Author Topic: Investing with a local developer  (Read 833 times)

jpdx

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Investing with a local developer
« on: July 19, 2018, 08:27:36 PM »
I have an opportunity to invest in "quasi-fund" comprised of a trio of projects with an innovative Portland developer. They create cool creative offices and hip live/work housing, and I like their business culture and the esthetic of their work. In this case they are looking to purchase three existing small buildings, renovating (hipsterizing) them, then renting them out.

I'm "all in" on Portland. This city has taken off and I think it has all the right ingredients to keep going.

They are looking to raise around $2M in $50k increments, and offering 12% simple interest annual return for, say, a 5-year term, then return of capital. The investors would all be limited partners, but there is no additional potential upside for investors beyond the interest.

They are running the numbers assuming a small recession, to insure it pencils out in that scenario.

Still, I have reservations:

+ The development company does not appear to have skin in the game. They are not investing their own capital beyond substantial sweat equity. With investors assuming all of the risk, they have nothing to loose (except time/effort) and all the upside to gain.
+ The properties are of course not diversified geographically. If the big earthquake hits, I could loose my house and this investment in a matter of two shaky minutes.

You're going to tell me that at good REIT would provide more diversification and less risk, however I think much of the real estate in the US is suburban sprawl garbage, which I want to avoid.

What should I do?
« Last Edit: July 19, 2018, 09:07:23 PM by jpdx »

AccidentialMustache

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Re: Investing with a local developer
« Reply #1 on: July 19, 2018, 09:22:55 PM »
12% seems like "too good to be true" territory.

ILikeDividends

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Re: Investing with a local developer
« Reply #2 on: July 19, 2018, 10:09:23 PM »
innovative Portland developer.
How well have you vetted these developers?  Did you know them before this proposal?  What is their history executing on this kind of a deal?  Any verifiable references from satisfied investors in earlier projects? Who approached who for an investment?

Having only the scant info in your OP, my skeptical spidey senses are tingling off the scale.  Are you buying legitimate debt, or are you buying a lovely sounding story that ends in a nightmare?  I can't tell, but I wouldn't have the slightest interest in joining in on this "adventure."
« Last Edit: July 19, 2018, 10:11:39 PM by ILikeDividends »

Retire-Canada

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Re: Investing with a local developer
« Reply #3 on: July 20, 2018, 07:38:54 AM »
What should I do?

Take that $50K and dump it into an index fund. You'll lose out on the interesting, but tragic thread you won't get to post later about how this was a terrible idea and you lost your money, but you will have $50K growing for you long-term. I like my investments diversified, simple and boring.

RWD

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Re: Investing with a local developer
« Reply #4 on: July 20, 2018, 08:18:13 AM »
This is essentially a hard money loan and the interest rate is typical of such. I have done a couple real estate hard money loans in the past which turned out fine, but neither were as good as they could have been.

The most important thing to mitigate risk is to be in a first trust position on the deed/title. This means if for some reason things go south you will be the first person paid when the properties are liquidated. Since they are raising $2M capital in $50k increments I doubt that is the case for this loan. Without this collateral this is extremely risky. In addition, the loan to value needs to be a very favorable ratio. If they are raising $2M to buy $2M worth of property then they are way over leveraged and in the case of failure you likely won't be made whole when the properties are liquidated, even in a first trust position. Ideally $2M in loaned money would go towards $3-4M in properties for this type of investment.

Another thing to keep in mind is that this is much less tax efficient than index funds. Your entire 12% will be taxed as normal income.

Other issues include the complete lack of liquidity, concentrated risk, and the possibility of being paid back much earlier than 5 years such that the amount you earn is small compared to the risk.

There was previous discussion on these types of loans on this forum here:
https://forum.mrmoneymustache.com/real-estate-and-landlording/what-are-the-risks-of-hard-money-lending/

Car Jack

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Re: Investing with a local developer
« Reply #5 on: July 20, 2018, 08:50:12 AM »
Having to offer 12% and willing to take separate $50k increments means that they're completely un credit worthy.  Pass.

DavidAnnArbor

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Re: Investing with a local developer
« Reply #6 on: July 20, 2018, 09:24:40 AM »
Having to offer 12% and willing to take separate $50k increments means that they're completely un credit worthy.  Pass.

+1


If it's such a great deal the banks would be all over this.

stimepy

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Re: Investing with a local developer
« Reply #7 on: July 20, 2018, 10:52:26 AM »
Still, I have reservations:

+ The development company does not appear to have skin in the game. They are not investing their own capital beyond substantial sweat equity. With investors assuming all of the risk, they have nothing to loose (except time/effort) and all the upside to gain.
+ The properties are of course not diversified geographically. If the big earthquake hits, I could loose my house and this investment in a matter of two shaky minutes.

The bolded is a big red flag in my opinion.   Any Real estate entrepreneurs without skin in the game are just taking advantage of you.  Even with OPM (Other people money) they will be footing the bill for repairs/updates/etc.  Which from what you said doesn't sound like it. 

If you really are interested, get as MUCH detail as you can.   Know the ins and outs.  And be absolutely prepared to lose $50k if you go forward.  (Not saying you WILL lose it, but be prepared in case.)

Questions you should ask if you are still even tempted.   What are their past Successes, and Failures.  (If they have no failures they want to talk (in detail) about, RUN AWAY AT FULL SPEED!) and how did they handle them.   Based on their failures, what is their plan B to pay to back if something fails on this current project?
Do they have a budget?  How tight is it (ie is there any padding in case they find something unexpected.)?  What are they going to do if they go over budget?  .... There are probably a hundred other questions you could ask, but these will get you a start.

Any physical investment (Real estate in general) is susceptible to natural disaster and while it should be considered it is not a real red flag.   It's mostly just a risk your always going to take on.

I suspect that if this is a new company (Or new ish) that the 12% is to drum up interest.   Personally I would do as others have said, walk away invest else where but only you know your risk tolerance.

tralfamadorian

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Re: Investing with a local developer
« Reply #8 on: July 20, 2018, 12:29:20 PM »
A few thoughts

-Five years is an almost unheard of long period for hard money. They should be purchasing with hard money, improving, then getting a loan with half the rate of interest within six months at a bank. Like @Car Jack mentioned, this strongly suggests that there is something in their financial history that prevents them from getting bank loans.

-Like several people have mentioned, the lack of investing their own capital is a huge red flag and should probably end your consideration of their proposal right there.

-It's awfully late in the cycle to be thinking about being a hard or private money lender. Eventually the music will stop and there will be folks left with properties that they cannot afford to keep and are counting on speculation aka appreciation to bail them out. Don't financially shackle yourself to those people.
« Last Edit: July 20, 2018, 01:25:22 PM by tralfamadorian »

Another Reader

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Re: Investing with a local developer
« Reply #9 on: July 20, 2018, 12:47:59 PM »
Essentially they are asking you to be a lender on what is probably a shaky project.  Unlike a real lender, you have no right to foreclose.  The general partner controls the deal completely.  Run.