There are many choices when it comes to structuring your private money deal. In fact, there are almost "too many" choices and it can be confusing, especially if you are just beginning to raise private investor capital for your real estate investments. Therefore, what I'd like to do here is break down for you the different ways in which you can bring private money into your investment property deals.
First of all, the structure of the deal depends on a few factors, such as:
* Type of investment property (house, apartment, mini-storage, mixed use) - the reason this is important is because each deal has different financial performance characteristics
* Time frame of investment - how long will the deal take from funding to completion? is it a quick flip or a long term hold?
* Private investor objectives - what does the private investor want? are they looking for steady returns or will they defer for bigger upside?
* Tax impact of deal - what is the tax impact to you and your private investors? do accelerated depreciation, 1031's or other factors come into the picture with the property?
Now that we know some of the drivers of real estate investment deal structure, let's look at some of the ways you can structure the private money investment:
1. Limited Liability Company (LLC) - you could bring your private investor in as a member of the LLC or as a private lender to the LLC. Members have ownership interest and lenders are creditors (just like a mortgage company). Investors that are LLC members share in the profits and cash flows. LLC's work well for many real estate investment projects, from houses to apartment buildings. You can set up different classes of members in your LLC, with some getting preferential distributions of cash or proceeds from asset sales.
2. Limited Partnership (LP) - You could bring your private investors in as unit owners in a limited partnership. LLC's have replaced LPs in many cases, but there are still some instances where LPs make more sense (when liability issues with the general partner come into play). Many people have heard of LPs before and there are also publicly traded limited partnerships as well, so there is a general investor awareness. Since they have been used for longer than LLC's, LPs can have more traction with attorney's and CPA's who are working on the deal with you.
3. C-corporation - the big c-corp - you would bring your investors in as shareholders (or lenders to the company). You can have different classes of shareholders (common stock, preferred stock, class A or class B preferred stock). Private investors would receive their returns in the form of dividends from distributed profits or when they sell their shares for a bigger amount than their cost basis. Double taxation is an issue with C-corps, as earnings are taxed at the company level before distribution to shareholders, who then must pay taxes on dividends received. Dividends are generally taxed at lower rates than other forms of income.
4. S-corporation- set up the same as an C-corp in form, but no double taxation. You can only have one class of stock and you are limited in the number of shareholders you may have at 100.
When you match up the deal factors with the investment legal entity structure, you can stack the deck to getting private money more in your favor. If your deal structure is out of alignment - for instance using a C-corp to flip a property in 6 months (you'd be subject to double taxation and you'd have to buy back or facilitate the sale of the investor's stock to return their capital) - you can expect to have a tougher time putting the capital together.
Carefully study deal structures and work with qualified professionals (attorney, CPA, securities lawyer) to set everything up the right way. Good professionals do come with some billable hours, but they are worth their weight in gold when they protect you and your investors and make the deal easier to complete.
This writing is for informational and educational purposes only The contents of this post and of this website do not constitute legal or tax advice. Before conducting any transaction, please consult proper legal and tax counsel.
Adam Davis is a real estate investor, author, speaker and founder of Ultimate Private Money. He teaches real estate investors how to raise capital from private investors. Adam has completed hundreds of real estate deals- from single family house flips, lease options to apartment buildings, land contracts and hard money loans - all with none of his own money. All told, he has raised millions of dollars from private individuals to finance real estate deals. For a FREE audio program on how to get private money go to: http://www.UltimatePrivateMoney.com.
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