How Our Passive Investors Earned 26.9% On One Deal

The Quick Version

1. We bought a house in pre-foreclosure for $160K.
2. We took over an existing loan of $87K and raised $95K to reinstate the loan, repair the home, and provide the owner with some cash to find a new place.
3. We offered investors a straight 8% loan. This means we paid them 8% on their money regardless of the timing.
4. Helping the original owner move, making repairs, and reselling to a new owner took 107 days, or 3.57 months.
5. We paid our investors 8%, or $7,600, after selling. Which, when annualized, is a 26.9% annual percentage rate (APR).

The Longer Version

Two weeks before the auction date, I met a seller in pre-foreclosure with $40,000 in arrears. He had two loans, and the lender in the second position called the entire mortgage due. And since he couldn't make his monthly payments, he couldn't pay off the $40,000. He was in a challenging situation!

The plan was simple: buy the house for $160K, subject to the first loan of $87K ("subject to" means the loan stays in the seller's name). We'd pay off the arrears, put some cash into the seller's pocket to find a more affordable house, and rehab the property after the seller moved out.

We originally planned to completely rehab the place, but then I talked with a friend looking for a fixer-upper who wanted it. So, we slashed our rehab budget and timeline (and resale price) and instead focused on making the house lendable for him. It was a deal that dramatically reduced our risk while sharing the upside with him. Here's the financial summary:

You might notice that the arrears aren't $40K, but $55K! That's because there was an additional $2,500 per loan fee for filing for the auction ($5K). Plus, the seller had a judgment of $10K, which we only learned about when we received the title report. All that impacts is the amount of cash the seller gets, but it was rough letting him know he'd only receive half the cash he thought he'd get.

Raising Funds

I was slightly nervous about raising the $95K. I had only talked about long-term equity investments with my potential investors, and this was the opposite: a short-term fixed-debt investment. Oh, and I needed the funds quickly! I could easily see people being interested but needing more time to transfer funds.

There are two types of investments: Debt and Equity. And they typically pay a fixed rate or some percent of the profits. Here are some investment structures. I was switching from offering common equity to a promissory note.

Each structure has pros and cons, and I wasn't sure switching structures would still match my investor's goals.

We offered 8% straight interest on the debt. That meant we'd pay 8% interest no matter how long the investment took. If it took 6 months, we'd pay 8%, which is equivalent to a 16% APR. But if the project took two years, we would still only pay 8%, which equals a 4% APR. Offering straight interest made projecting the cost of debt easy for us, and since we knew the project would take less than 6 months, the APR would be double digits.

Thankfully, the response was fantastic, and we raised the funds in time to stop the auction.

However, some investors balked at the 8% return. They wanted 12% interest that accumulated each month (like a typical loan). We tried explaining that if the project only took 6 months, they'd get paid less - only 6%. But, I understood the objection that they didn't feel protected if the project took longer than expected. And, I had to explain "straight interest" every time, which meant I was confusing people - not great. So, we've changed how we structure the debt to protect investors on the backside, reward me for moving quickly, and it's easier to explain.

Moving the Seller

We gave the seller 90 days to find a new place, and he took the full 90 days. It was, honestly, concerning as the deadline approached because he showed zero initiative to find a new place. I get it - this was his home, and he didn't actually want to move. Plus, despite having $18K to spend, he still had poor credit and, because of a recent injury, no income. That meant buying another place - even a manufactured home - wasn't an option. And because they also had pets, finding a place to rent would be difficult.

My partner did all of the legwork here. He connected them with a broker to confirm their lendability status. Semi-good news! They'll qualify in a year once he has a job and catching up on the mortgage payments goes through the credit bureau's systems.

Eventually, my partner found a solution: A landlord had multiple vacant homes that needed work, and he was willing to rent to the family in exchange for fixing up the other homes. He helped with the final negotiations and ensured everyone was on the same page.

And now a new problem arose: a seller wanted to fix up the place they would move into instead of moving. So, as the deadline loomed, he asked for more time!

We gave him a few days, but by this point, we had a closing date set for the new buyer, and we still needed to work on the inside. On the week of the new deadline, he called again and said, "Hey guys. I'm going to need another week. Sorry." And then pretty much hung up before we could say no. It was quite the power move! And just as that phone call finished, the new buyer happened to walk up and could tell something was wrong.

I knew the deal wouldn't fall apart, but I felt unprofessional towards the new buyer. So, we called the seller back and told him the deadline couldn't change. But, we could help by hiring a moving crew and renting a moving truck. So that's what we did, and he was moved only a couple of days after the initial deadline.

We had replaced the roof and sump pump during those 90 days, so all that was needed was removing the remaining items, cleaning, and replacing some drywall. Not too bad, right?

Rehabing the Interior

We ordered a 30-yard dumpster, which I thought was too big. However, I significantly underestimated how much stuff was left in the house and filled over half the dumpster on the first day!

We also discovered that the wall's water damage also affected the floor. This often happens in projects: once you open up something, there are more issues than initially thought. Though, I received some help with that project. 😀

We also discovered a leak in the kitchen and replaced a significant portion of the drain line.

We completed the interior work ourselves, except for the plumbing and final cleaning. It was a lot of work, but I find this type of work satisfying. Part of what made it feel like a lot of work was the compressed timeline: Had the seller not needed an extension, the pace would have been more normal.

And the day after we finished, we sold the property to my friend. The total hold time was only 107 days, or 3.57 months.

At closing, we returned each investor's principal and 8% interest. So, their ROI was 8%, but on an annual basis, the percentage rate (APR) was a massive 26.9%. And now, my focus is finding another project so they can reinvest the proceeds.

Communicating with Investors

Our primary means of communicating with investors is via email. I like email because writing is one of my natural communication methods, and it allows me to add other media, like photos and numbers. I have three types of email lists:

1. New folks: who receive emails every couple of weeks-ish that educates them on passive investing and introduces more of myself to them.
2. Everyone: who receive monthly business updates. I mainly share what I did the previous month, but I'll also share my life philosophy, economic predictions, and anything that seems relevant.
3. Current investors: who receive specific updates on their project. These are mostly progress updates where I share photos and how we're doing versus the timeline and budget.

For this project, I gave one update of "A new roof and sump pump!" followed by two updates of "We're waiting for the sellers to move out." and then a final "It's done!" update.

By the way, you can also join my investor club and start learning about investing with me.

Final Accounting

So, how did we do versus the budget? Did we manage to stay within our $182K estimate? In short, no, but it wasn't far off either. Here are the final costs:

I was slightly off on the closing costs, but the big miss was on the rehab budget. Specifically, the roof was more expensive because of some hidden water damage. Finally, I knew there was a lead fee, but I didn't know the amount. Thankfully, we only needed to pay the fee once we resold the property.

Even though we exceeded the budget by $5,000, the deal had enough margin to cover it. So, overall, I'm pleased with this project. It was a win-win deal where we built wealth and improved housing, together:

1. We helped a family avoid foreclosure.
2. We started someone on the path to building wealth with a fixer-upper.
3. We earned our investors a fantastic return.

If you'd like to learn more about investing in private opportunities with me, join my investor club.