Investing to acquire multiple streams of income is a key element in any wealth plan.

The process of successful investing, where you find and acquire multiple streams of income, is a trade off between time and money.

If you have a lot of time, then you can be a successful investor with very little money. You can spend your time studying the stock charts, or contacting real estate agents, looking for that bargain deal.

On the other hand, if you have a lot of money, then you can leverage your time by paying someone else to invest on your behalf. Your adviser will spend the time looking for deals while you do other things. For example, you may pay a stockbroker or financial planner... or you may pay a private investor to help broker a deal on your behalf.

In this Hot Topic, I'm going to outline how you can use other people's money to fund your own investment and wealth accumulation strategy.

People who have heard me speak know that I'm very passionate about developing a plan and setting goals. This isn't new or sexy, but it's the biggest factor in determining your success.

When Steve and I began investing in real estate, we had a very clear understanding of what our roles were. I looked after making the money... and Steve spent it :)

Seriously, I made the money by working as an accountant and Steve invested it in our property deals. This was a transition for us, because previously we both worked as accountants and had separate client lists to service.

Then one day, Steve and I talked through our frustrations and also our lack of passive income. We knew that for our financial situation to change, we had to take control over our investing future.

From that day forward, we decided that I would have the role of running the accounting practice and Steve would be in charge of investing the proceeds from the business.

We did not stray from our plan, no matter how difficult our roles became, or how much better we thought the other one had it.

It was difficult at stages when our workloads fluctuated, but before long our investments began to yield passive income.

So to summarise so far, before doing anything I strongly encourage you to set a plan. Once you have a plan, work out your time/money trade off. In our relationship, I earned the money to allow Steve the time to look for the bargains.

Your options depend on your access to funds.

There are four potential sources of finance that are available to you. Here's a list, from the cheapest to the most expensive:

1. Seller-Financed. This first source is where the seller or promoter subsidises your investment into his/her pre-arranged deal. It might be an employee share scheme, low interest housing loan, or vendor financed property purchase.

This is the cheapest source of finance because the promoter is looking to sell the investment to you and s/he is willing to be flexible on the terms offered.

While seller-financing is the cheapest form of finance, it is relatively scarce and is certainly not the normal way to access money. For example, we've never completed a deal with someone who wanted to vendor finance our purchase of an investment property. The closest we came was a vendor who would have financed our 20% deposit on a block of fifteen flats. But the terms he offered forced the deal into negative cashflow, so we didn't proceed.

2. Bank / Major Lender Finance. Applying for finance using a bank or other major lender may be tedious, but the rate they offer is set by competition (and a good dose of rate benchmarking by the Reserve Bank Of Australia).

Compared with what's available for non-bank finance, your interest rate is relatively cheap.

3. Private Investors. Using the funds of private investors is your third option. It's generally more expensive, because the investor is looking for above market returns and may want a share of the profits (or equity) as well as a fixed return.
4. Your Money. This is the last and most expensive option. There is only so much money in your bank account and once it's spent, you become reliant on other sources of funds for the continued expansion of your investments (or you wait for your savings to replenish). Your money should only be used as a last resort.

The concept of looking for the cheapest source of finance is something that Steve and I continually monitor with our investments.

Look back at your plan and identify what sort of investments you'd like to have in your portfolio. Then consider ways of funding the purchase of those investments within the sources of funds identified above.

For the purposes of this Hot Topic, we are now going to discuss option three in more detail.

Now you've made the decision to use investors, the next question is what type of investor do you want to attract?

Once you develop a reputation for being an expert, people will beat a path to your door to hand over money and be apart of the deal that you are putting together.

The temptation at the beginning is to be overcome with the joy of having someone interested in what you do. But this excitement will turn to frustration when you realise you've inherited a person who rings you every five minutes to get the latest update on how his/her investment is going.

