Private Lending Ownership Structuring

[James Johnson]

Hi all,

My business partner and I have friends which want to invest with us. We have an idea on how we would structure the ownership on a BRRRR (our idea of the structuring below), but were hoping for advise on how others have structured any private lending ownership. All feedback is welcome!

Our plan for structuring:

• Investor(s) - 25% down payment with 10% emergency fund initially. Investors would be included on LLC as signers.

• As monthly cash flow begins, Chris and I would immediately begin pay back the 10% emergency fund to the investors.

• 15% monthly profit after Opex goes to investors for a steady stream of monthly cash.

Overall ownership structure would follow:

• 35% equity and 15% monthly post-tax CF to investor(s) to give a 66% return if value remains constant.

• 65% equity and 85% monthly post-tax CF (to include emergency fund percentage, etc) to Matt and Chris

Thanks!

Chris

[Salem VanderStel]

Hi James,

I put together a basic model of your project to give you an idea of what this property would return to you and the investors.  I used a real property located in Chicago off of loop net and used rules of thumb based on other properties I've invested in to fill in the gaps. Of course, I'd need substantially more detail to fully underwrite it

Assumptions:

$2.1M Property

$54k Closing Costs (2.5%)

$200k Renovation Budget (40 units x your $5k per unit)

units $5000)

$537k needed for 25% LTV loan with Rehab financed through Investors

$53k Emergency Fund

$791k - Total Equity Raise

Returns:

Investors Equity - If your property compounded 6%YOY (more on this later) per year for 6 years in a row, the total value of the property would be ~$3.0M.  After paying remaining debt service and closing costs, this will equate to ~$1.4M in equity to be split up between GP (Matt and Chris) and LP (investors).  If the property was split 35% to investors per your model, this would net them $503k total equity after 6 years on their initial $791k investment.  

Investor Cash Flow - On a $2.1M property at $50k unit, I would expect this to be a high cap rate area.  Given current market conditions I would expect you to net about $75k in cash flow after debt service in year 1 and $150k after debt service in year 2 and beyond.  Based on your split,  the investor would receive $146k in total cash flow over the course of your project.  Note that this isn't factoring in that at that $50k/unit, the property is likely not in a great neighborhood, you would be paying a much larger portion of your return to unit repairs.  $15k turns are not uncommon in this tier  

Total Return for Investor - $790k investment would yield the investor $649k after 6 years ($503k in equity + $146k cash flow).  Or, a $140k loss

Conclusion:

I somewhat anticpated these numbers as soon as I saw your split but wanted to lay it out.  I'm by no means suggesting this project won't work, however, I would substantially change the underwriting.  A few initial recommendations.

- GP/LP Split - Right now you are at 65% GP /35% LP,  this should be closer to 30% GP / 70% LP.

- Appreciation Assumptions, for a buy and hold project in this market, the 6% assumption is quite risky and investors would need to be compensated for the additional risk. You could do this by further splitting the LP/GP in their favor. You could also instead focus on having an excellent operations team to drastically increase the NOI thereby mitigating the effect of the total equity change. Some hybrid approach would also work as well.

- Preferred return - as a personal philosophy, I would be very hesitant to invest into any deal where the GP group would earn significant equity even if the project produced me no return.  This helps protect against that.

- Working Backwards - For a project you are describing, where the return is primarily based on equity, I would target a total IRR for the investor of between 20-30% with a cash flow target of at least 10%

Please don't hesitate to reach out with any more questions.

Respectfully,

Salem

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