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Updated about 2 years ago, 10/05/2022
Question for structuring a JV deal
Hello,
I am currently in the process of purchasing a multifamily and I have someone who is interested in doing a joint venture on this property with me. They willing to put down a 25% down payment. We plan to hold this property as a long term investment. I would cover the closing costs and initial renovation costs, which are not expected to be more than a few of thousand dollars. I would handle the day to day operations on this property, which primarily will consist of managing our property manager.
Their down payment would get them 45% of the property and it's earnings. They will also receive 8% of their initial investment back before I am able to start to take my share.
I am curious what peoples opinions of this structure is. Do you believe it is fair? I am not sure what the typical arrangement, if there is one, for a deal like this would be.
I appreciate an insights any of you may have. Thank you for your time!
That seems like way too much.... If the investor puts in 25% and all other things being equal, the investor has a 25% stake in the investment so should get ... 25%...
Are you desperate for the money down? Is the returns setup somehow because its being considered as some sort of loan??
How is Title being taken? Are you going to use an entity?
How is the "joint venture" going to be structured? Maybe I am silly or ignorant, but JV to me is just a business term of two parties agreeing to partner on a business deal. Its not a legal entity, nor in it of itself does it imply any sort of legal or partnership arrangements. So, what's the deal?
Quote from @David M.:
That seems like way too much.... If the investor puts in 25% and all other things being equal, the investor has a 25% stake in the investment so should get ... 25%...
Are you desperate for the money down? Is the returns setup somehow because its being considered as some sort of loan??
How is Title being taken? Are you going to use an entity?
How is the "joint venture" going to be structured? Maybe I am silly or ignorant, but JV to me is just a business term of two parties agreeing to partner on a business deal. Its not a legal entity, nor in it of itself does it imply any sort of legal or partnership arrangements. So, what's the deal?
And no, it is not considered as a type of loan. It is viewed at as a long term investment.
My thought is that the initial capital is considered to be more valuable. The remaining 75% of the mortgage that is to be paid off will entirely come from the properties revenue. So 25% of what the partner owns is also going to help to pay off my debt.
And yes, my understanding is also that the JV is a term of two parties agreeing to partner on a business deal. We would each do separate taxes and would not be legally responsible for something that the other partner does. I believe that it is a cleaner and more simplified version of a partnership that allows each of us to have more outs if needed.
So, how are you taking Title? How would you "...not be legally responsible for something that the other partner does?"
I still don't see why they would get 8% back up front...
You each put something to capitalize the deal. He used cash, you used your credit. I see what you said, but don't really agree. Let me ask, when you said "...45% of the property and its earnings," did you really mean that the investor would have a 45% equity stake AND 45% of the rent vice 45% of the 'profit?' That's way too much, that's why I wondering if this was considered like some sort of other deal..
You could almost flip your argument around in that he is leveraging your credit... I wouldn't over complicate it. People also tend to be concerned about what the other party is "making" on the deal. Sure, you need to make sure it works for both, but don't get "over concerned." You guys realize that one is 100% leveraged and the other is 0% leveraged? Trying running statistics with those and your head will spin...
Truthfully we have not dived into the title yet. We are first ensuring that we agree on how the financials will be split before getting into those details. I am not saying that the title portion is insignificant, but if we don't have an equitable split then that question is irrelevant.
As for the JV vs Partnership here is something that I had seen helping explain the difference:
" In a partnership, as an example, one member can be sued for the actions of the other partner's children. For instance, if a partner let's his kid drive his car and the kid gets into an accident and seriously injures someone, both partners can be sued. Each of them are acting as agents of the partnership.
In a Joint Venture however, each member is acting as their own agent and the court will recognize that there is a wall of protection from one member's actions to the other. And there are several other serious differences. They are not the same as far as the law is concerned.
"Liability Issues
In a partnership, all members are jointly and severally liable for the debts and obligations of the entity. Individuals are accountable for their own actions, as well as the actions of the other members.
A joint venture may be set up as a separate corporation or other limited liability company, which means participants are only liable to the extent of their investment in the company they create."
