Private Financing is something of The Holy Grail for property investors and developers. Whether it’s debt or equity, there are 6 key areas that need to be considered from BOTH sides of the conversion...
The project, the parties, the terms, the security, the advisors and the paperwork. Let’s dive into this topic, which just so happens to also be a longish chapter in my forthcoming new book on Property Financing. Everyone loves a sneak peek, after all 😜
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Transcription of the show
Private Financing is something of The Holy Grail for property investors and developers. Whether it’s debt or equity, there are 6 key areas that need to be considered from BOTH sides of the conversion...
The project, the parties, the terms, the security, the advisors and the paperwork. Let’s dive into this topic, which just so happens to also be a longish chapter in my forthcoming new book on Property Financing. Everyone loves a sneak peek, after all 😜
Property Chatter
Welcome to the property voice podcast helping you to navigate safely through the world of property investing, get the lowdown and updates, insights and outcomes on all matters property with a splash of entertainment along the way, the property voice, a voice to trust among the crowd. Now, let's get started with your host, Richard Brown.
Hello, and welcome to another episode of the property voice podcast. My name is Richard Brown. And as always, it's a pleasure to have you join me on the show today. Well, some of you or many of you might even be aware that I'm currently writing a book and it's a book on property financing. But it's not just going to be about mortgages, basically, it's going to go a little bit wider and a bit deeper than that, just to give you a bit of a heads up, it's going to have what I call, it's going to have three sections, first being institutional finance. So that's kind of buy to let mortgages and bridging finance and things like that. But it also goes into alternative finance, and creative financing techniques. So I'm going a little bit wider, as I say, then many property books. So my heads into that. And in particular, my heads into a chapter that I wrote over the weekend, and I thought I'd share some not necessarily all of the segments of that chapter with you, I'm actually looking at it, I'm over 4000 words. And that's before I have a case study or two to add into it. And The theme is really about private financing. And basically, private financing is a form of property financing that's provided by an individual, a partnership, or an entity that's owned and controlled by such people. So in other words, is not institutions, usually you're talking to the people directly who make the decisions, or you're very close to them. And so just give you some examples, it could be you know, lenders or joint venture partners. It could also be small companies and partnerships. It could be pension funds, smaller ones such as sips, and SAS, pension funds, family offices and things like that. So you kind of dealing with human beings. That's the key point here. That's the key with private financing. And if you're dealing with a human being you're you know, dealing with them on that level, they may have policies and procedures and processes, and rules and criteria, etc, that they adhere to. But generally speaking, there's a lot more flexibility. And this is somewhat something of a holy grail really, of property investors and developers is to access private financing. And there's a number of reasons for that. The most obvious one, well, precisely several that probably are quite obvious, but the most obvious one is it allows us to scale. And it allows us to have access to financing that we don't ourselves have necessarily a say that everybody runs out of money at some point. And so it allows us to scale and do more with less in terms of funding. But it's also can be quicker, it can give us direct access to decision-makers, it can bring additional benefits into our property business. So don't just look at someone who's providing money is only providing money, they can provide other contributions, if you like to our business, such as skills and contacts and resources, they can play a role in in some of our projects or our business to some extent as well. And I guess, you know, I think the old adage is, you know, computer says no, with institutions, well, does the human being always say no, could they be persuaded to maybe look at something that a standard, you know, business or institution wouldn't look at. So lots and lots of reasons, really. So I'm going to whiz you through some of the components of, of what I've been thinking about, put this chapter together, just to give you a bit of an insight and a flavor. But without revealing everything, it's just a bit of a teaser, because probably around about Easter, this book is going to be available for you to look at. So basically, private financing breaks down into two main areas, trying to keep it simple. You've got debt on the one side and equity on the other side. And debt based private financing is typically in the form of loans. And the returns, you know, are paid and received are in the form of fixed-rate interest typically. Now, there's always variations on a theme, but just trying to keep it simple. And equity-based financing, on the other hand is some kind of profit-sharing arrangement. Typically, they gain share profit share, or you know, capital gain share. And so the returns by definition will be variable, and they'll be based on the success or otherwise of the venture. So you can see there's different types of arrangement there. And then of course, you've got six purity, which, you know, dovetails into the return. And that usually varies in line with the agreements or arrangements as well.
