Return on partner's investment

[Chris Eaker]

I was talking to my brother about apartment investing and he asked a question I want sure of the answer. Say I bring in a partner on a deal and they bring, say, the 20% down payment for a purchase, and we split ownership 50/50. When we sell the asset in like 10 years, do they get their initial investment back first before we split the profits? 

For example, we buy an apartment for $1,000,000 and they bring $200,000 for the down payment. Then we hold it some number of years and then sell it for $1,500,000. Does the partner get their initial $200k back then we split the remaining $300k half and half or do we split the $500k half and half?

I think this is all negotiable but what would a partner typically expect?

[Justin R.]

@Chris Eaker Great advice from very experienced people. Invaluable.

Returns are influenced by supply and demand - supply of capital and supply of attractive investments.  The General market's demands (as people have written here) are likely to be different than those of family/friend money.  When you're talking ad hoc projects and friendly money, it really all is negotiable.

I have friendly money that I've let co-invest with me.  I don't want to take advantage of them, but the reality is they'd be happy with much lower returns because their alternatives are limited.  The terms I've set are fair to both sides.  This may be the case with your brother as well.

Personally, I structure these as a preferred return on capital, then 75% to Class B (capital investors) and 25% to Class A (managing partner).  Mgmt costs expensed.

So, to answer your question, your brother receives some preferred quarterly return on his capital.  When sold, the waterfall looks like:

0. Repay any debt; close accounts payable.

1. Return everyone's capital.

2. Make sure the preferred return is met.

3. Whatever's left gets split 25/75 to you/him.

If you want more current income, add a mgmt fee and tweak his preferred return or equity split more in his favor.

Books are great on this subject. Also great to see what people are actually doing today is grabbing a double espresso and reading some of the LLC membership agreements for the investments on the various crowdfunding sites. That's really where we're headed.