I have a financing partner for potential rehabs I plan on doing and wanted to get BP's input on how to structure the profit split of these deals.
Some background information - I will be doing all the work from start to finish, so my partner will essentially be "silent" throughout the entire process. Given this structure, do most people split the profits 50/50 (half the profits for providing the capital and the other half for the work involved in the deal)? I plan on contributing a significant amount of my own money into these deals as well (at least 25% of the total costs), but wanted to see if the 50/50 split is a good base to start from when determining profit splits.
Is this in line with how other people have structured deals?
Thanks,
Kyle
In an effort to accomodate Bryan, lets use one of my deals i have in the works as an example.
Acquisition price is $1,150,000
rehab is $300,000
ARV is $2,400,000
Lets also say that resale costs will be $150,000 and holding costs (not accounting for any leverage costs) will be $25,000. We will also say that the total hold time will be exactly 6 months.
The spread based on these numbers above comes out to be $775,000.
Now, I found the deal, will manage the deal, and sell the deal. I will also guarantee that the money partner does not lose a dime and do so with a personal guarantee of which I actually hold assets with equity to cover any potential loss.
Lets also assume that both the rehab investor and the lender are both equally saavy in RE, but the money partner wants to remain completely passive, make no decisions on rehab or anything, just wants a good return.
Based on what Bryan laid out, the money partner would get $620,000 (80%) for a total cash investment of $1,450,000 which is a 42.8% return. Based on 6 months, that is an 85.5% annual return. Return for rehab investor partner is $155,000 (20%). Now, the rehab investor put up zero dollars so many can and would argue that is one hell of a return, I would argue that I took on quite a risk just to make $155,000, not to mention my 6 months of time which i value greatly.
Even if you made this a 60%/40% where I receievd 40% ($310,000), I would not do the deal under such terms and here is why: Without me, this money partner would not have the opportunity to be in this deal (yes Bill, he could find any RE agent to easily hunt down a deal with same spread, hire a GC to run the deal, and hire another agent to sell the deal and make all the money, this again assumes he/she cares to take on such an endeavour of time and risk) and would not have their funds guaranteed, nor would they have the ability to be 100% passive.
Now, let me go on the flip side just to be fair on non-bias as i too can be on the lender side. I am the lender and at 50%/50%, I would do the deal so long as my money had a minimum return guarantee. So long as the numbers hit as posted, i would make $387,500 on $1,450,000 investment, do so in 6 months, and be 100% passive (this would ONLY be done if the investor was as experienced as me as i did state in this example to keep apples and apples here.
So, in summary, many have argued the 50% split is not how it should go and under the circumstances I have laid out, i believe it is the most fair.
- Will Barnard
Kyle, I have seen this on most deals (50/50) I have a similar split with my partner. I also believe it depends on how well you know your partner. I would say you need to come up with what is equitable for both. I mean if it is a $20,000 profit and it is 60/40 you would get an additional 2k. But is it worth pushing the issue ? I would also ask is this your first deal? Another idea would be to do this one at 50/50 and document the number of hours worked etc and then when you guys decide to another deal this information could easily sway the 60/40 (or more)split. I wish you the best
Mike
Thanks Michael Sherwood, sounds like I'm on par with how others are structuring deals. Yes, this would be my first deal so I don't have any comparison to go off of. My partner is actually my father, so we are not trying to squeeze every penny out of the deal for ourselves - just want to come up with an agreement that is fair for both parties.
Thanks again for the feedback.
best of luck Kyle.
Everyone is going to have their opinion on this, but I'm in agreement that 50/50 is a good place to start when one party brings 100% of the capital and the other party brings 100% of the effort/time.
I too agree with the 50% split, however, if yo also bring in money as well, that split should trend to your favor.
I have a different thought. One person brings the money, and the other brings the time/effort, however if someone has money, they can hire any contractor and not split ANY profit. If the person doing the work wants to buy the property, they NEED the capital. So the person with the money has the advantage.
Will Barnard, thanks for the input. You are describing the situation I'm in. My partner will not want to get involved in the deal process - just wants a return on investment after the home sells.
Dawn A., you have a valid point though. For someone who wants to be involved in the day-to-day management of a deal, they really would never bring on a money partner unless they needed it (or to possibly cushion the risk).
Bingo!
Will Barnard deals can be found anywhere, however they do come in degrees. Anyone can find a "deal" but that doesn't make it a great deal. As long as everyone brings something to the table, and all parties feel that they are being treated fairly, then a 50/50 split is great.
A bad situation arises when one party feels that they are contributing more than someone else and not getting compensated enough for it.
Will Barnard, J Scott
Hypothetically, if you were Kyle's father, how would you structure this agreement? I know what I would do, but would like to hear your thoughts, as I am considering helping my son in a venture. My son will be doing all the work, I am just going to be the bank, he is not in a position to contribute any capital.
Rick
Rick
Has your son ever flipped a home? With no experience, you will also want to take caution there.
Lastly, do NOT use your retirement account to fund your son as he is a disqualified party to the plan.
If an actual partnership is going to take place and your son finds the deal, then you can simly create a 50% split structure and go from there.
