Silent Partner Rate of Return?

[Tyler Carpenter]

Hey all. Its been awhile since I have been on here.I lost my job and about lost it all trying to start my real estate business but now Im back and ready.I have a silent partner that is going to invest $50,000 in my real estate company. He has given me 5 years to pay him back and is interested in splitting the equity on my properties at this time. What would be a common return for this type of deal. I have never done this type of thing and want to be fair to both parties since he is fronting the cash while I do all the work. Does a 50/50 deal sound good for a 60/40? Just wanted to see what others have done in the past. As always thanks

[Jon Holdman]

50/50 for all profits is typical for your first deal with a partner who's proving all the money. Five years is a LONG time. He would be reasonable to expect double his money back after five years. That equates to about a 15% rate of return. If you're really keeping his money for five years, you need to be sure you can pay him that sort of return. Really, I'd figure out a way to get his money back in 6-12 months.

[Vikram C.]

Tyler, when your partner agreed to invest the $50K, he must have mentioned something about what he expects in return. If he did not give any numbers but just said that the two of you would split the profits, it means he assumes a 50-50 split.

If you want more than 50%, then a good way to approach the subject with your partner would be to discuss a performance bonus for you in the event your investments performed beyond his expectations. You can first ask him what kind of return he expects from his investment and then work your numbers such that you split it 50-50 up to a level that is slightly above what he expects, and then you ask ask for a higher share of anything beyond that.

BTW, I don't know any serious investor who will be happy doubling his money in 5 years in an unproven new venture. This is like an angel investment. My friends in the angel and VC industry have a simple formula - five times in five years. It sounds high until you account for the many duds and a few winners in their portfolio.

[Peter Giardini]

Great comments by Jon and Vikram...

Following up on what Jon mentioned regarding getting this investor paid out in 6 - 12 months.

That should be your goal. Once you get moving you are going to feel like you are doing most if not all of the work and splitting the rewards with someone who is doing nothing.

Let me explain.... once you are rolling you will find that your network of available resources including conventional and hard money llenders will expand and you will also find that in very short order you would be able to do this on your own... and splitting the profits will be harder to swallow.

I would recommend setting your goals on 12 months fro the payback, as Jon suggested and then prepare your partner that once the loan is paid back you would invite him to lend against specific deals and give him a great return.

[Tyler Carpenter]

Ill give you a little bit of a background as this is a little bit different than what most of you have been through. In feb 09 I lost my job and moved back home with my rents to save money. After painting fences for extra cash for a friend of my moms, I was hired as an engineer for her son at ballco manufacturing. I became the quality control engineer there and have been there since august of this year. I have been asked to work extra everyday and wanted the owner of the company to know what i do when i leave work and on the weekends. I wanted him to know so that way he realizes im not giving up on my dreams regardless of any job. After talking about real estate and my goals with the owner of the company, he became interested and wanted to learn more. I presented him with my offer of a cash on cash return in a year or two and pay him back in full. I think his style of thinking is a longer term and has given me 5 years to figure it out. This is where I am at. He has reserved the money for me once I have a contract that dismisses his involvment if anything gets hairy.

So everyone is in concenous that I should try to pay him back as soon as possible? At what rate would you provide? 50/50? Is that fair?

[Jon Holdman]

Hard money lenders for someone doing a rehab are going to charge 0-6 points and 12-18%. On a typical (is there any such thing) rehab, I'd figure about 10% of the amount borrowed. If you borrow 70% of ARV, that's about 7% of ARV. Six months would be a good time frame. If you buy right (buy plus rehab at about 70% of ARV), your profit should be in the range of 10-15% of ARV, maybe even 20% if everything goes well. Splitting the profit 50/50 would give your investor somewhere between 8% and perhaps as high as 13% of ARV, or roughly 12-20% return on his money. For six months, that very nice. You're giving up a big chunk, but make that work, and you'll have no problem funding future deals.

But what are you trying to do?

I agree, Vikram, that a 10-15% return for a speculative venture would be inadequate. That's why I suggest a shorter time frame. Further, real estate investing isn't venture capital. VC's are betting on an idea. They have no recourse, and a good chance of losing everything. So, they want to see a much higher payday, even 10X, if the idea is successful. Investing in a rehabber is much lower risk. The worse that can happen is you get a house that's incompletely remodeled, and you have to put in some more money then sell it or rent it. Unless you totally take your eye off the ball, the worst case downside is much less than losing everything.

Tyler, just structure this as a loan. If you create a liability, its yours, not the lender.

[Jon Holdman]

Oh, by the way, congratulations for speaking up and finding a potential funder. For anyone looking for private money, now you know the method.

If you'd like, Tyler and I can sell you a DVD where we dress in suits and say that 100 times. Normally $2999, but a special today only for BiggerPockets, its only $999. That's a joke.