Now, there are some rules and, you know, compliance, things to be aware of, particularly when it comes to equity-based financing. So I'm not going to dive into it too much here, just be aware, there are rules to follow, you can't just tap anybody up and offer them enjoy a JV. Basically, that's kind of the rule. So you have to know them personally as your friends or family. Alternatively, they have to actually qualify to be qualified individuals, such as a high net worth investor or a sophisticated investor or a business investor. So just look up the Financial Conduct authorities, guidelines on offering joint ventures, and equity and profit-sharing arrangements. And you're probably going to come across the legislation there.
So I think the main, the main thing to really cover off here is that I've, I've kind of developed if you like, what I call six key areas that need to be considered, kind of, regardless of what type of private financing, whether it's debt or equity. So here's the sequence we're gonna run through, we're just going to dip into some elements of this. So with regard to private financing, you've got to look at the project itself. And I'll come on to the definition of these things. And the parties that are involved, the terms that are being made available, or the agreed, the security, that's that sort and that is provided, the advisors involved on both sides, and how you're going to document and I call it the paperwork side of things, how you're going to document things onto the paperwork. So that's the process. And what you'll quickly realize is there's an interconnectedness here. So when I talk about projects, you know, it's hard to talk about project without talking about maybe advisors without may be talking about the parties, you know, etc. and security comes into the mix as well. So there's an interdependence and interrelationship between all of these different components. So, but to try and keep it simple I'll walkthrough. So the first thing to consider is the project itself. Now the project could be a literally a property project, something we're going to do. But it could also be a collection of different projects, it could be for a defined period to do something, it could be for an entire business activity. So the project I'm using as a loose term, but generally speaking, when it comes to property projects, this is kind of for, you know, General property projects, where private financing would come into play. And that boils down to whether it's a single unit opportunity or a multi-unit opportunity. Again, I'm just simplifying. So there's a single unit opportunity, probably the most obvious thing that you know, would allow a private financier and private investor to get involved would be a flip, buying and selling a property making a profit. So because it's a defined period of time, it's got a clear exit, as I call it, which is the sale. And so you know, typically, it works well, for both parties, it's not a long time, it could be six 912 months, for example, to get in and out of a project, take the money and undertake the project and return the funds after the projects being completed. So a flip is the easiest one to explain. And usually, it's a single property single home. That is that has some sort of value add-in and being resold, there's variations on the theme, obviously. And then a variation on that is if you're not going to sell the property that you're going to retain it. And typically that will be what's called a Brr buy refurbish refinance the project. So we're going to keep this project but add some value to it, we're going to rent it out and keep it and so the investor, in this case, would be repaid out of the refinancing proceeds. So we need to make sure there's enough money that's going to come out in the back end if the property is rented and retained. So that's kind of looking at whether it's a single-family home or a single property. And then if we look at a multi unit project, that's really what we're starting to look at development, that could be development with a small d or development with a capital D. And so what I mean there is it could be a house that you split into two flats. Now that's still developing, but it's not a really big project. It's multi unit, because it's two but you know, it's not a massive project. And so that would be a natural progression perhaps for somebody who's done a flip. If you want to flip a single family you know home, maybe you can do a title split, convert into two flats and flip that way. And that would be a buy-to-sell development project. And of course you can see how this can scale up and you have lots and lots of units that you're you're either converting something into multiple units or you're building from scratch builds is sorry, yeah Built to Sell is the is the watchword there and just as there is with the single-family home if you're not I'm most unit projects, you can build to rent as well. So I'm just using slightly different terminology. But basically at heart, we're even flipping the property or, you know, renting and refinancing the property for single units built to sell for, you know, multiple set of flips, in other words, or build to rent for multiple BRS taking place. And I guess, you know, many of you would have spotted, of course, that there is a hybrid, that is possible that you know, especially when you're looking at multi-units, so I don't reveal too much. But basically, you can get paid if you sell some and keep some. So that would be one of the tips. So that's the project itself. And of course, when we're looking at the project, it's really important that the investor or developer has the requisite skills, contact experience, know-how track record etc, to