running Out Of Cash To Fund Properties Stops People From Further Building Their Rental Portfolio

The number one problem people experience when growing their rental portfolio is running out of cash to fund purchases. Thankfully, there are a couple ways to overcome this problem:

First, you can live in each rental for a year. Since you're living there, the bank thinks there's less risk and allows you to contribute a much smaller downpayment (like 5% down instead of 25% down).

For our 1st, 3rd, and 5th property that's what we did. We lived in each for a while and then moved. Of course, we love our 5th property and have no intention to move. So that method is out for us. It's also difficult to find a property that will still provide positive cash flow given the high leverage, but it can be done.

Second, find a property that's significantly undervalued. Once you buy it, then you improve the value by fixing it up. Here's a simple example. Let's say you find a house for sale for $50K, but it needs $25K of work. BUT, if you do that work, it'll be worth $100K (which you know because the house across the street, of a similar type, just sold for that much). You buy it, fix it, and then refinance with a loan of 75% the new value (called the ARV: After Repair Value). Boom. You just got your money back and you still own the property. Or, perhaps you decide to sell it and earn ~$25K for your efforts (minus any holding and transaction costs)

If you could do that over and over, you can make a decent living and own a lot of property in a short amount of time.

But where did the $50K and $25K come from? Where did you find such a diamond in rough?

To find such a deal, you typically are finding properties NOT listed on the MLS. You're finding people who want to sell quickly or own a piece property in such bad shape it won't qualify for traditional financing.

To fund the purchase and rehab, you might need to pay with cash.

Raising Private Capital

That's where the book "Raising Private Capital" by Matt Faircloth comes in. His book describes how to raise money from other people (private individuals) to help fund that initial purchase and rehab. They provide you with cash as either a loan where they earn interest or as a part owner where they earn or a portion of the property's overall return.

Faircloth describes the two roles: The Deal Provider and the Cash Provider.

"The Deal Provider is the one who goes out and finds opportunities such as fix-and-flips, rental rehabs, and other real estate investments that require an investment using private capital."

and

"The Cash Provider is the investor or lender of the private capital for the project. Most of the time, Cash Providers are passive investors making a return on their money."

As I described above, you typically start out with playing both roles. But to grow faster you can pool funds from other people. What makes a good cash provider?

"Cash Providers who are a good fit understand that their role is to properly vet out you and the deals you bring them, make a decision, and then trust that you will make the right call on their behalf. They will produce the funds for the project when they say they will, and they won’t get cold feet and back out on you at the last second after they have made a decision to go with your deal. They will want regular updates on how you are doing with their investment but will not want to meddle in the day-to-day activities."

What I found interesting was all the different places people have money, and they may not even know it!

Source 1: A self-direct individual retirement account (SDIRA).
This is exactly like an IRA or Roth IRA you might have with Vanguard (with all the same tax benefits), except you can invest directly in anything (with some exceptions. For example, you or a family member cannot benefit financially from the asset or its derivatives. That means you can't manage the property yourself).

What I found interesting is that you can't use a 401(k), but after you leave a job you can roll it over into an IRA, which could be an SDIRA. So his advice is to chat with people who were at one company for a while and recently changed jobs. They might have a nest egg available to loan.

I personally haven't converted or helped someone convert a 401(k) or IRA into an SDIRA, but it sounds like it's fairly straightforward once you identify the right company to be the custodian of the account.

Source 2: Real Estate Equity

"In this case, the real estate equity I am referring to is the difference in the market value of a home and what the homeowner’s current mortgage balance is. If the mortgage balance is less than 50 percent of the home’s value, there is potential to unlock some of that equity."

If you have more than 50% equity in a home, it could be earning you interest from an investment. In general, I advocate avoiding the use of debt, especially if your primary house is your biggest asset. But, if you're already saving at least 10%-15% of your income for retirement, lived in your current house at least 15 years, or have a second property, this could be a viable option.

The way you'd free up that equity is by refinancing to get a new, larger mortgage or a home equity line of credit (HELOC).

Source 3: Cash
The third source, cash, can come from an inheritance, from saving, savvy investors, and high-income earners. The problem is that these types of people (especially the savers) can be difficult to learn about, but Faircloth goes into how to meet them.

He also goes into the types of deals that work with each source of funding and the advantages real estate offers (such as tax benefits like depreciation). It felt comprehensive and I felt like I could have a productive conversation with someone after reading this section.

Creating The Deal

The second half of the book is about preparing the deal so Cash Providers can easily assess if the deal is right for them. He even details what to do during investor meetings. He has chapters dedicated to structuring private loan deals and private equity deals. Again, it felt comprehensive and did a good job of breakdown each step the Deal Provider must take to successfully raise private capital.

The Start of a Master Class

The book feels like the beginning of a "master class". I mean that in the sense that does a good job of describing the steps but could go deeper with examples and templates. He does say that each deal is different, which is true, but he could still go down the path of "here's how we do it 80% of the time."

For example, he doesn't provide any resources for converting an IRA into an SDIRA. He also talks a little bit about creating a sample deal packet but doesn't give an example of the elements to include. For investor meetings, you get the sense he's sharing investor questions off the top of his head instead of tracking the number of times he actually gets asked them and sharing his responses and why he gives them.

I get it, you're not going to have that much detail in a book, which is why it feels like it needs a companion website or a $2,000 master class which includes some Q&A. He does have a youtube channel he regularly posts to where perhaps he covers more specifics.

At the very least, I now have the vocabulary and principles to go learn the detailed specifics I still have questions about it.

Next Steps

While reading the book, I sent out ~800 letters to multifamily property owners offering to buy their property if they were looking to sell. The day after finishing the book I got a property under contract to buy. And it just so happened that I had enough of my own cash on hand to purchase it the traditional way (25% down, a loan for the remaining 75%). So I didn't need to use the strategies I learned in this purchase.

But, I'm going to once again run into the number one reason people stop buying: I won't have any more cash.

Since I won't send out letters again for a few months, that gives me time to put together a sample deal package using a previous deal, learn how to convert accounts to an SDIRA, and put together a holistic strategy for raising private capital. Or, even decide if I want to go down this route at all. Buy a property every 2-3 years seems to be working pretty well at the moment.

If you're an investor in a similar situation of wanting to grow faster, I recommend reading the book. Then send me a message and let's talk. Perhaps we can learn together.