In the previous installment, I discussed the importance of equity, as well as a few time-tested, tried methods for attaining it. But to be honest, the process of attaining equity can be a diverse one; depending on your individual personality, your route to investment equity may look a lot different than mine.
Further, I’m also a big proponent of learning as much as possible from as many sources as possible. Towards that end, let’s go over some other sources of equity. The more information you have, the easier it is to find (and get) sufficient funding.
Friends and Relatives
It’s something of a cliche that you can’t rely on relatives and friends for funding–at least not if you wish to preserve your relationship with them. While I wouldn’t go so far as to discourage the practice entirely, as I have heard of positive anecdotes and win-win situations, I will say this: if you decide to tap relatives and friends for capital, you owe it to them to have a well-designed, comprehensive framework.
What do I mean by this? Simply speaking, you need to be transparent, honest, and, if you value your relationship, thorough. While there are plenty of lists about how to deal with friends and relatives, it comes down to this: don’t ask for more money than they can afford to invest; be very clear about the risks in the plan; and have a legal agreement that covers the details, such as specific repayment timelines and stakes in the deal.
As such, it may be prudent to hire an attorney to arrange the terms of your agreement. After all, this will demonstrate that you are taking this seriously, and despite (or because of) your relationship, you are willing to go the extra mile for them. Also, be sure to ask for loans, not gifts; though it seems like a small distinction, you do have to repay a loan–with interest. This will serve as an additional bulwark against the deterioration of your relationship.
In short, don’t treat your friends and relatives as anything less than other investors–which they are. Even if there is a temptation to skate by, based on your previous rapport with them–resist it. Instead, double down on your due diligence to ensure that your loved ones (and yourself) are entering into a win-win deal. If anything, your loved ones deserve more work and less risk than other investors, specifically because of who they are–and what they mean to you.
Ultimately, many of us have affluent friends and relatives who have more cash than investment opportunities. To lose out on this source of equity is unreasonable, and rather than avoiding it entirely, investors should learn to work around it.
In its simplest terms, a joint venture is a way to distribute risk amongst a group of individuals or companies. This model also works for equity because it allows real estate entrepreneurs to take big transactions (or grow more quickly) than if they stayed separate. Together, the joint venture partners share the risk and the rewards–but at a fraction of the equity that would have been needed if they had invested separately, as individuals.
The downside is clear: lowered risk equates to a lowered reward. But in certain opportunities, this tradeoff is worth it. This is particularly true for larger, riskier transactions, as well as deals that are just ever so slightly out of reach–but you know will generate high cash flow and upside appreciation later on.
As with raising equity from friends and family, the key is finding the right partner. I suggest that you seek out well-capitalized, highly-respected investors (both firms and individuals) to join you. Trust, needless to say, is paramount: I’ve worked with several joint venture partners, and we trust each other implicitly, developing our relationships over many years.
Similar to a joint venture, syndications differ in that they entail passive investor partners. These usually take the form of limited partnerships (or limited liability companies, or LLCs), and are most suitable for deals that require significant equity.
The downside to syndication is that it requires a lot of legal and technical research. For this, there’s simply no getting around a lawyer: a complex relationship like a syndication simply has too many parties (and their interests) at stake. Even though these partners aren’t competing against each other (after all, they’re in this deal together), their interests may not always align. Hence the need for legal counsel.
From my experience, I’ve found that it pays to be selective in choose investors for syndications. In particular, difficult people, as well as those counting on rapid, sky-high returns, will be a source of much headache and aggravation. Instead, turn to high net worth investors (HNWI) who want to invest a small part of their fortune in real estate–and who have a diverse set of income streams. They are less likely to complain than someone with fewer sources of income.
There’s no way to say it: this is the big leagues. Big institutions deal in multi-million dollar transactions and build entire real estate empires; these entities include major insurance companies, pension funds, and aggregated institutional investor pooled investment funds.
Institutional investors seek to partner with established, experienced real estate entrepreneurs for deals that often exceed $10 million in acquisition price. Because institutional partners have such deep pockets of capital, even allocating a tiny portion (say a fraction of a percent) can equate to millions of dollars a year. Furthermore, these large organizations often rely on real estate investors, simply because they often don’t have the necessary talent in-house.
Unfortunately, there are downsides to this type of partnership. For one, institutional partners, because they are so well-funded, supply the vast majority of the equity (usually around 90% to your 10%). Moreover, because they have so much equity–they have the power: cross them, fail or disappoint them in some way (no matter how small), and it’s an easy matter for them to remove you from the deal and find someone else. For this same reason, negotiation can be a one-sided affair, given that the institution holds more (and more powerful) cards than you do.
In the end, finding equity is an essential part of any real estate investor’s journey. What’s more important, however, is finding the right person (or organization) to provide you with equity. Choose carefully, because this is one relationship you can’t afford to mess up.