What percentage of equity is my work worth?

Question

Hello all!

Background: I am a 20 year old Junior in college (Go Irish!) who wants to get started with REI through rental properties. Thanks to BP's podcast, forums, articles, etc. I have narrowed down a market and established search/analysis criteria. I am fairly confident in these criteria, since every property that my analysis has deemed a deal has been snatched up within days of its listing. I'm now interested in getting involved and am in need of funding.

Current situation: I have found a duplex in MI that hits my cashflow needs and now am looking for ways to fund its acquisition. My plan was to put some of my savings in and get the rest of the down payment from my family. There lies the rub: how much equity should I get in this deal? From a pure capital perspective, I am putting in ~20% of the down payment. However this doesn't take into account the search, analysis, arrangement of PM, etc. All my family has to do is look at my numbers and agree to chip in.

Thanks for your responses!

(PS: If anybody has advice on financing options as a 20 year old college student, I would heartily appreciate it. My impression is that it is virtually impossible to secure a mortgage since I have no real income.)

Caleb Heimsoth · Answer

@Gabriel Krut how far is this target market in MI from where you live at notre dame? Your profile says you’re from San Diego, so is that where all your family lives?

I ask because investing in a non-local market while you’re in school sounds like a bad idea.  I recommend finishing school and getting a job first.

As far as what your equity percentage is, I’d say it’s 20 percent.  While deal analysis is worth something, the reality is you won’t be on the loan or you need a co-signer since you have no income.  Either way the person fronting the rest of the downpayment and co-signing the loan is taking way more risk than you.

If you take the family situation out of it, and look at it like a normal deal, I’d give you 20 percent equity if I’m the other investor.

Finally you should post some numbers on your deal, as there’s no way to tell if it’s a good deal or not based on what you’ve said

Lee Ripma · Answer

@Gabriel Krut

I think you’ll have a tough time getting a RES loan that will be sold on the secondary market, the loans with low interest, 30 year am, and backed by Fannie/Freddie.

There are alternative loans based only on your credit score. Some even have 30 year ams. However the interest is more like 7% rather than 4.5-5%. You can also look for a local bank that will give you a portfolio loan, again higher interest, they hold loan on their books, and it’s going to be tough without income unless you have a high networth (guessing that isn’t the case). You could also check into Commerical loans but same problem, no income, no track record, not a huge networth.

So if you’ve got someone in the family willing to get the loan that may be your best bet. Look into the other options but tough go right now.

You could also add a lot of value to the property using short term hard or private money and then go for a refi. Still going to have a lot of the same problems but at least you’ll own the property!

Russell Brazil · Answer

If you are putting in 20% of the funds, id say you are due 20% of the equity. You work in this instance would be worth zero, as you lack the capability to borrow.

Andrew Brewer · Answer

contrary to what others have said here, I would say your time is definitely worth something otherwise why would you put in the time and effort to find properties when you could just passively invest for the same percentage equity stake?The capital partner is just that, a capital partner, if finding and setting up deals was so easy then everyone would do it and there would be no passive investors.

Remember you've put in the time and effort to become educated on the subject matter and theoretically could have analyzed many more properties than just the one you're buying which means your overall time output is higher than just what you've done on the one property you buy. In addition, it sounds like you will be taking the time to structure the deal, and after closing you probably will be the one managing the manager.

If you aren't worth more to the deal than the money you're putting in then you should just be a passive investor and save yourself the headache. People are compensated based on what they bring, this could be many things: Money, deal, expertise, sweat equity, co-signing ability, ability to get a loan, etc the compensation for all of these things is negotiable.

That being said, holding to a specific equity split without regard to your capital investors return is not advisable. I recommend running numbers and looking at what the return would be to the capital investor. An investors potential return is going to be the most important factor in determining what percentage of the deal you can take. Figure out what you think it would take to get someone to invest with you, look at deals others are doing and what they offer investors. Is it 8% cash flow/yr? Is it 12% cash flow/yr? I would recommend using your capital partner as a co-signer on the loan, or have you co-sign on the loan they take out to show that you have "skin in the game"

Another thing to consider is the timeline of the deal. Do you plan on holding the property for five years and then selling? Or are you planning on holding indefinitely. When will your investor(s) be cashed out and what will their return be?

Running these numbers will also give you an idea of whether the property is actually a good deal also.

If you are getting the money from family, they might be willing to give it to you interest free or for a low rate for a period of time as a favor to help you get started, but I would strive to offer them some return. Remember -- money in the bank or a CD right now returns less than 3% so offering them 6-8% on a solid deal could be a good incentive.

Gabriel Krut · Answer

Thanks for your replies, all.

@Caleb Heimsoth, I am from San Diego, family is spread out but mostly in SoCal. The property is ~2 hour drive from school.

Caleb & @Russell Brazil, your points about being unable to borrow makes sense. 20% seems fair now for a first deal.

@Tim Delaney, As above, I now agree that no additional equity is deserved. As for talking to banks, is there ever a situation in which I would be able to qualify for a mortgage? I have a very strong credit score, but obviously low/no income.

Tim Delaney · Answer

I'm not sure about the equity split - that seems like more of a comfort level issue between you and your investors. However, you should probably be willing to accept a pretty low number since its your first deal.

It is still worth talking to banks. You should also consider trying to to find something near you that you can buy with a 3% down FHA loan.

Tim Delaney · Answer

I'm not sure on all the specifics of an FHA, but you are right, you may not qualify without any external income. However, if you can show a bank that the mortgage/taxes/insurance are only 80% of the expected income of the property they may approve you. It will probably be tough though without doing at least one deal to prove that you know what you are doing.

What percentage of equity is my work worth?

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