I should have said, this is not for a flip, its a small business venture related to real estate construction.
This thread made me think about it in a different light since Kyle and his father are going to partner, so I was interested in your view from a business perspective since you have been successful in real estate, which is why I said hypothetically speaking, would you JV or just make the loan if it was your kid?
I think I will just make the loan, probably at a favorable rate, but the thought of partnering might be better, maybe I could keep him from making to many bonehead decisions ( which he is prone to do ). If I did partner, what would be a fair split? My money, his labor! That was the reason I asked.
Rick
Gotcha Rick. I would use the side of caution and assist in your son's prone potential of making a bone head mistake, thus making it a partnership. If it all goes well in the end, and the key factor is to set your son up with the most profits possible, simply award him at the end by changing the agreement to interest, but at least during the deal, you retain some control of decisions.
Here is anouther approach. One I have used.
Instead of claiming what someone is worth why not cost it out?
You may think finding a deal is worth 50%, I disagree, I can get a Realtor to find deals for 6% all day long.
I can also get a CG, with experience and a good track record to do the construction at 15-20% over materials and labor. In a rehab, the CG swings a hamer as well, he takes his hourly/contract price +.
The job; plans and specs,it will take 160 hours of labor and unskilled trades at $12 an hour average or 1,920. 60 hours of skilled trades averaging $24.00 an hour or 1,440 for a total of $3,360.00 for labor.
Material cost estimated at $24,500.
CG fee is .2x (24,500+3,360)=$5,572.00
So far, looks like the guy finding and doing the work is sitting at $5572.00 + 6%.
Sale price of the castle in need of repairs, only $130,000. ARV, $195,900 for quick sale.
If the property is to be sold, 6% commission to sell plus costs to sell, say $3,000. Who does that? Construction management often oversees this aspect at 10% to coordinate it. $1,475-$1,500, for winding up the business.
Construction management, again 10% for accounting and general admin (not buying) another $1,500.00
Because the money guy has the money to do the deal and willing to fund he's worth 50%, I disagree, can someone tell me why Rick's money is worth more than the bank's money? What's the alternative?
Rick doesn't lend he gets 2%. Providing money at 10% gives him an opportunity cost of 8% if he doesn't lend. Any other alternative investments available to this money guy?
A HML will throw money in at say 16% (24% APR).
So, money itself is only worth the alternative cost, 10-24%, not 50%.
What I suggest is that you look at the deal, the value of the contributions based on alternative costs.
The partners then agree, under the pay me first concept, that each will be "paid" thier value first from the sale.
At this point, it seems everyone has been paid what they are worth. Question now is who claims what on profits and how they justify the claim.
Risk:
Money folks will always go here, but most of the compensation for the use of money, the real lending risk is pretty well assessed by what banks would lend at. If the borrower is not bankable, say poor credit, how does that really apply in this deal where the money guy might be in title? There is no credit risk! So, that is a bogus claim.
What's the risk of getting up on the roof? Where are the risks of being on the job site doing the work? That too has been paid through the alternative cost assessments.
If the property is priced right at a quick sale value in the market, letss assume a holding period at the average sale period for properties in that price range. This is a risk of doing the deal and it's really not assigned to either party but to both, actually the property account, funds set aside and if not spent or costed out, returned to project as profit.
Insurance takes care of other risks and expensed.
Unerwriting risks, this is the process of selecting a profitable investment, just like a stock broker picks a great stock or a bond underwriter selects a good risk that does not incur a loss. The assessment of the deal, not the management but the skill of making a winning deal. I'd say this is the guy who knows the market, provides the entrepreneurship coordinating the funds, construction, listings, purchase and sale transactions, checking on the overall progress and having the ability to avoid unforseen risks and expenses. This might be accomplished by one or both partners and may be considered by drilling down to more specific aspects.
The value, IMO, of entrepreneurship is difficult to assess in some cases, but could be viewed as the knowledge and skills required in accomplishing a similar function having similar risks and rewards. In a slam dunk deal, a Realtor can spot a great deal and get a deal to settlement, they do that at 6% (perhaps underpaid at times). In more complex transactions it may require an attorney who takes 20%. Somewhere between these two extremes of skill and management abilities lies an alternative value. So, you might buy a thrid party to oversee these aspects at 10-20% of the deal. At a 200K deal, total amount at an economic risk or overall value, that could be 20 to 40K! This is the area that partners need to negotiate, it can be pretty much on one party or it could be equally divided.
I'll say too, that a money guy who never really gets involved, just writes a check and shows up is not the entrepreneur of the deal, thier assessment of the deal is as a lender, covering thier interests, don't count that function twice as underwriting the money and the overall success of the project, that's like selling the ice cream and then charging for keeping it frozen.
And, in all fairness, I'd say that any profits remaing, unassigned by function, would be split 50/50, the value of being together in a partnership, might say the cost of putting up with each other!
So, each is entitled to thier value contributed, what's left over, if anything, is split. :)
6% of SALE PRICE and 50% of PROFITS are two different things. And finding a realtor to find you deals all day long are extremely extremely rare. So rare that I don't know of one (besides myself but I only buy for myself).
