Raising Private Money
On today’s Real Wealth Show, we’ll be talking about how to raise private money the right way. And we’ll also take a look at how to invest in syndications that make sense.
Back when I was first learning about real estate investing, I met a highly seasoned investor who acted as a casual mentor. I’d run ideas past him and he’d give the thumbs up or down.
At the time, California properties had doubled in value. Since I was a mortgage broker, I understood the power of leverage and bringing “dead equity” to life. So I refinanced our primary residence, taking as much cash out as I could to buy cash flow properties in Dallas, Texas.
My “mentor” approved of this plan and helped review the properties my husband and I were purchasing. We ended up buying 14 rental homes, but then ran out of money. I wanted to continue building up cash flow, so I asked my mentor what I should do next. He replied with a grin… “Ahhhh, yes, NOW you get to become a real investor.”
I asked him what he meant since I thought I was doing pretty well. After all, I was following Robert Kiyosaki’s advice by buying in Dallas, Texas at the beginning of it’s boom cycle. In less than 18 months we had more than a dozen properties.
Noticing my confusion, he continued. “Real investors use OPM. Everyone, even Trump, runs out of their own money eventually. That’s why you need to learn how to use other people’s money (OPM).”
The only way I knew how to use OPM was through conventional bank financing. Since we were tapped out on down payments I just stopped investing for a bit. And I’m glad I did!
Shortly afterwards, the Great Recession hit and real estate investors nationwide got hammered. One colleague of mine had a private lending fund, in which he’d raised millions of dollars in capital using “other people’s money.” His own father-in-law had invested over $5 million.
As property values plummeted, borrowers walked from their loans and my colleague had to repossess most of the properties in his private lending fund. By 2009 the homes were worth much less than what was owed and they didn’t cash flow, so he was forced to sell them at a major loss.
The investors in his fund were furious and some tried to sue him, even though he obviously wasn’t responsible for the housing meltdown. Nonetheless, legal bills mounted and he ended up losing everything, including his marriage.
That’s when I learned that using OPM was serious business, and I was in no hurry to use it from individuals.
However, that same year, one of our Real Wealth Network members told me I should meet one of his colleagues. I was very busy helping people buy foreclosures, but I decided to go meet this man anyway.
It turned out his colleague, Fred Bates, had over 40 years experience as a highly successful real estate developer, and had participated in many boom and bust cycles. He’d profited substantially during the booms, but made even more money during the busts. Bank asset managers would call him to off-load properties they didn’t know what to do with after they were repossessed during a recession.
In 2009, many builders went under. In many cases, their developments were solid, but their credit lines dried up and they couldn’t finish their projects. Fred told me he had made an offer on 27 riverfront town homes in Portland, Oregon that were 70% complete. The bank that had given the construction loan went under, and the developer’s credit line was pulled. The FDIC took over the property, and Fred was able to assume the $12.8M loan for just $3M.
Normally an established developer could walk into a bank to get the $3M for an incredible deal like this, but in 2009 there was very little liquidity. Banks were busy licking their own wounds. That’s why Fred wanted to meet with me – to see if our Real Wealth Network members might be interested in partnering. I had no idea if they would, so I sent out an email to see if there was interest… and there was! In fact, we had over $3M committed within hours.
I had no idea we could raise money so quickly. I also had no idea there were strict S.E.C. rules for doing so.
One of the strictest rules at the time was that you could only present deals to investors “with whom you had a pre-existing relationship.” Fortunately, the people to whom I sent the email were members of Real Wealth Network and regular attendees at our events. And luckily, the money came in so quickly that I didn’t mention it on my podcast, The Real Wealth Show. If I had, I would have unknowingly broken securities law because announcing a private placement to the public is a violation!
We raised the $3M right way, and the project ended up being very successful. Investors earned over 20% IRR in the midst of the Great Recession.
This was the beginning of my new role as a syndicator, and Real Wealth Network has done many development deals since then. In fact, we are currently raising money for Fred’s newest development – a subdivision near Reno, NV, just 20 miles from the new $5 billion Tesla battery factory. Reno is booming with growth, but Fred was still able to find a distressed property.
A development group tried to get entitlements to build 270 homes but ran into delays with the city. They ended up taking on a hard money loan, which came due. Rather than lose it all to the bank, the owners sold it to Fred for a discount if he closed quickly. And he did, because he partnered again with Real Wealth Network, where he now has raving fans waiting eagerly for his next deal.
Why am I able to talk about this syndication publicly when there’s a chance readers may not have a “pre-existing relationship” with me?
Thank the JOBS Act.
In 2012, Obama signed into law the Jumpstart Our Business Startups Act, or JOBS Act. It was created to help small businesses raise capital by easing some U.S. securities regulations. For the first time ever, private companies could raise money by marketing their offering to the public – with one major caveat. Only *accredited investors could subscribe, and they would have to prove their accredited investor status in writing by a 3rd party.
*The S.E.C. defines accredited as an individual who earns $200K+ per year or $300K+ as a married couple, or can prove a $1M net worth excluding home equity.
This gave birth to many of the crowdfunding platforms we see today. And while this is a huge boon to small business growth, it is also still very restrictive. Many people who would like to invest may not be accredited. As a result, Title III – the CROWDFUND Act – went into affect, allowing non-accredited investors to participate. But the capital raise is limited to $1 million, and requires a tremendous amount of reporting and oversight.
Tips for Raising Capital and Staying Out of Jail
- If you raise funds from anyone who is not necessarily an active partner, but rather a passive investor, your activity falls under security law. Therefore, always check with a securities attorney to make sure you are compliant
- Learn the difference between a Reg D 506B, Reg D 506C and Title III (google it)
- Disclose every single possible risk involved with the investment and make sure the investors understand the risks in writing
- Always issue a Private Placement Memorandum and LLC Operating Agreement so that your investors know – in writing – exactly what to expect, especially if things don’t go as expected
- Never promise or guarantee returns. Give best and worst case scenarios in your pro-forma. Over-estimate timelines and expenses and under-estimate returns
My mentor was right. Using OPM does take you to the next level because you can acquire much larger deals than you might be able to do on your own. You are also able to share the profits with others, but you would also potentially share the losses. So choose your projects very carefully, and only invest other people’s money as if it were your own.