What profit split %?

Question

I'm looking for advice as I structure a new real estate investment business entity. Specifically, how I should approach % of ownership?

My partner is a GC, who is going to take on all everything related to assessment and construction on the property. I'll take on finding the properties, securing financing, and property management of rentals.

All of our initial financing is coming from me, and his feeling is given my investment that I should have a larger portion of ownership than he does. I see his point, but I do want to be fair to him given his investment in time, expertise and connections. Although the initial nut is mine, going forward we'll both be putting in plenty of effort into growing this business and making it successful.

He's leaving the decision up to me, and I want to make sure I make one that our future selves will have no regrets about. My gut says 50/50, but I need a gut check on this!

Eric M. · Answer

This always seems like the ideal partnership right? The GC and the money guy? Maybe it is me but this has never worked out for me. Just look at his job description in your post. He is doing exactly what a GC does...no more no less... and GC's usually get 10% of the budget. So what is the "extra" value to you if he is going to be your 50% partner rather than 10% hired contractor? Is he giving up his GC fee to get 50% of the equity? If he says that, how are you going to track that and make sure he is only charging you his actual costs? (here is a secret, you can't track it) I guarantee even if he says he will do the job for his cost, he will be padding it. Padding is all he has ever known in his career. There are alot of other hidden costs to being a GC (licensing, tools, trucks, insurance, etc) that are not direct costs and hard to quantify per job. Sure, everyone thinks the idea of having a GC with ownership stake will somehow make him more trustworthy and reliable. I have not found this to be the case unless you are keeping his crew busy 100% of the time and he has no other jobs or clients. You are now the "client" who will understand when he is too busy to show up and he has another angry (paying) client on his ass to finish a job. Which one do you think he sends his crew to? Your property becomes the one he works on part-time when he has free guys. Your property becomes the one to cut corners on because you are not a paying customer. And what about his ongoing costs for his crew on your project? How are you paying him for that? Often because he is your partner you give him the full rehab amount up front (sometimes you give him nothing up front but that often backfires too). So when he inevitably has a cash crunch (he is a GC after all) because he has to pay his crew, he is going to tap the funds from your partnership....even to pay for hours worked on other jobs. This is just the nature of the way GC's run their business. They are very very often robbing Peter to pay Paul when cash gets tight. GC's are used to getting paid as they go. They live on cash flow....often paycheck to paycheck. Flip investors or buy and hold investors don't. We don't get the week to week pay. We have to wait months until the end of the project to get the big payoff. It is different mindset managing your personal money. GC's just have a very hard time with this waiting mentality because their guys have to be paid weekly. They have big expenses. It puts a lot of financial strain and gives them huge incentive to overbill the partnership and divert funds to get cash now rather than wait for the profit split at the end. This is my experience. It just doesn't work. Often spectacularly doesn't work. You don't end up getting that super reliable trustworthy GC and you have a harder time "holding him accountable" because now he is your partner and you need to get along....and you hugely overpay compared to just having them as your GC because you will pay him his GC fee whether you know it or not.... then you pay him 50% of the profits on top. And if he fucks up the job as a GC you can't fire him. But on the other hand, if a project starts to go bad and it looks like there might not be much profit at the end to split, he will bail on you. There is no incentive to keep putting in his hours to get nothing at the end. He has no capital at risk. Just seems to often turn out the worst of both worlds instead of the best. GC's are generally very very very bad businessmen. They make bad business partners because they have a different thought process and different pain points. You are his side hustle not his main business so you will be treated accordingly. Just hire him as your regular GC. Maybe after several deals together you merge into more but not at the beginning.

Doug Smith · Answer

I wanted to share a story of my biggest mistake. It had nothing to do with real estate investing, but it taught me 2 things: 1) stay in my lane and 2) always use an attorney for documents where there was another party involved. My expertise of 32 years is lending and real estate. I have a formal credit background from 2 of the largest banks in the world and I regularly speak at national conventions on rental lending and the foreclosure crisis. I was a fan of a local restaurant that had the golden opportunity to expand. They came to me for advice and I realized that it was a goldmine. Rather than find a way to lend the money, I became an equity partner and put money in, but I had a minority interest. I was cocky that I didn't need to pay an attorney and I did it myself. Their attorney put all kinds of subtle stuff in the agreements that put my on the hook for about $250K beyond my investment. As soon as they had my significant equity injection, they "voted" (a family) me out and took my money. There was nothing I could do about it and I nearly lost everything including my marriage. Not their products are in stores all over...after using my money to do so. Here's my advice...1) pay a lawyer whatever they ask for to look out for you or don't do the deal at all and 2) make sure you have some sort of control in the deal. Others have offered advice, but I wanted to share my story. I'm very embarrassed to admit that someone who supposedly is an expert in this sort of thing got taken for a ride. I just want to help others avoid the hell that I went through. Good luck to you.

Brett Deas · Answer

My gut says you deserve more because you are doing more. If you want to go 50/50 I would say lay off the property management to him, if you trust him. If not I would go 70/30 or 80/20. Just think, why would you give up % in the deal if you can hire out that part of it and keep the whole?