How does a cash out refi work as 50/50 partners and pay him off?

Question

So I am looking to buy a quad with a partner, and we've agreed to split everything up 50/50. We plan on buying this quad together and then fixing it up, and after we do the refi out, I will be able to buy his 50% of ownership and make the quad completely mine (he's fine with me buying his 50% ownership after the refi).

However, I'm having a bit of trouble understanding the refi process when it comes to this situation. When I buy my partner's ownership stake out, I am wondering how much I will need to pay him additionally out of pocket or if it can completely come out from the refi and if my numbers are accurate at all for this cash out refi scenario. Here's a breakdown of the numbers:

Here's the potential breakdown of our costs together (using estimates):
Purchase price - $120,000
Down payment - 20% or $24,000
Rehab - $30,000
HML @ 10% interest for 6 months ($96,000 x .05) (interest & principal)- $5000
6 months of holding costs (taxes & insurance) - $1,500
Refinance fees - $4,000

Total Cost Together - $64,000

Here's the potential breakdown of our total costs for each partner (using estimates):

Down payment - 10% or $12,000
Rehab - $15,000
HML @ 10% interest for 6 months ($96,000 x .05) (interest & principal)- $2500
6 months of holding costs (taxes & insurance) - $1,250
Refinance fees - $2,000

Total Cost For Each Partner - $32,750

Now, let's look at the refi process after our rehab is completed:

ARV - $200,000
Using 70% LTV (using very conservative estimate) - $140,000

Now, let's look at what I need to do to buy my partner's 50% ownership:

$140,000 (from refi) - $96,000 (HML loan) = $44,000

$44,000 - $12,000 (down payment) - $15,000 (rehab) - $2,500 (P&I) - $1,250 (T&I) - $2,000 (Refi Fees) = $11,250

Now because the property appreciated from $140,000 to $200,000, that means that I will need to give them 50% of the equity gained ($60,000) which will be $30,000.

So $30,000 - $11,250 = $18,750.

From what it seems like, I will have to pay $44,000 from the refi and $18,750 out-of-pocket to buy out my partner's 50% ownership stake. In total, this seems to be $62,750.

Total Cost For Me To Buy My Partner's 50% Ownership Stake - $62,750

Questions I Have:

1. If all of my estimates are correct and the ARV becomes $200,000, this means I will have to pay $44,000 from the refi and $18,750 out-of-pocket to buy out my partner's 50% ownership stake? A total of $62,750?

2. Can someone double-check my math and let me know if what I wrote is correct? Or am I missing anything such as certain costs or anything?

2. So let's say all of my estimates and ARV are correct, I will have put in roughly $32,750 (from down payment and rehab) and $18,750 out-of-pocket to pay off my partner's 50% ownership stake. So total, that is around $51,500. However, because the quad is currently at 70% LTV, doesn't that mean I have $60,000 in equity? So isn't this a complete no brainer for me to do? Because I am reducing risk by 50% and have all of my money I put into the property (and more) back in equity?

3. My partner and I are working on making an operating agreement with this 50/50 split. Are there any suggestions you recommend me to add to this that can be easily overlooked?

Thanks everyone and apologies for the long post. I greatly appreciate any feedback or help you can provide.

Bill B. · Answer

You have to make sure the refi is 100% in your name only, and you pay 100% of the refi costs ($4,000 not $2,000) otherwise your partner gets half that money BEFORE you try to buy him out. After all, he can’t be on the hook for a loan on a house you own. I didn’t follow/check all the math, but…. This seems like a boat load of work and risk for you to make a total of $9,000? (You will have paid $51,00 for $60,000 in equity, an unrealized gain of $9,000 that will cost you at least $12,000 in closing costs to get in your pocket, for a loss of $3,000.)The problem is your splitting $50k in “forced appreciation” before paying any costs. So you have $25k minus costs as your profit.

Nicholas L. · Answer

@Jimmy Lieu there are always closing costs on a purchase regardless of the type of financing, and HMLs may charge points. Do you know if any points are being charged here?I'm not saying this isn't a good deal if the ARV comes in at $180K, since you haven't talked about rents and cash flow. But you'll need a lot of cash out of pocket for various items if that is the case - you'll leave a bunch of cash in the deal.

Bill B. · Answer

Almost Any first deal is better than no deal. You’re not supposed to get rich on your first deal. You’re supposed to stop being afraid of starting. The $12,000 was just a ballpark and only comes in to play if you had to sell for some reason. It’s a seller’s cost not a cost you will face if you buy and keep it. It’s mostly made up of 4-5% in realtor commissions and another 1-2% in title insurance, title company fees, transfer fees, etc etc.

