How Do I Pay Out A Private Investor?

Question

I am looking to bring on a private investor for an apartment deal. However, I need to understand how to pay them out before I do so.

Example.... I put my own money down, and then use their money as well to buy a bigger apartment. We buy the apartment for $2mm, raise rents, and then make $500k on the appreciation.

We agree they get a % of the gain. I would like to 1031 my profits into the next deal. If they want to cash out,  can I just cut them a check and 1031 my portion? If so, are they then responsible for paying their own taxes after check is cut, or am I somehow involved in the tax payment process?

Dave Foster · Answer

@Steven Barr, There's several ways to do this.  But you're absolutely right to be planning ahead as each option has plusses and minuses.

1. Purchase the property as tenants in common.  When you sell each of you can take your % and do your own 1031 on your portion.  Easiest to sell.  Maybe more difficult to set up your management agreements and allocations

2. Create an LLC or partnership to hold the property.  Each of you contributes cash in exchange for membership interest.  Easiest to manage.  Hardest to separate at the end.

3. Create a loan from him secured by the property but with no ownership.  They'll lose some ownership benefits.  But easier to separate at the end.

You can't just pay out profits without the ownership entity suffering a tax event that may or may not pass on to the former partner.

David M. · Answer

@Steven Barr

As @Dave Foster pointed out, good to figure out your exist strategy up front.  Also, as he indirectly pointed out, you need to also figure out your "entrance' strategy.

Your OP didn't mention how you were structuring the deal.  Normally, it is advisable to use a legal entity such as a LLC if you are investing with non-spousal partners.  The Operating Agreement will spell out how you apportion profit/losses as well as how one party buys out the other.  At $2mil for an apartment, I'd like to think this will be some sort of apartment complex, i.e. more than 4 units, so it will classified as a commercial property.  You won't be able to get conforming residential loans so a legal entity won't get in the way, and in fact may be to your benefit.

I don't quite understand your example.  Are you not getting outside financing?  Depending on what your partner wants, you might just structure their involvement simply as a lender.  If he/she is just lending you money, then treat them like a lender and just issue them a Note in exchange.  Its even cleaner this way in many respects.

Make sense?  I'd be happy to chat if you'd like.  Good luck.

Tracy Kelly · Answer

I am a Private Money Lender in California, so it may be different elsewhere. But when I fund a loan, for the borrower it’s much like getting a loan from a bank. We agree on the amount of the loan, the type of loan (interest only or amortized over some period), the length of the loan, and the interest rate.

There is often a broker involved to handle appraisals, title reports, etc. and there are loan origination costs much like with a bank. But, and this is what may help you, I only get monthly loan payments, never a percentage of the gain. When you sell the property or otherwise repay the loan, all of the appreciation is yours. You do whatever you want with the proceeds.

Again, this is just my experience in California and it may be different where you are. But I hope this helps.

How Do I Pay Out A Private Investor?

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