[Scott Hubbard]

Originally posted by Tyler Carpenter:
Hey all. Its been awhile since I have been on here.I lost my job and about lost it all trying to start my real estate business but now Im back and ready.I have a silent partner that is going to invest $50,000 in my real estate company. He has given me 5 years to pay him back and is interested in splitting the equity on my properties at this time. What would be a common return for this type of deal. I have never done this type of thing and want to be fair to both parties since he is fronting the cash while I do all the work. Does a 50/50 deal sound good for a 60/40? Just wanted to see what others have done in the past. As always thanks

This is not a 50/50 split as you have spelled it out above

He is loaning $50K to be returned in 5 years. In return, he is expecting a split in equity. Although it is not specifically stated here, I assume this is 50%.

For demonstartion purposes, I am going to assume he will want an equity split of 50/50. Since his contribution is $50K and it will be a long term liability in the entity, he is really not contributing nothing more than a loan. If he puts in nothing else and you then put your time, energy, experience, I would argue your getting less than 50%.

There needs to be a value assigned for your time and expertise which you will need to be compensated for. After 5 years of work, he gets his $50K back and you will not get your 5 years back. Instead, you should be able to draw a salary, a performance bonus, or a deferred payroll credit.

When I get a loan from a bank, I expect to them back, but I do not give the loan officer 50% equity in my company.

I would approach the investor and say, you put in $50k in the form of a capital contribution and I put in 5 years worth of work at a value of $10K / year or $50K. Now you both have $50K each invested.

After the five years, we decide if we want to continue or disolve the partnership. If you disolve, then liquidate your assets or buy out your partner. If you choose to continue, each pull the $50K out of the entity and continue the partnership at 50/50.

If your investor is an active partner, then I agree with getting him/her a better return, an active investor will expect to double his money every 2 to 2.5 years.

If your investor is passive then 15 to 20% per annum is competitive especially if your able to securitize the capital. Doctors, lawyers, and professors are a good source for passive investment capital. Beware of any investor who wants more than a passive role in real estate. I have taken minority interests before and it has bit me in the arse everytime.

Good Luck

[Tyler Carpenter]

Haha I like it Jon. The way I figure it, by gaining this money at the start I can venture into real estate faster than I would on my own. I have no problem sharing some of my profit early on in my career. Like I said Im 24 and have plenty of time to regain some of the profits. Im going to propose somewhere between a 45/55 and 50/50 profit for the first few deals, if that sounds fair and equal from what other would agreed on? I have faith that I can buy right and make it work like you said. Thanks again for all the replys. I truly appreciate all of the effort that people put forth on answering my questions truthfully. I owe all my knowledge to this site and the people on it.

[Scott Hubbard]

Since you are flipping, I agree with Jon and others that you will need to give him a bigger split since it is much more speculative.

55/45 is a nice number as it will give you voting control.

[Vikram C.]

Tyler, I wouldn't suggest a 55-45 deal to begin with. Just got with a simple 50-50. Get the first couple of deals done, show your investor how good you are, and then negotiate.

[Vikram C.]

Jon, I understand what you are saying about the difference between HML and VC. But HMLs normally expect the borrower to put in 20 to 30 percent whereas that does not seem to be the case here.

[Tyler Carpenter]

Originally posted by Vikram C.:
Tyler, I wouldn't suggest a 55-45 deal to begin with. Just got with a simple 50-50. Get the first couple of deals done, show your investor how good you are, and then negotiate.

Would I be the 55%? and the investor 45%? Because orignally i was throwing around this ballpark number

[Tyler Carpenter]

Sorry Vikram. I read your statement wrong.

[Michael P.]

Since you are a beginner I think 50/50 is way fair for you. Think of it this way. If someone approached you and said hey I will lend you some money but I want a 50% cut. You would jump at that offer. What other means do you have to get into the game?

I am pretty surprised someone who has 50k is just gonna give it to you and say alright go at it boy. I bet when it comes down to it this guy will require some contracts and paper work.

This is how I would approach it.

You do "One Deal". That is it. After that one deal is done you figure out what the profits were. Hopefully there were profits. Say you now have 60k. 55k is returned to the investor and you now have 5k in your pocket. At this point both parties can evaluate if they want to move forward with another deal.

That is the only way I would consider loaning out money.

Don't get greedy...

[Tyler Carpenter]

Originally posted by Michael P.:
Since you are a beginner I think 50/50 is way fair for you. Think of it this way. If someone approached you and said hey I will lend you some money but I want a 50% cut. You would jump at that offer. What other means do you have to get into the game?

I am pretty surprised someone who has 50k is just gonna give it to you and say alright go at it boy. I bet when it comes down to it this guy will require some contracts and paper work.

This is how I would approach it.

You do "One Deal". That is it. After that one deal is done you figure out what the profits were. Hopefully there were profits. Say you now have 60k. 55k is returned to the investor and you now have 5k in your pocket. At this point both parties can evaluate if they want to move forward with another deal.

That is the only way I would consider loaning out money.

Don't get greedy...

Im not greedy at all. Like I said this is the owner of my company that I work for. I laid out many proposals with differnt cash dollars and he is set on $50k. He knows thats a lot of money for me but not a lot for him and also knows that 50K can buy a lot of properties right now while they are cheap. This is a very smart man that took a 2 million dollar business yearly to 36 million a year in 20 years. He also invested 60% of the earnings yearly back into the company.