Luciano A. · Answer

@Jimmy LieuWorking with someone who knows the ropes is a great way to jump into RE and get moving. You mentioned the 4plex is in a neighborhood full of them. Might want to get a Realtor that is familiar with this area and have them pull comps. This will help you see what things really sold for. Also, check what rents are and how long they are staying on the market. In Texas, you got some neighborhoods full of the same number of units making up a subdivision. The issue I see with such a community is a high level of competition thus one owner who has owned for say 10+ years can lower their rent and still cash flow while newbies cant lower rent otherwise they will go into negative cash flow. If all the structures look the same then you are relying on the rents to drive traffic. It is like owning a condo. If the complex is full of rentals then you can be competing against others to get tenants. You can fix up your place really nice but if other owners arent then attracting that tenant that will pay for a nicer place can be hard if other landlords are taking the first person who has the security deposit to move in.In such neighborhoods, you don't have as many house hackers thus the price another investor will buy is based on if they can make cash flow. Regarding Hard Money. If your partner has a large portfolio why is he using HM when he can use a local bank and get a line of credit. This way once you are all done he can have you refi to cash him out. Would save you both a lot of money and risk. If not check to see if HM lender does conventional loans thus getting pre-approved to roll the hard money loan into a traditional loan after rehab. This will give you peace of mind that you can get out of the hard money loan. Best of Luck

Caroline Gerardo · Answer

Your costs are way too low. Cost to purchase in table funding state $7000 title escrow taxes appraisal loan fees points on transfer taxes Hard money loan will have a prepayment penalty perhaps 3% Who is in charge of spending $30000 rehab and who is accounting for all the changes and problems Who is the general partner and who is the worker? Cost to refinance title escrow loan fees appraisal points transfer taxes again as is a sale $8000 Cost to carry during construction add insurance, property taxes What if the value does not increase? Can you qualify to refinance? Do you have a job past two years? Who is doing the labor if you have a job?

Steve Vaughan · Answer

A person leaneth in purse is ill-advised to seek partnership with same. A partners value is found in complementary skills rather than just another with lean purse. The way to terminate is draft a QCD and have him notarize it in exchange for his $92k. But you mentioned an HML. Lenders are different than partners, with the sole purpose of making their purse fat at the expense of yours which is lean. Do it in your own spake the lessons of Babylon.

Joe Splitrock · Answer

@Jimmy Lieu your numbers are confusing and there are errors. You are paying $120,000 for the property and financing $96,000. The costs, including loan down payment and financing fees total $65,500. So at the end of 6 months, you have $161,500 jointly invested into the property or $80,750 each. If it appraises for $200,000 that means you each have $100,000 value. Assuming you sold it, after selling expenses, you may both get around $92,000. That means from this rehab project you each stand to profit $11,250 if sold. A fair buy out price for your partners share is around $92,000, which is his expected payout if sold. That is the amount your partner should get a closing. Since you plan to owner occupy the property, I would pursue an owner occupied loan with lowest possible down payment. Your partner doesn't pay refinance fees, because it is your loan. I believe for owner occupied duplex, you may be able to qualify for 85% LTV, so that would reduce your down payment to $30K, which is about what you already have into the deal. Another option is just shopping the market for a $200K duplex that has been rehabbed and is move-in ready. Using 15% down payment for owner occupied, you would need $30,000 to do the deal and you could move into the property in two months. As it stands right now, you will be paying $172,750 for this duplex, but you are also taking on risk. What if the rehab budget is wrong or ARV comes in low? Building materials are going up every day. Maybe real estate prices will be higher in six months, but maybe not.The only value I see here in working with the investor is gaining knowledge and experience. Financially, it is too risky for the potential gain.Write up an agreement with your partner that uses actual numbers for payout. That way if rehab costs run high or appraised value is low, he only gets the actual amount. If he doesn't agree to that, I would walk away.

Peter Walther · Answer

What does your partner think he should receive? It's really his opinion that matters.

Nicholas L. · Answer

@Jimmy Lieu so maybe I'm missing something but if that is the case, why go through all the trouble of the HML and the refi? Why not just buy yourself with conventional financing since you intend to occupy, and pay for the rehab yourself? HML + partner + refi is a lot of work, a lot of fees.

Nicholas L. · Answer

@Jimmy Lieu I think it's at least worth checking if it will qualify for conventional financing. And I'm not saying you don't compensate your mentor for whatever you're getting - it sounds like you're saying they'll act as GC for the rehab. That's valuable. It's the joint ownership that's hard to disentangle. But the HML is going to be the owner of the house if you can't pay the hard money loan off =)Have you listened to Spencer Cornelia's BP podcast episode? It's invaluable. He was managing the rehab from out of state, so that would be different from you owner occupying, but great lessons in it.