When developing a plan to attract investors, consider the following points:

• What demographic is your target investor located in (age, family status, annual income etc.)?
• Identify your criteria for taking people on (application forms, phone or live interview etc.)?
• How are you going to attract investors (classified ads, network marketing, referrals and affiliate programs etc.)?
• What information are you going to provide to a potential investor (brochure, online presentation, prospectus etc.)?

When preparing literature to send out to potential investors, you may like to use the services of an accountant to help you prepare a professional and comprehensive document. As a minimum you should include a summary of your scheme, an idea of money flow within the deal (using case studies and sensitivity spreadsheets), testimonials from others who have used your system and a referral point where more information can be found.

Don't give away the secrets to your system because a lot of people will contact you looking to suck away your intellectual property. Have a basic information sheet that you hand out to start off with. You'll also need to filter the tyre-kickers from the serious investors to make efficient use of your time.

Finally, be very careful using your family and friends to fund your investment endeavours. Steve has a saying, "blood is thinker than water and using money to soak up blood spills is always messy."

Following on from your feedback, let's now examine the use of investors in property deals.

At this point I should say that Steve and I haven't used investors to fund our property deals, but we have plenty of contact with clients and other people who have. To date, all our investments have been funded using bank finance and our own money.

Here's a case study of a property that Steve and I purchased in Ballarat. It's the one that Steve outlined in his May edition of Financial Independence (3 Bedroom Brick house). Pay attention to the numbers, as we'll be analysing them in more detail.

In the deal above our nett cash flow per year is $3,773.12 ($150.68 less $78.12 by 52 weeks per annum). Our investment tied up in the deal is $7,500. One way Steve and I use to evaluate a deal is cash on cash return, which in this case is calculated by:

If this deal came across your desk, the key parameters for you to consider are:

• Do you have cash of $14,500 to put down when you purchase the property to start off with?
• Can you qualify for a loan of $48,000?
• Is $3,773 positive cash flow per annum enough of a return for the risk you have assumed in the deal?

Let's imagine you can't (or don't want) bank finance and that you've found an investor who is able to fund the $62,500 needed for the purchase of the property (they may provide the $14,500 cash for the deposit and closing costs and borrow the rest). For his/her money, the investor wants 50% of the cashflow and 50% of the first homebuyers grant too.

The numbers now change as follows:

However, when you take into account the debt involved, the numbers are not that great. Some popular gurus claim that 17% is far better than the term deposit rate the bank offers, currently around 5%. That's right, but your typical sophisticated investor doesn't look at term deposits for his/her fortune.

Such investors look for higher yielding investments. Speaking as an investor, I wouldn't invest in a deal with risk and leverage that only returned 17%. I'd want much higher and speaking with other investors, I know they have similar feelings.

No doubt you'll come across some people who feel a 17% return is a good deal.

What I want you to appreciate is that if you are attracting people who accept 17% as a return, then that's a good indication of the level of their sophistication. Are they going to understand non-payment, default clauses etc? Or did they just get blinded by the higher rate of return?

Using an investor halves your return, but you also don't have to contribute any money. Instead, what you provide is time. Time to find the property and the work the lead. Time to negotiate the purchase and organise all parties. Time to monitor the ongoing deal.

You need to determine whether or not your return is sufficient to cover your 'wages' for the time spent brokering the deal. For example, if monitoring the investment takes one hour per week (52 hours per annum), then your 'wage' is $36.27 per hour.

Overall, is this worth it? It depends on what your alternatives are. If you're a high paid executive and you like your job, probably not. If you're unemployed or want a more flexible lifestyle, then perhaps it is probably a good opportunity.

Now you have a plan and some idea about how much money you're likely to make, let's consider how you could potentially structure deal.

Here are five possible ways to structure a deal using investors. They all have their own advantages and disadvantages and in the end you'll need to choose the model you are most comfortable with.

The title of the property goes into the investor's name and his/her lender (if any) takes first registered mortgage. The investor takes full responsibility for servicing the loan and you are paid for setting the deal up and the ongoing management of it.

