Ideas for joint venture arrangements for vacation rentals

[Chris Luth]

The TL;DR version of the question: How should I structure a JV agreement between me (acquisition/management) and a silent partner (capital) specifically for a long-term investment in a vacation rental property? Any particularly creative (and mutually-beneficial) arrangements I should think of?

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I manage several vacation rental properties and have an ownership interest in most of them. I'd like to continue expanding my portfolio with some great off-market deals that are available now, but I'm out of my capital.

Background:

Vacation rentals here in the Branson market are quite a lucrative investment because the cost to acquire property is relatively low, but nightly rent rates are strong and the tourist season is long. The properties I've acquired myself have performed extremely well (extremely high cap rates and cash-on-cash returns).

I started out self-managing my own properties, but I took on a few clients who were attracted by seeing how well my properties were performing. (My units tend to average 25-50% higher occupancy than most others in the market.) Word has sort of gotten around that I know what I'm doing, which is kind of nice...and I'd like to try to leverage that positive reputation to open up some deals I wouldn't otherwise be able to access right now.

Goals:

Since I'm out of capital myself for now, I see three possible ways I can leverage this expertise:

• Manage others' properties for a commission
• Source private money for down payments and purchase them myself
• Form a joint-venture partnership with someone who has capital

I've already done the first two ideas, but I'm really intrigued by the last one. I actually have been approached by several investors who have expressed interest in doing something together, but I'm struggling to think of how to structure the arrangement.

I'm not really interested in the traditional 50/50 split where we each put up half of the capital, since I'm out. Plus, I'd be managing the property and they'd be pretty much a silent partner, so there would be an imbalance in the amount of work there.

What attracts me to the idea of a JV is that it's a way for me to basically trade my expertise and my work for equity. I could simply offer to manage the property for them, but I'm willing to forgo short-term revenue and cashflow for long-term equity and wealth building.

Value-adds:

Here are the three major things I think I bring to the table that other investors (especially those not focused on this niche of the market) don't have:

• Acquisition: Access to off-market vacation-rental-approved properties at below-market rates
• Set-up: Expertise with navigating the necessary licensing, connections to furnish properties quickly and extremely affordably
• Operation: Successful (and proven) management (above-market revenue and occupancy--high reviews, fast response time, competitive rates, etc.)

I would thus definitely say I bring value to the table. I know a number of investors who are interested in jumping into the world of vacation rental but don't really know how to navigate it and/or don't have the time to dedicate to it, because it is a more active form of investing than a traditional passive rental.

Analysis:

So what I'm trying to do is figure out a way to leverage the high returns in this market and create value for both myself and other investors in a fair way.

I see a lot of discussions in other threads about 50/50 JV partners--one person puts up all the capital and the other (usually the enterprising flipper) does all the work. Would such a model work here, where the goal isn't a quick turnaround and a big payoff but rather a long-term investment with positive cashflow?

Let me set up two hypothetical examples here.

1. A four-bedroom turnkey vacation rental property for $230,000, financed at 85% LTV and 5.5% interest on a 25-year amortization, with $37,000 cash required for down payment/closing/set-up costs, with expected revenues of $65,000 and expenses of $22,000 for a net income of $43,000 per year. After debt service, the expected positive cashflow is $28,500. That equates to a cap rate of 18.7% and a cash-on-cash return of 83%.
2. A three-bedroom unfurnished vacation rental condo for $90,000, financed at 80% LTV and 5.5% interest on a 20-year amortization, with $33,000 cash required for down payment/closing/furnishings, with expected revenues of $24,000 and expenses of $11,500 for a net income of $12,500 per year. After debt service, the expected positive cashflow is $7,000 per year. That equates to a cap rate of 13.9% and a cash-on-cash return of 20%.

Most vacation rental managers in this market collect a commission on gross revenue of between 25-40%, which eats away at a good chunk of (or, in some cases, all of) the owner's cashflow. Plugging an average 30% management fee into the two examples above, the first owner would see his or her cashflow drop to about $8,000 per year (10% cap and 24% cash-on-cash return), while the second owner would see his or her cashflow go slightly (~$300) negative (6% cap and -1% cash-on-cash return).

In contrast, if I were to approach an investor with an idea of a 50/50 JV agreement, where they put up the capital, I take no management fee, and we share equity and cashflow 50%, the first owner would see cashflow of $14,250 per year (38% cash-on-cash return), and the second owner would see cashflow of $3,500 per year (10% cash-on-cash return)--both significantly better than hiring a professional manager.

Of course, in the second scenario, I would end up with less cashflow than I would managing the same property at 30% ($14,250 vs. $19,500 for the first and $3,500 vs. $7,200 for the second), but that's OK with me because now I have equity in the property (with a potential infinite rate of return if and when the property is sold).

The question:

So, would something like this be an equitable arrangement? And, perhaps more importantly, what would a "typical" investor looking to partner up with me expect as far as a return on investment?

Obviously the first example is quite generous no matter how you slice it, but that second example is pretty lean (or at least I guess it's comparable with a moderately performing long-term rental), so I'm guessing that there's a line somewhere in there that maybe I should target to keep above as I do my math--12%? 15%? 20%?

If I can't meet that minimum standard of being an attractive investment with a 50/50 JV arrangement, are there any creative ideas for what a JV agreement might look like? I thought of a few options but wasn't sure how they'd work out in practice:

• Reduce my equity stake (say, 30% instead of 50%--in that second example, that would effectively give my partner a 14.8% cash-on-cash return)
• Stick with a 50% equity stake but agree that my partner is entitled to a greater share of any monthly cashflow to meet their rate of return goals
• Designate that a higher portion (e.g. 75% or 100%) of any cashflow goes to my partner until it's equal to their initial cash investment, after which it reverts to an even split (so assuming 100% of positive cashflow goes to my partner, in the second example, he or she would be "repaid" in 2 years 8 months)
• Tie my equity to my work (as a manager) on a sliding scale--at closing, my partner would have 100% equity, but I would effectively "buy into" the property over time based on what I would have otherwise taken as a management fee (in the second example, since a 30% management fee would normally grant me $7,200 per year, I'd effectively "repay" $7,200 per year towards my half ($16,500) of the $33,000 cash invested in the property, and so after the first year, I'd own a 21.8% equity stake, after the second I'd own a 43.6% equity stake, and then after 2 years 4 months, I'd hit my 50% equity stake)

These are just a few "creative" things I came up with after mulling this over a bit, but maybe there are downsides to some of them or maybe there are other options. I guess that's why they call all this stuff "creative financing." :)

Anyway, I thought I'd run this by the BiggerPockets community so y'all could poke holes in my logic or shoot me down entirely. :) Thanks!