undertake the project. That's something that from the private finances point of view they're going to be interested in. Now, I do know that, and I think I've probably been there myself where people have put money into a project of mine, where I didn't have that much experience. And you know, it's important that you've got ways in which you can protect the downside risk for your finance partner, I'm just going to leave it at that. And now, but usually, you know, looking at the project, you're looking to match it up to the investors track record and experience and capabilities. And this is actually one of the reasons actually that raising private finance as an investor can be a challenge, because you kind of need the experience to attract the private financing. But sometimes without the private financing, you can't get the experience. And it's capital-intensive business, of course, property. So I do get that. And it does, it does go with the territory, I'm afraid. The second step in the process is the parties that are involved. Now, this might sound very simple. Obviously, if you look at debt financing, you've got a lender and you've got a borrower, they're the parties, ones giving the money or not giving loaning the money, they're the ones repaying the money. And then you just have to get too far ahead of myself. But you have to work out on what basis they give you the money back, they return the money. But I want to go a little bit further here, because in addition to the parties, just having a label, like equity partner, joint venture partner, lender, etc, I think it's also that it's to define the roles. So it's not just to define the parties define their roles. Now, the role might be just straightforward money in money out the arrangement. That means they're just putting their money and they're very passive. They might want to know how the project is getting on from time to time, but pretty much they're waiting to get their money back out. Once the project has been concluded. Well, it could well be the case that they could get involved in different ways they could play a role in the project, maybe more than one party brings money to the table, for example. But again, I just think it's important that we understand who the parties are, and what kind of I'm gonna call it a vehicle that is being funded. Is it the individual property investor or developer? Is it a company is a special purpose company or a special purpose vehicle. So these are some of the factors that need to be taken into consideration when you're talking about the parties that are involved. And as I mentioned, there could be more than one party and so you could end up layering different parties. But I would probably avoid overcomplicating having too many debt providers or equity providers, by all means, maybe have one of each. But maybe having two or three in each hand get hellishly complicated. So that's the thing to keep in mind. Now.
The next part of the process is about terms, as I call it, the terms are really the commercial arrangements have the offering of the arrangement that we're looking to get into. And that really boils down to asking some quick or answering rather, some key questions. This is the how much format, how long? And what kind of return questions in the book, I'm going into a quite a lot of depth and detail here. But essentially, it's like, how much for how long? On what basis? And what kind of returns will I will get back. So that's the that's the terms. It's, it's, you'd be surprised, actually, the people's understanding and expectations of returns, varies wildly, varies wildly based on their experience, and their knowledge, but it also varies wildly on their risk profile and their risk appetite. So somebody might say that, oh, you know, you're offering me 8% Well, that's too good to be true. There must be a catch that kind of thing. Well, whereas somebody else might say 8% 8% but I'm taking I'm putting all the equity capital into this. And you've got you know, a heap of debt. Loads of risk in that sense, nowhere near gonna compensate me for that. So you can get these, you know, just for a percentage up I want to make I said 8%. But you can just get different opinions, different perspectives. And of course, it can't, I can't talk about returns without also talking about security and risk. So they kind of go hand in hand, and yet they're slightly different steps in my process. So I don't want to get too, too ahead of myself. But in terms of returns, they could be a fixed fee or a fixed percentage basis, they could be a percentage of profit, or a fixed fee return, or variable amount of return. So there's various ways in which you can carve up things. And what I recommend is a bit bit of a throwback to last week, actually, I talked about having conversations or having meaningful conversations, when it's exactly the same when you're talking with a finance partner is have a meaningful conversation with a finance partner, and work out what it is they are looking for. And you actually you get, you get to understand whether they leaning more towards debt financing on a fixed rate basis, with a higher level of security, or alternative, we're looking for a higher rate of return with higher, you know, upside potential, but you know, maybe take a little bit more of a risk in terms of less security, then maybe the debt financier, so you, you can quickly work out, but there's there's risk, appetites and profiles and personalities, financing personalities, literally, that you end up talking to, I will share with you one of the tips under this section, because it's just one that I kind of throw out quite a lot, actually, when I'm talking about private financing. And it's this, I