A big part of building a portfolio of multifamily properties is fundraising. I’m sure that many of you out there are afraid of asking friends and family to help fund your deal for fear that it may go sideways and lose all their money. So that begs the question: Should you let friends and family in on your deal?
I totally understand where that question would come from and fear is a powerful thing. We are afraid that if our brother or sister puts down $100,000 and the deal fails, they would not only not speak to us again, but they would talk to the rest of the family and tell them what happened. Losing that same money from a lifelong friend could ruin a relationship too.
That fear is something that haunts everyone, and more so when it comes to money. But it all depends on how you handle that fear. When a person invests in one of my deals, I feel an immense sense of gratitude that someone has trusted me with a sizable amount of their money. I also feel such a great deal of responsibility to protect their capital and produce a reasonable return – even more than if I used all my money. The thing is, I make sure that the deal I am working on is so solid that the chances of it losing money are very small to non-existent. My margin of error has to be great enough that it would take a total disaster to wipe out the property. And even then, there is still insurance to protect the asset. That said, the probability of losing my investor’s money is remote. It all begins with me getting comfortable with my underwriting, plan of attack and selling the property to deliver the returns promised and protecting the investor’s capital.
We all know that sometimes deals don’t work out. So what do you do in that case? Let’s go through a scenario where you’ve made some money flipping a few small houses and now want to go a little bigger. You get your hands on a run down 4-plex for $40,000, you plan on putting another $50,000 and selling it for $175,000. You borrow the entire $90,000 from your family and you get to work. But there are some mishaps; You underestimated the construction costs by $25,000 and you can only sell the property for $125,000. Instead of an $85,000 profit, you only made $10,000. This is a terrible disaster. But what do you do?
You have a couple of choices. You can either:
A. You can honor your commitment to your family by making them whole on what they gave you. You pay them back the principal plus interest. They will feel for you because you took the money from your savings, but that trust will go a long way. They will still talk to you and not ostracize you from the family. In fact, they would probably tell their friends about how you made good on your word.
B. You let the 9 family members that kicked up the $90,000 – plus your parents that kicked up the other $25,000, know that you will be returning their principle, but no interest and roughly $1,000 of the profit from the sale. Since you at least returned their principle, they will probably still talk to you, but you did not fulfill your promise. They will keep that in mind for the future – especially on the next deal you want to do. It will take a lot more convincing, but since you have a good track record, they may lend to you again.
We’ve looked at the best case and worst case scenario, but there is the consideration of not using friends and family in the first place.
When you are first starting out, friends and family is usually the first place you turn to get the financial support for your deal. This will extend beyond just the immediate people you know, but also their friends, neighbors, and people they work with. If you think about it, your friends and family network is huge. If you don’t leverage these people for your deals, it will be difficult if not impossible to raise the money needed to get the deal done – especially when you are starting out. You need to take the money if you are going to do a deal.
This means overcoming the fear and ask everyone you know – friends, family, people at work, everyone – to invest with you. It’s that fear that will hold you back if you don’t act and raising capital is important to getting the deal locked up.
The way you overcome the fear is to get so good at underwriting, get broker opinions before you buy, and plan for the worst. By preparing, you will eliminate your fear.
Have you taken money from friends and family? How did it go? Please let me know what you think. I’d love to hear from you.
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