Thoughts on this partnership structure???

Question

I live in Los Angeles, and I've been investing in multi-families in the midwest for quite sometime now. A business colleague, who I've worked with in the past and trust 100%, mentioned that he wanted to invest in real estate as well, but didn't know how to get started. He hates the LA market for obvious reasons, and we both have similar goals of seeking buy & holds to generate cash flow.

He's proposing a partnership where he puts all the money for the down-payments and I find the properties, which I think is very interesting since it requires no money from my end.

My duties will most likely include flying out to the midwest, meeting with agents, closing deals, and setting up the PM company/minor rehabs, while he will be providing all of the capital. He trusts me 100%, and he is pretty much going to let me decide what properties we should go after.

Now, my question for BP.... what do you think would be a fair equity breakdown for each of us? I want this to be a win-win and for both of us to feel really good and excited about the new venture.

As of right now, we're thinking of 65% him and 35% me, since I never have to put any money down.

Simple example of how it would work with a property we're looking at:

Duplex for $80k, rents for $1250.

He puts down the 25% ($20k) and takes care of closing costs to acquire the property.

Lets say all expenses total for $600/mo. Of the remaining $650, I would get $227.50/mo & he would get $422.50/mo.

We would split costs of all expenses and repairs, and if we ever sold the property... he would get his money back first, and then we would split the profits 65/35.

Is this fair, or is either of us asking for too much? We will obviously set this up through an attorney, but I'm interested in hearing BPs thoughts on the appropriate % breakdown for a situation like this. He has a lot of money, is very interested, and could easily help me acquire 2-3M worth of properties without any money down.

Rohan J. · Answer

Roman M. some great points you guys mentioned.I like the idea of guaranteeing a 7% return and then breaking down a percentage equity after that, with costs and repairs coming from the rental pool. A couple quick questions:1) What would be the most practical structure where we have all expenses paid for from the rental income? ( i.e. should we set up a little $3k emergency fund first, or whenever something really large needs fixing we then start taking it away from future rent, etc. ) Curious on what you guys think works best and is easiest to keep track of, from an accounting perspective.2) What numbers are you using to calculate interest percentage paid? Example: lets say Bob is my investor, and he buys the duplex for me by putting down $20k (25%) + an extra $4k for closing costs, so all-in of $24k to buy a property. If I wanted to guarantee him 7% returns and then split 50/50, would it be monthly payments to him of $140 ([$24,000 * 7%]/ 12 mo), and then splitting everything above $140 and expenses?I'm definitely trying to pursue this in a way where I can cash flow from this property asap (not until waiting for a sale), but would love to hear your thoughts on what that would look like. Splitting all rental income after he receives 7% and after all expenses are paid for seems pretty fair imo.

Victoria Townsend · Answer

Interesting points Roman M. - shouldn't he get 35% of profit every month, not just after the sale? In his example, if the duplex is making $600/month after all expenses, wouldn't he be getting a deposit for $227.50 (35% of the remaining $650) every month? It looks like they're sharing the cost of additional repairs/expenses... so I'm guessing they can split charges whenever something ad-hoc comes up. As I'm also considering a similar type of partnership, I'm curious to hear your thoughts on why he has to wait years to make money until after the sale. Thank you!

Roman M. · Answer

1. I think your small repairs should be paid out of monthly cash flow. You can ask your money partner to fund larger replacement items as needed & that amount will be added to his capital in.2. You are on a right path on number 2; as he gets part of his profit his capital should be going done and so as the interest payment as part of his capital is being paid back through profits. Eventually he will have zero in the deal and he doesn't get guaranteed interest anymore and you just split profits.

Shaun Patterson · Answer

I agree your discounting your sweat equity a lot. I would use this as a stepping stone to build your down payment money up for future deals. From what you said everything is split 65/35 what if a furnace has to be replaced or the ac breaks? I dont know your area that much but these are just examples. It might not be alot for him but you might run negative on your part. Make sure that you think about things like this. I think if you run the numbers properly and include reserves in your numbers for these expenses. BUt all in all if he is putting up the money and your getting cash flow from your hard work this would be a big boost to your ability to partner better with him in the future (probably up to the 50/50 mark when you have some skin in the game on deals.)

Jeff Filali · Answer

Are you splitting the repairs 65/35 also?I think your cut is a little low for all you are doing. You are going to invest a lot of sweat equity and time for very little return until and if the property is eventually sold for a huge profit. What happens if the property is sold for a loss or break even? You could end up spending more in repairs then you ever make.Time is the most valuable commodity we have... You can never get it back!!

Roman M. · Answer

Rohan, Congrats on your new venture partner! It seems like a good setup. His proposal is fare when it comes to profit sharing, however you have to wait for the property to be sold in order to see money in it. I noticed that you will be most of day to day stuff associated with rehab, finding properties, etc.Here is a little suggestion which I saw with other partners and I think its customary: I think you should get 3% management fee from the rents & 10% of the rehab costs from managing construction. This is for just been an active partner. Profit sharing of 65/35 is good but you don't know when you are going to sell the property and when the property is actually going to payoff itself (for the profit to actually start kicking in). Maybe your money partner should have guaranteed return on his down payment of let's say 8% per year and anything after that for that year gets split 65/35. Just a thought. Best of luck.

Rohan J. · Answer

Thanks @Darren Eady . Totally agree on the Cash is King. I'm fortunate to be in this opportunity, I just want to make sure this is a win-win for both of us, and that we can build a great long-term relationship.The only other place where his money would work this passively would be in VG index funds, making 5-7%. My hypothesis is that this should be an easy win over that, but I'm happy to hear others critique my assumptions.

Darren Eady · Answer

Cash is KING! I would ask him what deal he thinks is fair. If you don't perform, he can replace you, if he doesn't perform, you may not be able to replace his money. 65 - 35% makes sense to me.