The title is held jointly by both you and the investor, but the loan is in the name of the investor.

You may like to do this to give yourself added protection that the investor does not play funny buggers. However the lender may have issues setting up a loan in one name, when the title is in joint names. Be careful that you don't end up guaranteeing a loan.

Option three is where you pay an investor for his/her good credit rating. You take title of the property and have the loan in your name too, with the investor guaranteeing the borrowing.

This option requires that you form a company. The shares are owned jointly by you and the investor. The company takes title of the property and has a loan in its name, which is guaranteed by the director with the sound credit history.

The final option discussed here is where you and the investor form a company and jointly own its shares. The company takes title of the property, which is funded using capital injected by a shareholder outside the corporation.

That is, the shareholder(s) borrow money outside of the company in their own name and then pool that money to purchase investment properties. This structure works well for people with equity in their own home. They can remortage against a current security and loan that money to the company to use in acquiring properties.

In reality, there are many options that can be used and each one will have its own peculiarities. How do you choose? You need to determine what your need is and what the investor can contribute to your deal.

For example, if you had a deposit, but couldn't get finance then 'Borrowing A Name' might be the better option for you.

Summarising, the reason that you invite an investor into a deal is to solve your financing problem.

At this point you have a plan, you have an idea of how much money you want and why you want to use investors. The next problem is how do you get access to the investor's money to go and buy houses?

Is the investor going to put the money into a separate bank account and allow you access to it? Will the investor write the cheques as needs arise? Both options have problems associated with them, but they can be overcome through open communication.

If you're asking an investor to put money into a bank account, it would be a good idea to show him/her periodically (say monthly) exactly what you have done with the money. Being accountable goes part and parcel with investors and savvy money managers watch proceedings like a hawk!

On the other hand, if you're going to ask your investor for a cheque, it would be wise to give him/her as much notice as possible, as well as probably an estimate of where you need the money sent and by when. You'll need strong organisational skills, as investors can't be bothered with the detail, otherwise they wouldn't be using you in the first place.

The easiest option in terms of handling money is to have the investor put money into a separate bank account. You can both be signatories, but in reality you'll be handling the day to day operations. Setting up this way involves a significant amount of trust.

This bank account can be used to receive all monies and pay all expenses such as loan repayments.

Before you go to an investor you need to decide what type of properties you are buying, since the type of property will alter the investment risk in the deal (ie. commercial property is more risky than residential property).

You also need to establish whether you have pre-approval from the investor, or whether each deal needs separate authorisation.

My preference is to work out an agreed system for buying properties. For example, form an agreement on price, location, condition or age, structure etc. So long as you find deals that fit your established criteria, then you should have pre-approval so you can begin to negotiate immediately.

If you have to seek approval, the time it takes may mean you miss out.

Steve and I have a policy of developing an exit strategy before we purchase a property.

This is like an emergency plan if something goes wrong. The need for such a plan is obvious in a multi-story building and so it should be in your investment plans too.

You need to develop a policy to handle events such as vacancies, interest rate changes and movements in the property market. Ideally your plan will be developed in conjunction with your investor.

A sample plan might be that the house is going to be wrapped. If later the property is vacant, it should be rewrapped or in worse case scenario, rented.

If your investment turns out to be a lemon, have a strategy for resale to recoup as much of the purchase price as possible.

Having monetary benchmarks (eg. if cashflow per week falls below a certain figure) is useful, as it takes out any emotion in a deal.

Generally, problems don't arise with dividing up the profits, rather it's the issue of losses that causes the most anxiety.

In our earlier deal, the profit was the difference in the cashflow, or $72.56 per week. But what about your overhead costs such as phone calls, postage and petrol? What about expenses (if any) associated with the property or loan that aren't reimbursed by the tenant (ie. loan fees etc.)

You should seek to have all this spelt out in a written agreement, together with how the profit is to be divided.