I do like your point about one side leveraging credit as well. And I couldn't agree more on people being too concerned about what the other side is making. The COC return her is excellent and it would be hard for one to be able to get such a high return on a property that is basically a turnkey. That is another element that allows for some leverage.
Thanks again for the thoughtful response David. I appreciate being able to bounce these ideas off of others.
suree... But I guess that's my point about JV... I maybe silly/stupid/ignorant (never actually structured a JV nor heard of anybody ACTUALLY doing it), but its not an entity of itself. Sole proprietorships, Partnerships, Limited Liability Corporations, Corporations are the "recognized" entities, at least as far as I know in this country. That is why to me its just an agreement between two parties to work together. I know "big" businesses do it, but they still have a flurry of underlying legal frameworks to go along with it. Even your quote says, "A joint venture may be set up as a separate corporation or other limited liability company..." You still have the setup the legal framework...
Sure, if you can't figure out the split, then there is no point researching it further. However, how you execute it is also important. If you can't operate with your personal name because you need to set up a legal framework, then you can't use conforming residential loans. You'll need to get commercial financing. That was one of the aspects I was leading towards.
But back to the split... As bp has discussed many times, you should probably take a Property Mgt fee. The logic is work as an "employee" should be paid out. Equity profits, i.e. when you sell, are paid out in accordance with the equity split when you started (as adjusted for any buy-ins, buy-outs, etc.). The free operating cash, i.e. the profit (after your mgt fee) from the rental business, is also paid out according to the equity split. That would be more of my "starting" position. You mentioned closing costs and reno that would be limited to few grand. Either adjust slightly (e.g. add that small amount into your equity contribution) for that or let go "in the wash."
@Devin A Hanley
I agree with you that a 25% equity partner should get significantly more than 25% ownership and 45% seems reasonable. The whole debt service thing needs more thought, though. I suggest analyzing this from the equity partners perspective. You are asking him/her to put in 25% up front, which is the highest risk position. Then, you want him/her to take on more risk by backing the loan and then he/she would have to pay off half the mortgage. At the end of the day, the partner will have paid 75% of the project costs and taken all the risk. All this for an 8% preferred return and 45% ownership. I can’t imagine an equity investor going for this.
To me, the JV should be set up where the equity partner puts in 25% and the general partner takes out the loan and does all the work. The equity partner would still get 45% ownership and the 8% preferred return with everything split 45/55 after that.
I wouldn’t get hung up on the structure. The equity partner would be a limited partner and you’d be the general partner.
Quote from @Account Closed:
@Devin A Hanley
I agree with you that a 25% equity partner should get significantly more than 25% ownership and 45% seems reasonable. The whole debt service thing needs more thought, though. I suggest analyzing this from the equity partners perspective. You are asking him/her to put in 25% up front, which is the highest risk position. Then, you want him/her to take on more risk by backing the loan and then he/she would have to pay off half the mortgage. At the end of the day, the partner will have paid 75% of the project costs and taken all the risk. All this for an 8% preferred return and 45% ownership. I can’t imagine an equity investor going for this.
To me, the JV should be set up where the equity partner puts in 25% and the general partner takes out the loan and does all the work. The equity partner would still get 45% ownership and the 8% preferred return with everything split 45/55 after that.
I wouldn’t get hung up on the structure. The equity partner would be a limited partner and you’d be the general partner.
Thank you for the response! I appreciate your insights here. We are currently planning on a structure very similar to what you had mentioned. What the current plan is for a 60/40 split, my partner putting in the capital will have the 40% share. My name will be on the loan so I will be the one responsible for servicing that, and those funds used to service that will come from the revenue our property makes. So I am not asking them to take on that extra risk of backing the loan.
They will also take a 5% preferred payment, meaning that I will not take a cut until they have 5% of their initial investment paid back to them, which we estimate to take about 4 months.
I will be managing the day to day (which should really just be making sure our PM is doing his job) and I will do so without taking a management fee. I am also not taking any acquisition fee either.
As of today we both seem Ok with this set up. They would like a higher preferred payment, I would like more equity, but it seems like we may be able to move forward with this arrangement without anyone feeling like they are being taken advantage of.
This is not set in stone, and I am new to a partnership like this so I am unsure what may be typical here, but it seems like we could both move forward happily with this arrangement.