Partnership Model - do you think this would work out?

Question

Hi everyone! As I'm new to real estate investing and to BP, I've been reading and educating myself a lot before going into anything solid, but I do want to start as soon as I feel ready to.

Sorry if this post is really basic, but wanted to hear your insights and ideas on this.

I currently have around 20k to invest only and a really good access to credit, so I've been thinking a lot on how to make a partnership with such money work for both me and my partner. So I thought about a strategy and wanted to hear your thoughts on this if this makes sense or if doesn't.

I'd like to start with a flip, and my main concern would be about renovation costs, as they usually are not included in mortgages. So I thought about a partnership where I would come up with the mortgage to buy the property, and my partner would come with the money for the renovation. So just an example (of course these are rough and hypothetical numbers just to exemplify the idea, and not the numbers)

Purchase cost of the house = 100k (I can make a 20k down payment, and finance the other 80k).

Renovation costs = 40k (which will come from my partner)

After repair value = 200k (sticking to the 70% rule just for an example)

In this example, that would give me 71% of the partnership and 29% to my partner giving us roughly (just some HGTV calculation, but I do know there are lots of other costs, but again, I just to exemplify the strategy) 43k of profit to me (after paying out the whole mortgage) and 17k of profit to my partner.

Do you think this would be a doable strategy? Do you think this can work? Am I missing something here? Again, I do know that there are several other costs to consider (holding costs, closing costs, fees, insurance, etc, etc ), and market conditions, etc. Just need your inputs in the partnership model.

Any thoughts will be greatly appreciated.

Thanks!

Tae C. · Answer

@Stefano Grottoli

Who would be actually managing the rehab?  Who would find and bring the deal?  I think those types of role definitions would play a factor in the profit split.

Andrew Kerr · Answer

@Tae C. we were doing a slow flip. Buying distressed, rehabbing, raising rents, and basically forcing appreciation to increase value. We took this approach so we wouldn't be taxed at regular income on the gains. The shortest one we did in 13 months and the longest was 3 1/2 years. The split was of net profit. We paid all costs to own and run the property, management, carry costs, utilities, maintenance, capex ex, then what was let was split.

Brian Schmelzlen · Answer

You are not wrong, but most investors place a high value on cash.  Therefore, they tend to look at things from how much cash is on the line, and view debt as a cost of business.  Don't gt me wrong, the fact that the loan is in your name definitely means something, but I simply don't think that most investors would give it the same weight as the cash you are contributing.  I know I wouldn't.

There are other factors that should go into the profit-split calculation as well.  Who will be doing what work?  If you are only looking for a money partner, and you will be putting in everything you said plus be responsible for all the work I think 70-80% of the profit is reasonable.

Andrew Kerr · Answer

@Stefano Pellegrino Grottoli - yep you could very well do it that way.

As an example, if you approached me and said you were putting in $100k cash, I would be fine with it. But if I feel like you were only putting in $20k cash and getting a loan for $80k, to me that isn't the same level of risk as putting in $100k. But that is my personal preference.

When I have talked with partners and investors, I also go with the approach of building a relationship first, then find their needs/goals/objectives, then present my option for a return. You could very well find folks that would jump on board with your idea.

I would look at potential returns for them. If they put in $40k, are they getting a 6% return or a 20% return. I found if someone is getting a 20% return they tend to not care as much about splits. I did these great series of investments with a father and son. They put in all the cash, I did the work and got the financing. They averaged 10-14% cash return each year. Then when we sold they got almost double their principal back. I made great money, but it was such a win for them, they were ecstatic and provided dozens of referrals.

I get you want to make money, we all do, but you are also new. I am very big on paying the money partners very well. I want them walking away not with a good deal but with a great deal.

Don't let this discourage or dissuade you from your potential split. I would go try it out. Then if you don't get anyone to bite, go back to the drawing board.

Andrew Kerr · Answer

@Stefano Pellegrino Grottoli the example you gave could very well work. I would just present it to a few folks and see how it goes. You could easily find someone that just has cash sitting in a bank so that would be a good deal for them.

While you are taking the risk of holding the mortgage, keep in mind you couldn't do the deal above without that extra cash from the other partner. And they are putting in twice the cash you are, so they have more capital at risk. My view is this money is riskier, as when you sell, the loan gets paid off first, and the capital is what is at risk. I think you should also pay the money well. So well it is a no brainer and they come back to do it again.

As an example. What if you put up the down payment, they put up the capital for the reno, then when you sell, the loan gets paid first, each person's initial capital put in is returned, then any profit is split 50/50.

Brian Schmelzlen · Answer

That is a workable strategy if you can find a partner willing to do it.

Although the loan would be in your name and thus there is more potential risk for you, you have to consider the fact that any potential partner would (probably) be looking primarily at how much cash you are both putting into the deal.  If I was putting in twice as much cash as my partner, I would not want only 29% of the profits.

I think the fact that you have the mortgage in your name and would be putting up 1/3 of the cash is a good argument for it to be a 50/50 partnership.  If you can negotiate a better deal with a partner, go for it, but that is my thought.

Also, I would spend a lot of time courting the right partner.  You are essentially marrying the person, so make sure you both are comfortable with each other and can work well together before either one of you commits so much money.

Stefano Grottoli · Answer

Thank you! I absolutely agree with you, and thank you for the insights. I will probably go for something like 50/50. Just wanted to get a sense if I could start in the business with the amount of money that I have, and now I'm more confident that yes, I can (and will). Thank you so much!

Rich Cavanagh · Answer

This! ^

Make sure you take the time and break down every detail. The responsibilities of each individual as well as how you will handle multiple unforeseen bumps in the road. What happens if you need more cash for closing? If you need more cash for rehab? who is responsible?

This is where a lot of people go wrong with partnerships. Some people are skiddish about putting these scenarios on the table for discussion and getting them in writing but its not out of mistrust....or shouldn't be if you are seriously considering them as a partner. The reason for a detailed plan / breakdown of responsibility is to clearly and swiftly set a standard for the course of the partnership and then squash any potential breakdown later on down the road in case either partner forgets what was agreed to.

Personally, I like a percentage based split. 60/40 for example. They may be more comfortable with that as well. Rehab numbers can be off. Especially when you are new. Percentage based splits make it feel like you are more in the game together in case the numbers are off...for better or worse. At least IMO.

Tae C. · Answer

@Andrew Kerr

Ok gotcha, I didn't realize you were saying you guys had held as rentals for a little while.  I was assuming it was just a straight flip, so I was a bit confused on that 10-14% return you were talking about.  So if you got financing, I would assume there were holding costs with the interest payments as well as utilities, etc. - were you paying those every month?  And if so, did you recuperate those costs before the profit split on the back end?

Andrew Kerr · Answer

@Tae C. with that specific example I did four deals with the son and one with the dad. They put in the cash, I found the deal, structured the deal, got financing, managed the rehab and put management in place. We split net cash flow at 50/50. Then when we sold, the loan was paid first, their initial investment was returned then we split any profit above that 50/50. They average a yearly return between 10-14% return on their cash, I made the same as they did but had no capital at play. When we sold they got back almost double. As an example he put in $20k for rehab, he made 10-14% per year on that $20k. Then when we sold he got back about $38k, so almost twice what he put in.

These were high value add deals with a lot of forced appreciation. I also don’t see deals like these today as cap rates are so compressed.

Partnership Model - do you think this would work out?

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