Most people assume it is always 50:50, but in reality you can set any percentage you like.

You might also like to consider the timing of profit distribution. Is it going to be weekly, monthly, quarterly?

I personally recommend quarterly, one quarter in arrears (ie. pay the first quarter profit at the end of the second quarter). This allows for a pool of money to be available in the event of emergencies.

The issue of what to do with losses is usually not discussed, because people seeking investors think that talking about failure is like talking about death... it makes people uncomfortable.

Instead, they over-promise and under-deliver and when unplanned events occur, tension builds.

For example, from time to time people may not pay you. Does the investor understand that during these periods s/he may have to make repayments without any income to offset? Will they expect you to fund the difference?

I've found a better strategy is under-promising and over-delivering. You need to show your investor the numbers based on a worse case scenario and then surprise them by having the actual numbers a lot better.

Being realistic and covering contingencies flags you as a professional, since most sophisticated investors understand that problems arise from time to time and making plans for when this happens is a skill that most people overlook.

Ideas for who has responsibility for losses are:

• You, as your penalty for not putting together the deal you said you would; or
• The investor, as they are the ones who are taking the financial risk; or
• Both parties at an agreed portion, since you both have an interest in the transaction.

Whatever option you choose, make sure it's documented.

When you agree to buy a property and use an investor, it's reasonable to expect that the transaction is going to last for a long time. As such, it's prudent to consider what happens if either you or the investor wants out of the deal.

You may decide to opt out because your share of the cash flow is no longer worth the amount of effort that you put in.

The investor may want out because the deals no longer fit into his/her investment plan.

There is also the possibility that if the deal goes for 25 years, one or both of you may become too ill (or your husband or wife) to want to carry on. It's natural that priorities change and you should plan for this change in advance.

If the investor wants out, you should ensure that you have an option to buy his/her interest. Perhaps you could pay a percentage of the cashflow left in the deal? In any event, you need the security of being able to retain your income source should the investor change his/her mind.

You should also prepare an exit strategy that the investor is happy with in the event you no longer want to be in the deal or you become incapacitated.

It is probably unrealistic to expect the investor to be doing the paperwork behind the deal. It's more likely that you're going to have to record both the cash received and the cash paid and provide summary management and taxation reports.

One idea for what you could produce is to replicate what rental managers put out. I'd also be building an on-line gateway so that investors have access to the latest reports and information 24 hours a day.

When looking to buy houses using investors, be aware that the Australian Securities and Investments Commission has certain regulations on what is and is not allowed when touting for investors.

One law to be aware of is the law of Small Scale Offerings, as such offers do not need any disclosure. What's a small scale offering? The offer must be limited to 20 investors and the maximum you can raise from these investors is two million dollars in any twelve-month period.

Note, you can advertise for as many investors as you like... but you are only allowed to take on 20 investors and raise not more than $2m from them in any twelve month period. I encourage you to seek legal advice about this if you are in any doubt.

Outside these parameters there are complex disclosure issues that you must include in your offer. Again, seek legal advice as necessary.

Don't just jump in and start using investors. Instead, form a plan (a money goal within an identified time period), then consider how you are going to raise the money. Investors are just one of four possible sources of funds, which should be used to help you reach your goal.

Remember also that you remain in control of the terms you offer your investors. Make sure you are fairly remunerated for your effort and intellectual property... don't just give it away. Have faith in your ability and avoid taking on an investor just because they have money.

Most importantly, keep a door open that you can exit out of the deal from if necessary. Financial independence is a great goal, but if you have the responsibility of managing a massive property portfolio that you can't delegate, then it's just like having a job. It might be fun now, but the novelty will wear off.

To date Steve and I haven't used investors, as we have access to bank finance. Things may change in the future and we always keep our options open.

If anyone has any comments or experiences, I'd love to start a discussion on the Inner Circle Forum Board.

Sincerely,

David Bradley