Rental Property Investor · Concord, CA · Member since 2016 · 499 posts · 219 votes
So I have been thinking about this a lot for the last few days. In a partneship, if one person is a money guy and the other is the rehab guy with a split for 80/20 or 60/40 (take your pick on the numbers). Now after refinancing (only money guy on loan), they split the extra proceeds based on the split. Here are the numbers (hypothetical):
Purchase price: $200,000
Repair: $75,000
ARV: $400,000
Cash out while refinancing with 20% down: $45,000 (ignoring the closing costs)
60/40 split: $27,000/$18,000
All good so far. Now what happens if economy tanks (extreme scenario) and partners are unable to rent the space out so they are forced to sell. Since the rehab guy doesn't have skin in the game and already took the cash out split, they can just walk away, leaving the money guy to pay for that extra $18000 that was given to rehab guy.
How would you avoid that? Would that ever happen? Does the refinance bank ask for rehab guy on loan as well? Or its just better to get an asset based loan to avoid all this?
Investor · Kansas City, MO · Member since 2017 · 791 posts · 1k+ votes
9y
Also in your scenario, take a look at the other side... economy booms, it becomes worth $700k and they sell. The cash guy is the only one on the loan and title. Cash guy could sell, get $300-400k and rehab partner has no real recourse to claim he's owed any of it.
Rental Property Investor · Concord, CA · Member since 2016 · 499 posts · 219 votes
9y
@Austin Fruechting .. Thanks for your comments ... the rehab guy gets the 40% split after expenses in the scenario you mentioned. The title would be in LLC and both the guys are 60/40 partners in LLC.
Investor · Kansas City, MO · Member since 2017 · 791 posts · 1k+ votes
9y
If rehab guy is on the LLC, and loan and title will be in the LLC name, rehab guy will be on the loan and be signing personal guarantees in most cases until you get into much larger non-recourse loans.
Rental Property Investor · Concord, CA · Member since 2016 · 499 posts · 219 votes
9y
@Austin Fruechting Interesting .. I thought only the money guy would go on the loan ... So far I have invested alone so had no clue what to expect in partnerships ...
@Austin Fruechting Interesting .. I thought only the money guy would go on the loan ... So far I have invested alone so had no clue what to expect in partnerships ...
If the loan is in the LLC name, most likely you'd both be on the loan. With my bank anyone that is 25% or more owner has to be underwritten.
Even if a bank would be willing to write the loan for only one member of the LLC, a solidly written operating agreement can provide some additional legal recourse of obligations to the LLC in an event like that.
It's good you're thinking about all of this. It's best to have all the scenarios thought out, planned out, and written out in the operating agreement as opposed to having to deal with stuff as it comes up.
Real Estate Broker · Austin, TX · Member since 2012 · 1k+ posts · 1k+ votes
9y
@Avi Garg In addition to all the really great ideas, it would be smart, in my opinion to talk to a good attorney. A good experienced real estate attorney will have some great ideas to mitigate the risks for both partners. It might cost you $200 for the advice and then an additional $300 for doing the llc but in my opinion its better to be proactive than reactive on a deal. My attorney is well worth his fees. I swear by the guy as he has saved me thousands and have even made me a bunch of money as well. A cpa might be a helpful too.
Investor and CPA · Arvada, CO · Member since 2015 · 2k+ posts · 3k+ votes
9y
A partnership and the loans associated with it can go any way you choose - both on the loan, only one - whatever.
The key here is the Operating Agreement of the Partnership. If the property is an asset of the partnership, the loan can be structured in any manner that works out best (probably as a loan of the LLC, but can honestly go any way the bank will allow it to).
In the Operating Agreement, you spell out what happens in different contingencies, such as economic tank, economic growth, etc. If a partner skips out on a loan, the recourse occurs through the courts, utilizing the Operating Agreement as the ultimate guide for what should happen. The courts will then enforce the Operating Agreement as written.
This is why I always tell people who are going into partnership with somebody they aren't married to to get their Operating Agreement done by a VERY competent attorney. The attorney will write anything into the Operating Agreement that you want (money guy brings donuts on Fridays. If the house is sold on a Tuesday, then rehab guy takes everybody out for drinks). It can get as specific as the partners want.
Then when somebody doesn't live up to the agreement, that Operating Agreement is as iron clad as it could be and the courts force the partners to live up to the agreement they signed.