Cash.

I like it. A lot.

So it should.

And I like to walk away from any real estate closing I can with that in my pocket. That’s the whole point.

However, there are certain situations with raising private money where it might not be the best idea to ‘withdraw’. This is what I mean:

Buy a property priced at $100,000
The property needs $20,000 in repairs
This. Sale Price: $180,000
You get: $140,000 in private money
$140,000 private money minus $120,000 property cost basis = $20,000 private money surplus.
LTV: $140,000/$180,000 = 77% (a little high, but not outrageous).
What to do with that $20,000? Hmm… Vacation in Hawaii?

Casino?

Lottery?

Well… back to reality…

There is a school of thought that says you can keep it in your pocket. After all, you borrowed it against property, so you should be able to do whatever you want with it, right?

Mistaken.

If your private lenders (in this case) don’t know how your funds are allocated, you’re not doing it right. You must tell your investors where the money is going at all times.

Now, if the investor signs on or is aware that you’re going to pocket that extra $20,000, then that’s fine. Some investors won’t mind pulling cash off the top at the start of the deal, as long as the LTV is reasonable and you’re looking after the investment.

What is the problem with this anyway? How come it’s not a big deal to do a cash-out refinance with a bank loan but it is with a private investor?

Two reasons:

1. Disclosure: You must tell your private investor where your funds are placed. This is just good business practice and is necessary if you want to earn a reputation that will net you seven figures (or more) in private money.

2. The banks are not lending your hard earned money: they are lending money created out of thin air by the “money multiplier” effect of fractional deposits (part of Federal Reserve banking), they are lending money from shareholders, and they are lending money from depositors. The banks’ lending decision would be very different if the members of the loan approval committee were lending their own funds instead of someone else’s. You cannot think of your private investor and the bank in the same context. One is an institution, the other a person.

And, here is the special bonus reason #3

Downside protection. Going back to our example, let’s say you couldn’t sell the house for $180,000. Maybe the appraisal gods didn’t like the house. Who knows.

So you have to sell the house for $160,000. Well, that’s still not bad. $20k profit after paying the lender. But let’s forget about… the secondary costs of ownership. Maintenance costs, taxes, etc. It is never a good idea to manage your investment properties near the “red line.” There’s a whole graveyard of investors who got excessively in debt with money from private investors who are now driving trucks and wondering what hit them.

Raise as much private money as you need (including a cushion), but no more than a project can reasonably handle. It’s better to take that extra $20k and invest it in another property.