Partnership with contractor - what's fair?

Question

Sparing some details here - I've completed a few flip projects using my contractor. Looking to partner up on the next project to see how it'll go. I'm the capital guy and accountant, he's the construction arm- we both serve as 'acquisition managers' finding deals and we're both on any loan we need to take out. Essentially I fund the down payment and rehab costs up to a certain amount. We've decided on a 50/50 split in profits.

I'm hung up on if the contractor should be paid at all for his personal labor in the project as an expense that will be reimbursed before we split the profits. If so, I'd argue I would need a finders fee for getting the deal, a % for accounting etc. It could get messy. My belief is if he needs to sub anything out, we'd agree and the sub would be paid directly. But, what about his own time? Shouldn't his sweat equity be the input in this deal so he should not be compensated?

Hope I'm clear in what I'm asking.

Leigh C · Answer

@Aref Shehadeh This has been talked about so many times. You are going to get the contractors on here with their point of view their time is gold. The investors that are experienced say they are a dime a dozen. The newbies and newcomers thinking everything in between. Each flip has a different amount of work and what you will more than likely find is your contractor won't physical do most of the work if he can outsource it with you paying half the bill. It takes time for them to get lazy though.It's capitalism, pay them no more than it would cost for you to replace their contribution while still maintaining enough profit for yourself to justify the deal.

Derek Cahill · Answer

I completely agree with what some of the others have said in this situation. If you are having a contractor come for just the work and they are not helping you sort out properties ect. It may be best to just to hire someone out.To clarify what I said before.Whoever is doing the work is going to be giving the flipper or investor a price to do the work and for almost all of us, that is just labor cost since flippers are usually the ones buying the materials. I am physically the one doing the work, so I give a quote based on the work that needs to be done. What ever that quote comes out to be, that is my investment. So if it's $20,000. I'm investing that much money into the property in the form of my time and craft. Than the same way other investor's put in their money and and get their initial investment back on the house plus interest or a percentage, I get my initial investment back in the form of money, since their is no way to give someone more time.In the bigger scheme of things, and looking at if you just split 50/50 with your contact. If you end up with a final profit of 10,000 and now you split it. You each get 5k. However did you get back your down payment back that you put on the house originally? I'm assuming yes, because paying back initial investments is part of getting to your profit. So now you get your investment of let's say 10,0000 back so you are at ZERO for your investment. Now you only get profit of 5K. . . If the contractor only gets his $5,000 but it was $20,000 worth of time he invested. Now he's in the red $15,0000. A HUGE aspect that I had to totally understand before I felt like it was a WIN WIN for everyone was the aspect that TIME IS MONEY and that is the investment we are making..The biggest piece I see for this being an issue is if you have the money and you don't need any other aspects from the contractor and you can do it on your own. Than do it. . We are just starting out and all bring different strengths, plus we are friends and push each other. Every situation is different and I hope I was able to better explain. If not, I would be happy to keep answering questions.Derek

Jared Cali · Answer

These are very good ideas for a rehab and flip. I typically take the seasoned contractor view (as one!) But clearly see the investor stand point of not wanting to be burned and protecting their investment. My question now is; how does this change in an investor/contractor partnership for the famous BRRR method (Buy, Rehab, Rent, Refinance, Repeat)? We are looking to create a portfolio of rental properties.

Aref Shehadeh · Answer

Late reply... So, like you said. Your situation may warrant your partnership setup for sure, especially just starting off. I'd like to stir the pot a bit, though... How do you quantify/ come up with your figure? Is it a market based labor charge? For instance if your figure is $50 an hour for other projects, are you using the same numbers with the partner? I ask because I believe there should be some discounting as part of this partnership... Unless your partner is truly just a passive money guy. Is he?For my potential partnership setup, I am usually finding the deal, making sure we're on budget, helping with house design, helping with materials, and more ON TOP of being the money guy. That being said, im certainly not acting as general contractor so that is where Im seeing value in partnering with one (assuming they're legit). My guy has done his share of house flips so he has an understanding of the law of diminishing returns so I know I can truly let him be if I need to. My vision is to be able to scale quickly and not have to worry about the construction side- holding him accountable to that end.But, I am interested in the partnership IF he's working to cover what he needs (not necessarily profiting). It's all about the deal, so your example would probably be unrealistic. Putting in $20K of effort into a project that would only yield $10K? And you mentioned that is for labor only. Clearly that deal should never happen. With my partnership, we're looking to only jump into deals in which we make 20% margin. So typically splits of $40K ($20K each) before I pay him for an agreed upon labor kickback... In that example the contractor will likely have $15K of MARKET effort in the project. But we both know he is not getting that. Again, all about the deal. If I needed to pay him $15K ... Then I would need to be reimbursed for my time as well... An acquisition fee, an accounting fee, a project management fee, etc... Gets too hairy. Rather keep it simple and agree on the labor kickback project by project. I'm going to see how it goes for a couple projects!Thanks for your perspective, though. It truly does depend on the levels of experiences, the deal, the market and more. Great conversation!!

Josh Nix · Answer

I do this same thing with my partner, except he is strictly the money guy and I find the deals, fix the deal or manage the subs, market the deals, figure the numbers etc. We split profit 50/50 I don't get a dime until its sold. I don't mind doing this for now because I couldn't do it without him but it's not my long term plan. I think your partner has it made, unless you need him to get the loans with you. I would talk to him because you could just pay another contractor what your paying him and the subs but making 100% of the profit. just my 2 cents

Derek Cahill · Answer

Just some insight from the opposite side of the coin. As the contracting partner in the Flipping aspect of things. My investment to the process comes in the form of my time, which like you said is sweat equity. Where as my partner, who is the money man and financial loan side of things, uses his money as an investment. We both spend time looking over properties, he spends more time handling meeting with an other investors we may have as well as working with the hard money lenders.I am a numbers guy, so I will explain my point using an example.Say the down payment is $10,000 that my partner covers the cost for, as well as $10,000 for all material going into the house. (again this is just an example so I'm making the numbers easy to follow) Now, my end with the construction and remodeling. I come up with a total labor amount that would be $20,000 with the amount of work that needs to be done. Now when we sell the house, both of us are paid our portion of our investment back. His in the form of cash for cash, and mine time for cash. Time is the most valuable item we have so their for splitting the money 50/50 after would only make logical since. It has been a big win win to start our flipping process. Hope this helps you all see the other side of the coin.

Cave Johnson · Answer

If your contractor partner is on the note he has the same liability as you the money man. I like the idea Aref had. Agree on a labor fee up front that is paid before the profit split.

Aref Shehadeh · Answer

Hi Derek, very helpful. My partner and I have pretty much the same setup. Though, I was following until you said "I come up with a total labor amount that would be $20,000 with the amount of work that needs to be done." This confuses me because you said your investment is in your time, maybe it's just semantics.How do you determine this total labor amount? Is it determined based on your market rate or is it simply your cost after paying subs. In other words, are you profiting from that $20,000? Like others have said here, if you (or my contractor) is benefiting financially from the labor amount that will be paid back, it would make more sense to just hire a contractor rather than split the profits. Thanks!

Jordan Truelove · Answer

I would have to agree with @Josh Nix. If you need him to get the loan that is good reason to split commissions with him. If you are doing it because you are friends and/or you just wanted to have a partner to make it easier on yourself so you did not have to deal with getting all the subs together and paying them individually for all their work that's a different story. You are not paying yourself finders fee or accounting fee, he should not ask to be paid for reno on top of his 50% split. Im being kind of redundant here but I think it is important you dont get walked on!! Best of luck @Aref Shehadeh!