Is this partnership structure unreasonable?

Question

Friend of mine and I are trying to form a partnership relationship hoping to acquire a small multifamily property (20 units or fewer as long as price is $1 million or less).

My responsibilities:1.  Will be sponsor and responsible for obtaining loan on the property.2.  Will be responsible for finding, analyzing and acquiring deal.3.  Property will be managed by a property management company. I will oversee the property management company and also make any day to day decisions as needed.

Friend responsibilities:1. Provide cash for down payment. (and possibly some fund for reserves – details yet to be worked out)2. Silent partnerThis is a very high level view of the partnership. Most of the details will still need to be worked out. I am thinking 50/50 equity partnership, which I think would be acceptable to him as well. Does this sound reasonable? If not, then what would be a reasonable split? If the initial property works out well, we are planning to do more deals (hopefully bigger and better). Please let me know your suggestions/thoughts.

Joe Fairless · Answer

@Kazi R. congrats on setting your sights on getting a multifamily property done. What you described is a security and it needs to be registered with the SEC. Anytime you have a passive partner then they are expecting returns based on the mgmt experience which means it's a security. That can be costly and probably cost prohibitive given the size of your proposed deal.

Therefore, I recommend doing a JV as you described, however, your friend would need to be in on the mgmt decisions alongside with you. Assuming that happens, then the 50/50 split certainly seems reasonable.

Marc C. · Answer

Not uncommon for fix-and-flip deals, but for a buy and hold, I think you should probably be happy with 20-25% of the cash flow and 20-25% of the increase in equity. You could also offer him an 8% preferred return but charge a 1-3% annual asset management fee and take whatever higher percentage of cash flow and equity that yields a total IRR of 15-20% over a 5-10 year hold. That is REALLY common right now...crowdfunding sites are full of those deals right now: 8% a year, 15-20% a year over 5 years. But there are just so many ways to do it, it really depends on your friend's situation and sophistication.

By the way; According to Gene Trowbridge, an expert securities attorney who structures lots of syndication deals, the only way to not make it so that you're offering a security is set up a MEMBER-managed LLC and you both get an equal vote on all major decisions. In other words, your friend is not a passive investor, but "active" because he's involved in decision-making...instead of leaving all that up to you as manager. You still need an LLC operating agreement, but according to Trowbridge, you likely don't need a Private Placement Memorandum, Subscription Agreement or file any securities paperwork with your state. And the accredited investor rules likely don't apply, either.

Another key consideration for larger deal sponsors: Many states offer what is known as a SEC Rule 147 exemption to SEC securities registration requirements if the investment is in that state, the sponsor is headquartered in that state, and all investors either reside in the state or are companies headquartered in the state. In some states, you can advertise these intrastate offerings (after you register them with a state), provided you have a prospectus that discloses all relevant risks in the investment. An intrastate offering offers a lot of advantages over SEC Reg D. offerings that are usually only open to accredited investors. Legal fees still should be under $10,000.

Either way, best of luck in your venture. I hope you've had the benefit of having a mentor or at least know some other multifamily owners you can consult with.

Joe Fairless · Answer

@Kazi R. sounds like @Jessica Zolotorofe has the hook-up for you on the JV. Good luck!

Kazi R. · Answer

@Joe Fairless

Thank you so much for your reply and also pointing out SEC registration issues with having a passive partner. I don't think either one of us will have any issue with doing a JV. Do you know where I can find out what goes into a typical multi family joint ventures agreement? Obviously we will be making modifications based on our own specific agreements. Should I get in touch with a real estate attorney who deals with multi family deal structuring? Thanks for any information on this.

Kazi R. · Answer

@James Wise & @Marc C. Thank you so much for your responses. This is the exact discussion I was hoping to have!

Regarding 50/50 equity split, let me share little more details. My friend/potential partner has no interest in being actively involved in the process. We are likely to have a JV in order to avoid SEC registration requirements as discussed in this thread, but I know he wants to provide the down payment and expects me to handle everything else before and after the purchase of the property. I mentioned he would also come up with the reserve money, but we can structure the deal in a way so that he is paid the reserve money back fully first before we start splitting the cash flow.

As for my part, I will be sponsoring the deal, therefore will be bringing in 80% of the funds (hoping for 80% LTV)  I realize that it's not my money, but I am risking my excellent credit if something goes south with the deal. My friend is cash rich, but cannot quality for a loan on his own (different story).  I also bring residential real estate rental and property management experience, which he lacks.  I will be doing ALL the legwork that includes developing relationships (including with commercial RE agents), building a team, figuring out all the legal issues, finding and acquiring deal and hiring/managing a property management company once the property is acquired among other things. Any cost beyond down payment will be split between us. Given I am doing ALL the work and am bringing in majority of the funds, I think it's reasonable that we split 50/50 or at least that's what I would like to propose to him initially. Any thoughts? I don't know 15% to 20% IRR is possible for him in a deal structure like this, but I figure it will depend on the quality of the deal and our exit strategy. We are both interested in long term partnership, so don't think it will be a big deal if the first deal doesn't provide ideal returns as long as we learn from it and apply the knowledge on the next one.

James, yes we are planning to use RE agent to find the property.

Marc, unfortunately I don't have a mentor yet, but am working on finding mentors as soon as possible and also acquire some formal training (beyond books and free content) on apartment investing early next year.

James Wise · Answer

@Kazi R. Seems way lopsided to me. I think your going to have a hard time getting your friend to agree to that. You simply are not providing enough value to justify a 50% split.

How are you finding the property? Are you gentleman using real estate agents?

Kazi R. · Answer

@Jessica Zolotorofe Hi Jessica, thanks for the information. I have sent you a PM.

Is this partnership structure unreasonable?

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