Private lenders believe that borrower’s financial contribution to the house flip transaction makes a loan less risky. By investing their own funds, borrowers demonstrate their ability to save and manage money. They also show their faith in the transaction and its profitability. Having “skin in the game” motivates borrowers to move fast, work hard and make responsible decisions.
At New Funding Resources we fund the lion’s share of what’s needed to buy and rehab a property. However, it’s not uncommon for the new investors to struggle when coming up with their own share of the funds. Some have little in reserves and need to save more before becoming real estate investors. Others have some seed capital, but still might fall short of what’s needed. For that group, bringing in partners who can contribute the rest of the funds might be the right solution. However, before you run out to find such partners, consider these three mistakes. They will not only complicate your foray into rehab business, but also cause a havoc in your relationships with your partners.
HAVING MULTIPLE HOUSE FLIP PARTNERS
The right partner can propel you forward both financially and professionally. He or she can help you qualify for a loan by contributing funds and providing a personal guarantee. They can save you time by taking on a part of the rehab job. If they have more experience than you, they can help you efficiently manage the house flip process and avoid costly mistakes.
Despite all the benefits of having partners, underwriters are often concerned when they see more than two partners on the deal. Why? The more partners you have the higher the chances of misunderstandings, inefficiency and conflicts. One of the partners might not have as much time to contribute as others creating a feeling that he is “slacking off.” Another partner might not have enough experience and require too much hand holding.
Perhaps more importantly, having multiple partners reduces profits for everyone. If you were planning to make 50K in profits and split them equally, each partner in a two-person partnership would anticipate taking home 25K. The pay day will be more modest in a partnership with three people. Each of them would take home only 16K.
Let’s say you’ve run into unexpected expenses that reduce profitability of your house flip down to $35,000. With two partners you still get a respectable $17,500 profit per share. However, with three partners you house flip profit dips below 12K each. How would your partners react to this reduction? Some might become aggressive and combative, others might feel demotivate and disengage from the process. You have a problem in both cases. For this reason, keep the number of your partners to the minimum, preferably one. Your life will be easier, your house flip process smoother and you will make more money.
NOT DEFINING EACH PARTNER’S CONTRIBUTION AND RESPONSIBILITIES
Regardless of the number of partners you are working with, the straightest path to conflict is not setting expectations. To avoid problems, define what each partner’s contribution will be, where it begins and where it ends. Also, define their responsibilities. If one partner contributes more money that the other, does it mean that the second partner contributes more in time and labor? Is the money partner expected to pay for any additional costs? Who makes major decisions regarding the renovation? Who is paying carrying costs of your rehab? Unless you discuss these questions in advance, you are running a risk of imploding relationships and dwindling profits for everyone involved.
NOT DOING BUSINESS AS AN LLC
Doing business in your personal name opens you up to all types of risk and liability. This risk is multiplied when you work with a partner. When you and your house flip partner buy a property in your personal names, your interest in the property is likely to be affected by your partner’s liabilities. For example, If someone sues your partner personally – even if it’s on the issues unrelated to your rehab business – they might go after the property you own together. If your partner has IRS liens or judgments, they might be attached to the property you co-own. While we always advise against doing business in personal names, not creating an LLC while working with partners is asking for major problems down the road.
New Funding Resources is a private mortgage lender that funds rehabbers doing business in Washington DC, Maryland and Virginia.