have a general rule if you like and it's the closer you are to the source of the heart of the financing, the lower the cost of the financing, I said, again, the closer you are to the source of the financing is hard, the lower the cost of the financing. Now, that isn't always true. But you know, your mom might like you a little bit, she might want you to succeed in your property venture your sister might do, you know, people are close to people who care about you, and they might want to support you. And so maybe they won't ask for or demand such a high level of return, then perhaps the hard nosed sophisticated high net worth investor who's got multiple fingers in pies, let's say. So as a general rule, but equally, I think you need to be careful about the opposite of that. So if somebody is offering something that seems too good to be true, and they don't really know you, and you're trying to figure out why. And keep wondering, right? It's not always what it seems. Okay. So that was if you like that was the terms, which is the commercial terms of the arrangement. The next thing then to consider is the security that is available or is on offer. And what you find here is I've got a diagram in the book, and it really just shows arrows pointing in the opposite direction, with security on the one side and reward on the other side. So usually with higher level of security comes in lower level of reward or return, and vice versa. So it doesn't always follow. That's the case. But usually it does. So somebody who's really secured, we know, I'm going to come on to the types of security. But if they're very heavily secured, well, what is their risk. And so the risk might not be that high. And so therefore the returns that they're going to receive may also not be a high, it's not as simple as that is not just the risk reward equation. All as I mentioned, all of these factors come into play, the party's risk profile, the terms that are available, the track record of the part of the individuals concerned who are undertaking the developments, all of these things come into play. But I do want to divert to say one thing. And when people think about return, they normally think about well, how much will I get on top of what I put in? Okay, so what I put in is your capital, very simply. And what you get back is your return. So you got your capital, and you got your return doesn't matter what you know, else we call them. But that's quite a simple concept.
I think it's Warren Buffett and Benjamin Graham, etc. They basically say Don't risk your capital, don't risk losing your capital. Well, if you're, if that resonates with you right now, you thinking yeah, yeah, I definitely don't wanna risk my capital, then that might put you more in the category of a debt financier. Okay. Because usually, with debt finance here, you can take some security, which will give you a degree of protection against your capital being lost. Whereas if you're an equity provider, you put in the equity, you don't usually have a lot of security behind that. You might have some, and I'll talk about some of the types of security that you can have, but it's not as tangible. It's not as realizable as what it might be if you're putting in debt and so if you find yourself getting a bit twitchy about the potential to lose some or all of your Capital, then you might want to steer towards providing debt financing if you're talking to people like me or other people who are investors and developers. And similarly, if you're concerned about your partner, so from my perspective, looking at my finance partner, if I can sense that they're really risk-averse, and they're nervous about the potential loss of capital, or might steer them down the debt route, rather than the equity route, they may prefer the upside rewards that come with equity. But actually, I'd be doing them a favor by putting pushing them down the camp of maybe protecting some of that downside, loss of capital risk. So that's just something to keep in mind. I think another thing that comes into the equation here is what I call the funding stack. So the funding stack, just pictures for a moment, a pyramid in front of you, which breaks down into three segments. So you've got the base of the pyramid, the middle part of the pyramid, and the top of the pyramid. So the next step really is looking at Well, you know, at the bottom, it's much more stable. And that's where there's a high level of security that's available, and usually accompanied by lower levels of return. If we move up the pyramid, we can still see things you know, the shape obviously is narrowing as we get towards the peak, and in the middle, we get medium security, and medium returns. And at the top, we get the low or even no security and higher returns. So what you find is, you've got debt at the bottom, and you've got equity at the top. And this middle section is usually what they call a mezzanine. It's called a mezzanine because it bridges the two, it bridges the bottom with the top. And so mezzanine is usually some form of quazy debt cause I equity, there could be some security, then you know, attached to it. So that's why it's called mezzanine. It's another level that sits between debt and equity in particular. But it did talk about security, I'm just going to literally rattle through not necessarily describe them, I'm going to rattle through some of the types of security that might be available to discuss with your private financing partner. So first, most of us will be familiar with the concept of a first charge that's typically bought to let mortgage territory, if you go for a buy to let mortgage, the lender will ask for a first charge. That means they're first in line, if anything goes