What is the norm for ownership and sharing the cash flow when three partners purchase an income property?

Question

Let’s say one does all the work, the two others come up with down payment.

Is everything going to be divided by three or 50 – 25- 25 or how is this going to work? In a way that is fair and reasonable

Nate Tanner · Answer

Hi Alex,

When you say one does "all the work" do you mean the property management and fixing up the property?  Also, it could vary based on if you purchased it as a business entity since profits are generally split among owners based on ownership equity percentages.

In a recent business purchase (a small gym) I was involved in it had three partners.  The way it was structured was one partner had the capital, one was going to run it, and the third had the needed credit.  In this deal the managing partner was paid a wage as compensation for their service (for example, if your person who is doing the work is managing it, you could give them a reasonable percent off the gross rents like you would a property manager).  The other partners split the remaining profits from the business 50/50.  One thing to note is that in my transaction the managing partner took their wage as a contractor and was paid as an expense from gross revenue, not net profit.

Good Luck.

Emily Dixon · Answer

*But he doesn't manage renovations are you talking about a long project? You definitely should be paid for managing the contractors.

Emily Dixon · Answer

The person I know who manages 7 different LLCS for his investors gets 5% . He does all  the legal filings for the LLC coordinates the tax return and K1s for the LLC, pays all the tiny amount of bills for the LLC and acts as the broker as well. No investment himself. 5% to be the LLC Managing Member and take all headache away from investors. . And I think that is fair for the amount of work.

Nate Tanner · Answer

A justification I could see for a 50-25-25 split would be if they were investing in a business.  If you start a business and bring on investors, they purchase an equity share in the business.  if each investor brings in $10,000 to buy 25% equity in the business, then you are valuing the business at $40,000, if the value goes up, their equity would go up.  If you then pay a dividend from the profit of the business, you having 50% ownership would get 50% and they would each get 25%.

What are the investors expecting for a ROI? if you know that, then you have better negotiating power.

Alex R. · Answer

George

in this scenario what is the justification of me taking 50% of profit and not less.

I mean I like to take a bigger chunk but would that be fair ?

Alex R. · Answer

Jon 
Thank you for your detailed answer.
This was really helpful

George Paiva · Answer

If you are not on the hook for any $ even repair and improvement money and only managing then the equity ownership will be 0 for you while the other 2 will get 50/50% ownership.  The profits maybe split 50% to you, the other 2 will get 25%.   Down the road as the prop mgr you will get the option to purchase a share of the ownership. I have sometimes seen owners give the prop mgr 10% ownership to have a little skin in the game but they are usually contractors that do a little more than just invoice and collect rents.

This is what I have seen so your involvement maybe different.

Jon Holdman · Answer

I have investments in similar deals.  You, as the one who puts the deal together but who has no cash invested, get a management fee for running the company that owns the property.  Period.  The property manager you hire gets paid the property management fee.  Both of these are expenses for the company that owns the property.  If there's a loan, you're probably going to get to personally guarantee that, too.

After all the bills are paid, including your management fee, ALL of the remaining proceeds get distributed to the investors.

Said another way, they own 100% of the equity (stock if a corporation, units if an LLC.)  You're the CEO.  You get a paycheck.  But you didn't contribute any cash, so you don't have any of the equity.

Now, of course you can try to convince the investors you deserve some equity, too.  If you say "we each get a third", they what you're saying is your contribution is equal the cash each is putting in.  That's almost certainly not believable.  If the whole thing goes belly up, you walk away.  They lose their money.  They have MUCH more risk.  Even if you sign the loan papers, you still have VERY LITTLE risk.  Short of something catastrophic, there will be enough to pay off the loan, but they may suffer a significant loss of their money.  If they're putting in all the cash for the whole deal, you have no risk at all.

You might be able to make a case you deserve a small sliver of equity.  This is going to depend, to some extent, on your track record and the experience of your investors.  If they put in, say $900,000, and you want a 10% share, you're claiming the whole company is worth $1 million.  But if the only assets the company has are the $900,000 (initially in cash, after the purchase the property plus the remaining cash), then there's really no justification for any valuation except $900,000.  Claiming 10% for yourself is equivalent to them giving you $90,000.  Depending on how the operating agreement is structured, you could turn around the next day, sell the property, dissolve the company and walk away with 10% of whatever is left.

Also, keep in mind this is a private placement, covered by SEC Regulation D.  There is a significant amount of legal work to be done to do this correctly.  You need this paperwork to protect you WHEN you end up in court with these investors.  Hopefully, that never happens.  But you MUST assume it will at this point and take the proper steps to protect yourself.

Alex R. · Answer

Hello Nate and thank you for your response.

Doing all the work in this case means I will be the person who makes this deal happen. Who found the property, will negotiate the price, take care of all paperwork, managing the renovations on an ongoing basis ,…

Basically the two other partners are very wealthy people who don’t want any headache at all. They just want to write a check as for the down payment and they receive a monthly check for the cash flow and also a big one when and if property is sold.

So basically I will be the person who will be running the show from the get go on. But we will hire property management however that management will not be in contact with those two investors per their request.

They just want to receive a report and also a check every month. I am not putting any money down.

It’s a 25 unit apartment with a very high occupancy rate.

What is the norm for ownership and sharing the cash flow when three partners purchase an income property?

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