Some Basics About Raising Private Money
Not far into your education on commercial real estate it becomes clear that raising private money is a skill you need to develop, and then perfect.
Indeed when wholesaling, you can sidestep the earnest money issue when flipping single family, but once in multifamily, inking a contract means you have about a week to wire a four or five figure earnest money deposit to a closing attorney to secure the contract.
If you have that money and are willing to post it, fine. If you don’t you need to raise that money from private individuals with capital they want to invest.
There is a lot of information swirling around out there about private money. While it is a very straight forward process, there is a legal component you must be aware of to stay on the right side of securities law.
For example, when you talk to a person about their investing in your deal, are you selling a security?
One way to find out is the Howey Test. In 1946 the U.S. Supreme Court heard the case SEC v. W.J. Howey Co. that established a precedent for determining what a securty is.
The Howe Test says, ”an instrument is only a security if it involves an investment of money or other tangible or definable consideration used in a common enterprise with a reasonable expectation of profits to be derived primarily from the entrepreneurial or managerial efforts of others.”
So if there is:
– an investment of money
– an expectation of profits from the investor
– profits arising from a common enterprise
– the operation of the enterprise depending on the efforts of a promoter or third party
… then you are selling a security and must be licensed with the SEC to do so.
This sounds ominous as just about every real estate deal ever done would fit that description.
There are exceptions to these securities laws though. The most relevant for apartment wholesalers wanting to raise private money is Rule 506.
Rather than me try and describe it to you, which I am not qualified to do, I (highly) recommend you watch the video Private Money 101 With Securities Expert Gene Trowbridge, and the followup video Private Money 201.
This is a part of your real estate education it is good to get square on, and not cut corners with, as tempting as it may be to do so.