Sweat equity in a partnership agreement

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Sweat equity in a partnership agreement

Hillary Windrem
Member since 2021 · 6 posts · 1 vote

Hello everyone, this is a two-part question. 

Our family is discussing pooling our resources to invest in real estate. My husband and I already have experience with rental property. My mom has a good bit of cash from a divorce. The idea is for her to buy a property cash. My husband and I would pay for improvements, supervise the work, and manage the rental. Once rented, the rent would go to us, and all equity/future profit from sale would be hers. We would formalize this with the help of a real estate attorney to keep things tidy. My first question is: does this sound like a fair agreement?

The second part of my question pertains to my brother who does not have liquid assets but is able to invest sweat equity. He paints and is handy in a lot of other ways (though is not a licensed contractor). We want a way for him to participate in deals like this if he is interested, but don't really know how to bring him onboard without being able to easily calculate % ownership based on $ paid in. I hope this makes sense. Has anyone ever let someone earn a stake in a property via labor? If so, how did you structure it? Is there any way to do it without someone feeling like they got stiffed? Is this a stupid idea? (We would have him sign workman's comp waivers and formalize everything with a contract)

TIA

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  • Hillary Windrem
    OP
    Member since 2021 · 6 posts · 1 vote
    5y

    Realizing someone is going to ask for the numbers.  Over ten years the net equity (which would go to my mom) is estimated to be around 46,000, plus she would have the tax benefits. Our collected rent payments over ten years would net 56,000. 

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  • Peter MckernanBusiness Member
    Residential Real Estate Agent · Irvine, CA · Member since 2013 · 2k+ posts · 1k+ votes
    5y

    @Hillary Windrem great idea of getting that money together to do the deal, the biggest thing that you need to work out with the attorney and the people involved is the % that is fair to all parties. You could for instance a 33.3% spilt for 3 people and 2 out of the 3 are putting in money, and the 3rd is just doing all the work hiring the contractor, and doing the property management each year indefinitely. Even if they are doing the work/labor of the whole deal, and that works for everyone else that is perfect. 

    Anything can be drafted by an attorney in the AO of the partnership, it depends on all the people involved. 

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  • Kevin Sobilo
    Realtor · Hanover Twp, PA · Member since 2018 · 3k+ posts · 3k+ votes
    5y

    @Hillary Windrem, it does not sound like a fair arrangement. It is too haphazard. You mom might be bankrolling most of this, but only getting a modest equity/appreciation return. Appreciation is the least controllable part of a real estate investment. So, she has a risky investment that COULD lose money while you have a safer investment collecting cashflow!

    If you are partners you should share the same risks and NOT have opposing interests in the deal!

    My recommendations are:

    1) All partners should have an ownership interest strictly based on their financial contribution.

    2) Anyone doing active work for the partnership should be paid based on the value of the work

    For example: You might be paid $2k to manage the rehab, plus 8% of rent collected to manage the rentals. Your brother should be paid hourly for his work and if he wants that money can be set aside and put toward a future deal/partnership.

    This way everyone is working towards the same goals. Everyone is compensated fairly for what they do. Also, if you decided later on to hire a PM, the cost would transition seamlessly because it would be around the same 8% you were paying yourself. 

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  • Hillary Windrem
    OP
    Member since 2021 · 6 posts · 1 vote
    5y

    @Kevin Sobilo thanks for your input. I agree with you that I don’t think my brother can have a % ownership and our best bet is to hire him, pay him well, and give him excellent referrals until he can save $ to invest.

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  • Kevin Sobilo
    Realtor · Hanover Twp, PA · Member since 2018 · 3k+ posts · 3k+ votes
    5y

    @Hillary Windrem, if you don't like my advice about aligning yours and you mom's interests in the deal. Maybe change it up entirely.

    Don't partner AT ALL. Just have your mom be the bank and lend you the money. She can have a lien on the house and collect a fair rate of interest. This way she knows her rate of return. Property prices are high right now. Its hard to "estimate" what property will be worth when it comes time to sell. So having her invest for equity just doesn't seem like the kind of investment anyone I know would make.

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  • Hillary Windrem
    OP
    Member since 2021 · 6 posts · 1 vote
    5y

    Thanks for your time. I will take both of these ideas to her and discuss. 

    0Reply
  • David M.
    Morris County, NJ · Member since 2020 · 5k+ posts · 2k+ votes
    5y

    @Hillary Windrem

    https://www.biggerpockets.com/...

    Please reference my very recent post above..

    You could do anything you want.. but from an investor point of view it doesn't make sense.

    i agree with Kevin's structure.  Have your mom hold the Note, since that is really what she is doing.  Title would be held in your name and your husbnad.  Your brother would just be paid

    Trying to structure it differently would take some thought to align everybody's interest.  sure, you could use the effective work performed by your brother as the effective investment.  The share of profits would change as he does more work.  So, now you need to agree a price/rate for his work.  Also, will be upset if he thinks work should be done, but you guys don't?

    You need to talk to some qualified professionals about the apportionment of the expenses.  Your Operating/Partnership Agreement would spell that out.  Maybe you could say that member/partner X gets the rent while member/partner Y gets the tax deduction.  However, just seems silly to split that up since they won't subtract from each other on Schedule E when on different returns.  So, Y perhaps can't take the deduction since its a passive investment while X is paying taxes on the rent at their ordinary rate since they don't have sufficient deductions to apply.

    Anyway, there would be some serious details to be worked out.

    I hope you don't find this too morbid or out of line, but another strategy is to put Title in your mother's name.  When she passes away, you get the automatic step up in basis.  I believe she would just need a Will providing instructions on who gets ownership.  Consult a professional, but the step up in basis may even wipe out the accumulated depreciation which you need to pay tax to the IRS as depreciation unrecaptured nominally at 25% (there is no free lunch with the IRS).  Just mixing in some estate planning for tax efficiency -- but dont' take my word for it.

    Good luck.

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  • Hillary Windrem
    OP
    Member since 2021 · 6 posts · 1 vote
    5y

    @David M. Thank you so much for your input. I hadn't even thought of that.  This forum is so great. I think we will pump the breaks on this deal until we have things pinned down. 

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  • David M.
    Morris County, NJ · Member since 2020 · 5k+ posts · 2k+ votes
    5y

    @Hillary Windrem

    Hey, no problem.  If you have a family where "blood is thicker than water" applies, there are many things you can do.  Direct message if you every want to chat and brainstorm.  Take care.

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