wrong, they can take the property back, they can sell it and they can get repaid. And that's why you know, a lot of people are really hung up on getting the first challenge. Well, first of all, the first charge isn't the be-all and end-all. But obviously, if you are risk-averse, or you're worried about that loss of capital, then you might want to take the first charge. And so going down the list, though we have some alternatives that we could talk about. And there's some merits in some of the alternatives. So there's a second charge, well, it stands behind the first charge probably well to work that out, then we could have a debenture. So the thing with the charges, it's against a specific asset, whereas the debenture is usually against a company's assets in total, I don't want to get too deep into it. But they can have what's called a fixed charge, or a floating charge when it comes to a company. And then you've got things like a debt declaration of trust, which is sometimes called a deed of trust. And that differentiates the beneficial ownership from the legal ownership of an asset or obviously, in this case, a property. You can have shares in a company, you can take guarantees, and you can take guarantees from multiple places, you can take guarantees from people and from companies, for example. And then there's something called cross-collateralization, which is not easy to say at the time of recording this. And that's really about taking alternative types of assets to support a loan. So not just linking it to one form of security, but maybe taking different forms of security linked into different assets, without getting too into it. And there could be some other indirect security, for example, restrictions on title, option agreements, they fall into that kind of category. So I'm not going to go into it too much, but just signpost you to, to that when it comes to looking at security.
The next section really is all about advisors. Now I've got a section on advisors because a lot of people don't, don't take any advice. They don't get people involved. Now, there is a cost, obviously, to bring in people onto your team. And I've highlighted at least three main categories and then some of the others as well. So we've got financial advisors, legal advisors, and tax advisers. And then within the other categories of these, we really are specialists, it could be architects, it could be planning consultants, they could be surveys, for example. But primarily you'd be looking at financial advisors, legal advisors and tax advisors. If you just went out and got one of each of them just because you want them to have them on your team. You start talking about an agreement that you know you're going to have with a property investor or developer and you go to your financial advisor go To your legal solicitors effectively, and you go to your tax advisor, where you might find there's a bill that's ratcheting up pretty quickly, and getting out of hand. So it is a case of doing things, you know, in proportion, and in scale to the, to the arrangement that you've got ahead of you. So don't get carried away. But you know, and, you know, it also depends on your own level of sophistication. If you're used to investing and investments and reading contractual terms, and that sort of thing, as I kind of, am and I was trained in financial services, then, you know, I'm more, you know, comfortable advising myself, from a financial point of view, and to some degree, attach points of view, and understand some of the basics of the legal. But I still have a solicitor that, you know, helps me on, on my agreements. So have the right advice. And as the old adage, say, says, free advice is worth every penny. So yes, do expect to pay something for having the right people around you, but they can protect you, and they can protect the downside risk. So it's always worth having. And then the final step in this particular process that I wanted to outline is what I call the paperwork. And that's really how you're going to document things. And this is where a lot of things come unstuck. I don't know about you, but you know, I can have a conversation with my wife, for example. And later on, we could try and recall the conversation. And we both have a slightly different version of events. And we just sat down, we had dinner, we watched a TV program, we discussed them. And then we try and come back later and just recall what it is we discussed or what it is we agree. And we might have a slightly different perspective or recollection of events. And the only way we could resolve that not that we do this at home, would be to write it down, write it down and show it to the person and go, is that what you understood? Oh, well, actually, no, it's not I said this, okay. Let's change it and make it right. So that's the point really, of having things written down, is to avoid confusion at the very basic level, but it's also to avoid dispute. And it's also to give adequate protection to all the parties. So always, always commit what you've agreed to writing, even if it is your mom who's giving you the money, even if it is your sister. So, you know, nobody wants to go to a court of law. But it's there to protect us. So in my agreements, I also go here quite wide, I talk about the consequences of things going wrong. And what I cover things like well, what if we don't agree? If this is a joint venture agreement, what if we don't agree? What we're going to do in that situation? How long is the project going to last for and what if it overruns? What will we do in that situation? So there's a bunch of things that I do cover off in my agreements. And, you know, generally speaking, just everything is committed to writing.
