Promissory note for investor interested in my 4-plex?

General Real Estate Investing
1

So my business partner and I just purchased a 4-plex. We had to put 20% down to purchase, and we used our HELOC’s to pay most of that 20%.

We would like to bring an investor on board (and have an interested party) to help us pay back our HELOC’s, which have crappy APRs. Our plan is to write a promissory note for 20% ownership of the building. Instead of making regular interest payments to the note holder, we would offer 20% of any positive cash flow each month, no management or maintenance responsibility, and a balloon payment of 20% of the net sales price when we eventually sell the building (probably 3 to 5 years from now). “Net sales price” would be defined as gross sales price less excise tax and other closing costs paid by the seller.

Does this strategy make sense, or are we way off track? Is this a reasonable offer to an investor, or are the terms not favorable enough to be appealing? What types of safeguards would you recommend (buy-out clauses, specific note language…)?

We’re trying to incorporate investors into our real estate endeavors and we want to do it the right way. Any information is much appreciated.

2

Using the percentages you provided I don’t think that you will find many takers. Look at it using real numbers. Lets say that the property cost 100K. You put down 20K as the down payment. If the property cash flows a profit of $200.00 a month then your investor makes $40.00 per month? They could put that money into a money market account and if they are earning 5% on there money they would earn $83.33 per month. With no risk. As for 20% of the sales price minus tax and closing costs they could end up losing money. Using the 100K example; if the property appreciates at 3% year it would be worth $109,727 after 3 years. Even without paying closing costs 20% of that would be worth $21,854. So if you had to sell at less than 100% of sales price they could end up with less than their 20K. You would be better served refinancing your HELOCs.

Depending on the value of the property you could also refinance it at current appraised value and pull out some cash to pay off the heloc’s. Although this would only work if you bought at a significant discount.