Look at the numbers, I gave 6% of the sale price. And yes, it's not the same as profits, but to get to the profit I simply pay for the function as it would cost in the market.
I doubt there is an investor that would be significantly better at locating a good deal than a good full time Realtor, they do find them and that is what they charge.
It will be par for the course for someone to justify thier abilities as being more valuable, they also tend to blur the functions together. After you pay the going prices as an earned amount, the remainder is still there to split anyway. This just keeps it more to apples and oranges as to what one really provides. :)
Not sure where all these numbers come from but it all makes this more complcated than it needs to be. Secondly, costing it all out and totally costs to arrice at a % split is not accurate either as it leaves necessary things out.
For example, saying you could fibd any realtor at 6% of acquisition to find deals leaves out the fact that the investor still has to analize each possible, goibg through many before obe is locked. That takes time, skill, and market knowledge. Certainly an investor is not going to give full rein to the agent.
Gc overseeing the rehab - good luck having them include design and pickibg out items for each house, good luck paying them cost plus and keeping them incentivized to keep costs down.
Finally, even after you take all the these cost factors, by the time you get to your final figure, I bet it comes out damn close to 50% of profit, which as Justin pointed out, us quite different from costs.
KISS is in order here, no need to make it so complicated.
I'm with Will here, just keep it simple. In my early years I took on money partners at 50/50 and they always felt they provided the gold they should make all the rules. So when they asked about the next deal I told them someone else wanted to partner at 60/40 and quickly got a I'll do it for 65/35.
I decided to look for private money, people that were earning 3% at the bank at the time and give them 8%. Pretty soon others were told by my lenders they were getting 8% and if I had a great payday I gave a bonus not part of the agreement, and I would get calls from them.
What happened was the 50/50 split guys were saying I'll loan at 10%. As was said having money and no place to put it was a problem for them. So I offered 10% on the money or 20% of the profits whichever was greater and my former 50/50 guys fell in line while they tried to find someone who would take 50/50, which was hard because you could get more profit using a hard money lender.
It was a mile long post so for simplicity's sake, it appears Bill is stating that the funding partner may possibly hold more worth than 50% split of profits since he/she can hire out agents to find deals, contractors to do projects, etc. Well, that assumes that the money partner has the ability, time, and knowledge to do all of that.
For all things being equal, IF the funding partner has no time, no desire, no skill, and no experience to perform any of the duties associated with finding and managing a rehab flip deal, and the other party takes 100% of that on, then I think it is common ground to arrive at a 50% split each.
From there, you can make adjustments and edits as one party made add or bring more to the table. For instance, if I am the money partner, I also bring my experience and knowldge, so perhaps I do warrant more than 50%.
On the flip side, I as the non-money partner again bring my history of experience, my team, my ability to find the deal, etc and thus, IF the money partner has zero experience, perhaps yet again in this cenario I may warrant greater than 50% for my end.
I also agree with Will. You're assuming that the money partner is a knowledgeable investor which in that case I can understand Bill's position but most who look for partners want someone who let's say has money tied into a ROTH IRA,stocks,bonds,401,etc and can get better returns in real estate than what they're getting right now.
As as far as Realtors finding good deals I doubt that considering that most Realtors aren't in the business of finding investor deals. Most want a higher selling price so they can maximize their commission so they're not out there finding something 70% of the ARV or less.
A good rehabber that has knowledge of the market,good negotiation and analytical skills can outshine the average real estate agent right there when it comes to finding good properties for investments IMHO.
Well said James.
James, Are you suggesting you can "outshine me"....LOL, Seems that's a pretty high opinion. If we are comparing a new Realtor, one with less than 5 years, one that may specialize in say the RELO network, you might be right.
It boils down to experience and knowledge, I'll have to go with the Realtor over the deal operators everytime if they have been in the business for the same length of time.
I can't think of a successful RE investor in this area that is not a Realtor or has never had a RE license at some point. I can't think of any successful investor here that doesn't work with a Realtor or that won't work with one.
I just take a more business like approach, IMO, that being taking on any partner is pretty much like taking on an employee, they need to carry thier own water, I'm not paying for something that is not beneficial and I'm not paying more than they are really worth or more than I can obtain from other sources. Basic economics. What's being said here is pretty much fluffing opions of who is more valuable. I slice the loaf pretty thin, some cut it thick, in the end the loaf still gets eaten. It's pretty easy to say 50/50 and that can be the most appropriate depending on who they are. I've been in many 50/50 deals, but in bigger deals, the value needs to be shown. I'm certainly not paying someone based on thier claims of how valuable they are.
You might be surprised what some Realtors can do that have been around for 20+ years. Thinking they can't find a deal? LOL, they can get on the phone, never leave the office and find a deal in a day or two while the guru investors are licking postage stamps, running all over the courthouse or driving for dollars and peaking in windows. They might recall old George who bought a property 12 years ago, they know his wife passed away, they know his health is poor, they know his kids are out of state and they know he paid cash and they noticed the last time they passed by the place it needed some repairs! The old Realtor just needs someone to jog his memory to find an old fix and flip....... :)