So I think we talked at the top of the conversation about well, why use or indeed provide private financing? Well, I mentioned didn't I really that everyone will run out of capital at some point, that's on the investor developer side, and on the provider, the financing side, where you can get a return on your money, which is maybe a bit better than leaving it in the bank, maybe it's an alternative to an alternative form of investing, maybe you can get involved in a project in some degree, and learn as you're going along and observe how things go. They'll often say that selling shovels is, you know, makes more money than digging for gold will, you know, providing finances the shovels. So some people make more money out providing finance they do from actually undertaking the projects. So I think, you know, partnerships and financing are commonplace in most businesses, all businesses usually have some form of capital put in there, it wasn't always come from the founders. So you know, taking investment is a very common activity first, so it is in property as well, we just need to make sure that we do it in the correct way. And that's why I've talked about this six-step process so that things are properly covered off, and everybody's adequately protected, and they're going with their eyes open. So basically, there's lots of ways the holy grail allows you to grow and scale allows other people to get involved in property maybe it more of an arm's length without getting there that you know, without rolling their sleeves up if you'd like. And they could even get involved depending on the arrangement. And I guess, you know, where would you go to find private finance? Well, I'm not going to give it all away. It's all in the book. But I will say this, many people go to property meetings looking to raise money for their property projects. And I'm going to say to you, that's the wrong place to look. And I would suggest that in most property meetings, whether it's online or face to face, that probably maybe two out of 100 people in the room. Were looking actively looking to put money into property investors in their projects. So in other words, you've got 98 people looking at the two. So what are the odds What are the odds of being successful in raising private finance in that situation? I know that people do it. And you hear about that, and people even sell courses about that. Go to property meets and present yourself, and you can raise a lot of money. But I'm just playing the odds. So in other words, the best place to go is not a property meetup is actually where people with money hang out, basically. And now, it could also be property meetups, I understand that. But because there's a lot of us looking for, it's the holy grail, don't forget, of, of being in properties to raise private financing, then there's a lot of us, there's a lot of eyeballs really trying to find the two. And wondering if we're gonna if we're going to be the one that they choose to put their money and if we can convince them. So in other words, go elsewhere, I list a number of places in the book, you have to just wait for that one, you but I've mentioned it on one or two other occasions as well. And I'm giving you a few tips there as well. So there we go, I'm not gonna go into too much more of it. There's a lot in there. But I just wanted to give you a bit of a flavor. And I think the main thing I really wanted to cover off today was this principle of the funding stack, which is quite simple, hopefully, to understand, but those six steps in the process. And that's really what I wanted to get over. Because I think if you're a recipient of private finance, or if you're a provider of private finance if you go through those six key areas, then you're not going to go too far off the path. So you can have a sensible conversation. You can work out what it is you want, you can work at it, what it is you you are able to offer. And then you can present that to your side. There's a lot of things that you can do, and discuss, obviously, but you can find an agreement that works for everybody, hopefully, get it documented. Get on with your project. And make sure you look after that private finances funds, treat them, well treat them better than your own. That's what I do, actually, I have a mantra, I treat my finance partner's funds better than I treat my own. And, and that usually means they come back Of course, they get their money back and they come back and they reinvest. So that's it, I was what I wanted to share with you this week. And I've got a couple of things in mind for future weeks. But I think I wanted to draw a line there. So as usual, the show notes are going to be over the website, thepropertyvoice.net if you'd like to talk to me about anything from today's episode, you know, you can email me a podcast at thepropertyvoice.net and I'd be delighted to hear from you. But I guess all the remains to be said this week. He's thanks very much for listening once again to this week's property boys podcast. And until next time.
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