Should I be a partner or just loan??

Question

Hello Everyone I hope you are all doing well and are healthy.
Unfortunately, I have a friend who is going through a divorce and asked if I wanted to take over a share of his partners stake in their property.

The NJ property is a 1936 duplex 2bd 1 bath 1200 sq ft, with public utilities, off street parking. The current tenants pay $2275 and $2300 they also pay all utilities. He feels the property will appraise at $600k which I am looking into comps to see if that seems correct. His mortgage is around $1600 per month.

The deal!

option1 He offered me an option to purchase 1/6 of the property for a monthly dividend and a return of my money and 1/6 of any additional equity the house accumulates over the course of us holding the property. Im not sure what would be an appropriate amount would be for a dividend.

option 2 He offered me an option just to loan money on the property, and receive a monthly payment at an interest rate that we would agree on. Im not sure what would be a reasonable interest rate to charge.

Im going to go look at the property tomorrow and speak to him in person.

I would greatly appreciate any advice or questions I should be prepared to ask tomorrow.

Wishing all of the BP family well during these unique times.

David Ginn · Answer

@Ken Moyer

I would not do a 1/6th dividend with him.  To me, that sounds messy.  If you can instead get into an equity position and make more money and hand the risk to him, that’s a greater way to go as a lender.

Where a lender has weakness is when he has a note and deed of trust that secures the property, but he has no ownership or control of the asset.  So what I would say is I’ll lend you the money but I don’t want to carry the risk of loss.  Instead, I want you to carry the risk of loss by virtue of a personal guarantee or a cross collateralization of assets.

So the best way to lend is to lend to someone who has multiple assets, so that if one fails, they agree, through the operating agreement, to pay you back through the other assets they have.

Then, if you can also be a member of the LLC which has ownership of the property, then that would also help you from being as vulnerable because it could give you some form of control.  This would limit your risk, making you a partner in the transaction which would place you in a much better position.

The other thing you have to be careful of is if you are lending with IRA / 401(k) funds.  If you are lending with IRA / 401(k) funds and you go in as a partner, you cannot do any of the work yourself because that is a disallowed transaction.  So, if you are lending money in an IRA / 401(k) fashion,  there I would tell you to do it more as a pure lender.  Don’t go into the equity share side as much.  I mean you can, but you just need to know the rules.   But I would just caution someone

Allen Arden · Answer

Thank you @David Ginn

Hank Feller · Answer

@David GinnThanks

Ryan Daigle · Answer

Hi @Ken Moyer. It's hard to say what you *should* do given we don't know what your investment goals are. However, there's usually a very clear risk/reward tradeoff to being debt vs. being equity.

Equity usually has more upside, but at the risk of losing a lot of value too (sometimes all of it). Debt is more limited in the upside, but its payments gets first priority from cash flow and is usually collateralized in some fashion (i.e. the debt holder gets something if the borrower can't pay, like ownership of the property itself).

Your situation seems different in a few ways. First, on the equity front, you mention a dividend. I'm assuming this will be some portion of the cashflow the property generates. Do you have a good understanding of the financial performance of the property? I would definitely want to see a T12 to know what my future dividend realistically looks like.

Second, on the debt front, I doubt your loan to your friend would be collateralized by the property itself since it already has other debt on it and it has shared ownership. So how will your loan to your friend be secured? What do you get if he can't make payments?

Overall, the complexity associated with assuming ownership of 1/6th of an existing partnership seems quite high (unless the LLC bylaws already provide a mechanism for transferral of ownership)? Whereas a loan from one person to another is much more straight forward (be sure you're still getting an official note drawn up by an attorney here). So there's the administrative overhead to consider as well.

Hope that helped with your decision!

Ken Moyer · Answer

Hello Guys thanks for the feedback.

Johnathan the property is in Peapack- Gladstone good HS good location to 287 etc. I think were he is getting 1/6 is that I would put in 100k on the property that is worth 600k.

Ryan I was looking for my next investment to be cash flowing me around $1000 a month. Its such a unique opportunity I can't seem to find a way to make a deal out of it.

What Im ultimately looking to achieve is to cash flow at least $1000 a month with an adjustment of 4% each year for cost of living until I die or call on the note of 100k I invested.

Jonathan Greene · Answer

Where is this in NJ? Those numbers don't sound possible unless it is in Hudson County. I don't see how either of those options help you. Usually, when someone wants "help" going through a divorce, the help part primarily relies on them getting a lot and you getting very little because you are a friend. There is no reason in the world to ever own 1/6 of a property. What's the point? Just the structure to protect yourself on the deal won't be worth the 1/6 out or the claim of what you will get which will not materialize. Why loan money on the property? This is the best time to buy the property from him at a discount and help him that way. That's what investors do, nicely.

Bjorn Ahlblad · Answer

@Ken Moyer someone who is going through a divorce has no control of how and where their assets will end up until the divorce is finalized. It is unfortunate, but I would suggest you consider neither in this case; especially since he is your friend. All the best!

Should I be a partner or just loan??

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