Does equity partnership makes sense for me?

Question

Hello,

I am looking to acquire rental properties in the Cincinnati, OH market. I make good money, financials in good order, and own a primary residence already. As a way to scale quickly and reach a target goal (25+ units), I have discussed partnering with 3 cousins and each person puts in $20k with equal equity, and I will be the manager and make major decisions for 1% annual fee.

1) Am I being too generous for only 1% fee and equal equity?

2) if others will be limited to only 20k total contribution, and not more, does it even makes sense to partner with them since distribution amounts will be "small" after division? I have lot more disposal income to contribute, but also wanna scale quickly.

3) does limiting partnership, but higher individual contributions, makes more sense even though we will have to move more slowly in the beginning?

Thank you.

Mohamed Berete · Answer

Thank you @Kris Wong, @John Corey, @Tim DiVito and @Eric Martel . Going to use these feedbacks as talking points to flush out the structure with my cousins.

Kris Wong · Answer

The immediate issues I see are:

- You want to close on the properties in your own name. That means your partners, legally speaking, have no ownership in these properties. If you kill someone in a car accident and get sued, they could lose all of their equity. On the flip side, you are also personally liable for the operation of the business. You will have to open your own umbrella policy to protect yourself. That costs money.

- As @John Corey points out, if your bank statement shows $60K in "mystery fund" deposits, the lending bank will ask you about that. When you explain the situation, that will definitely cause issues with the loan.

John Corey · Answer

Mohamed,

I like the ambition. Second, if you are strictly working with family members, there could be some exceptions or other flexibility. Otherwise, be very careful.

1. Lenders will likely have issues with the funds coming from people who are not on the loan. The more people on the loan, the hard it will be to obtain the loan.

2. When you manage money for others or pool funds from multiple people for an investment, you are crossing the line into a securities offering. As I noted, you may be exempt from some of the rules if the group is all 'family'. Even if that is how it started, you may find it is wiser to use a property securities set up so you can adjust in the future. Maybe someone gets married or divorced. Maybe one person needs out and a close friend wants in. Events like this can easily change the structure.

3. The more you manage money for others, the more you have liability to deliver. Be clear about the legal requirements and consider insurance. Errors and omissions can and will happen.

Mohamed Berete · Answer

Quick note: I have no prior experience in this space. I am a software engineer, but have consumed ton of material and contents over past 6 months.

Mohamed Berete · Answer

Thanks for the great and quick feedbacks. I will try to be as detailed here:

1) There will be 4 us total, including myself. Each will put in 20k for 25% equity. So total raised is 80k. For this, I think we will max out between 3 - 5 units with a combination of SFR, duplex, or triplex. Most likely only myself and 1 other person will be able to go beyond this 20k number in the long run.

2) I will be the one taking out conventional loans for these properties, especially in the beginning, because of my financial positions. I make more than 120k a year. I hope to transition to other financing options once theres credibility. For my "troubles," I will get 1% fee for the amount financed as a one time line item expense.

2) I have a personal goal of 30+ units (or way more), and prepared to invest more dollars probably in a new LLC after this initial round. After couple of units, I think it will be easier to get other financing.

3) I "manager" of the overall business. Starting with creating the LLC and operating agreement. Working with the realtor to find deals and put them together. Finding the right tools and putting the business ops and processes in place. For these duties, I will take 1% fee per year of the total dollars we raise.

4) We will share the property management responsibilities.

5) There will be no distribution before 2 years. After that, it will be quarterly per equity.

My logic here was that it will be easier to get the first few properties with less out of pocket costs and leverage that into more credibility to get financing deals with banks. While that is good, it doesn't feel right. However, not sure what additional equity I should get or whether I should even do it.

Eric Martel · Answer

Not sure what you mean by being the manager. Do you mean property manager or just GM? If you are looking for a percentage for doing Property Management such as finding tenants, repair and maintenance calls, and handling tenant issues then the going rate is more 8-10% of gross rent not 1%. If you are talking about management as a GP/Sponsor then I always look at my return and my investor's return to make sure it is attractive for both sides.

First you should get consideration as part for putting the deal together (Acquisition Fee): finding the deal, making offer, EMD, creating the structure of the LLC/LP, finding financing, finding property management, ... If you are getting financing and you are the guarantor on the loan then you deserve some additional consideration.

Then determine the value of General management such as: paying certain bills, communication with property manager, accounting, working with CPA on tax reporting.

Then calculate the final returns for yourself and your investors. The returns were never high enough for us to split cashflow on residential properties.

Steve K. · Answer

@Mohamed Berete

Welcome to BP. Looks like your first post.

It's worth a lot more to your "investors" than 1% fee. But, you may not be an experienced expert operator of this partnership?

It's not as simple as pooling $80,000 between you and buying the 1st property and repeating until you have 25. (and by the way, is your goal to own 25% of 100 units, or 25% of 25 units? If you're talking small properties, it's a lot of work to share 4 ways??? What if loans are needed in the future? will you be 100% on the hook for the loan, and let the "investors" have a free ride on risk of foreclosure?

Separately, listen to some podcasts on multi-family syndications. In this established industry, it's customary for a passive investor to earn 70% of the rewards and the manager makes around 30%.....but they have to have a proven track record before they can get that investor to trust in them. To repeat. The folks with the money get 70% (and contribute no day to day manpower), the manager has the vision, locates the property, closes on the transaction, arranges financing and oversees an onsite manager.....and get's 30% of profit (without putting any money into the down payment)

If you own a single family rental, you'd pay 6 to 10% of rent proceeds to hire a realtor to manage the property and tenants for you. Are you doing that job too, for the 1%?

Tim DiVito · Answer

That sounds low to me.... mostly because I know how much work you are in for.  I do like that there will be one clear decision maker/ manager. Not having that has caused me disaster in the past.  Have you considered doing it for more equity in the partnership.   Perhaps you keep at the 1% so that you can maintain cash flow but then take an additional 5-10% in sweat equity.  In a sense you are making them silent partners and your payoff would be more long term.

Kris Wong · Answer

Before I answer your questions, I need to ask what size properties you plan to invest in? 2 - 4 unit properties have additional considerations due to differences in lending (residential vs. commercial).

Also, the size of the deals is a consideration in your first question. I suggest you estimate what your 1% "asset management" fee will earn you, and the number of hours you will work to earn it.

$60K in total contributions obviously won't get you too far, but maybe it gets you into a deal or 2, and allows you to provide a decent return to them. Is it worth it to you to deal with the overhead of a partnership?

You also need to understand that what you are proposing is syndication, and is technically under the purview of the SEC. Perhaps if it's only your 3 cousins investing, you are not concerned with that, but if you start to accept investments from others, you need to talk to an SEC attorney (or at least research the regulations on your own). If any of your investors were to sue you for whatever reason, you could find yourself in hot water.

Does equity partnership makes sense for me?

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