Structuring Partnerships and Private Money Financing of Property

[Nicholas TenBrink]

Hello everyone!

A good friend and I are looking at forming some type of REI partnership.
He is a more seasoned and self sustained real estate investor that is living the dream, I'm the newer guy with the time, W2, etc . You know the story.
I'm going to skip the conversation about, "would you, or should you partner with this person?" since that is not to my question to you all today.

As we are looking at our opportunity to work together we have the obvious, "what if's" around business and partnership structures. So in that theme I have outlined a few 'options' to how we could structure our opportunity to work together and or partner.

I've scoured the depths of Bigger Pockets and I think I have determined these 3 may be the the 3 different formats that we all (bigger pockets) identify as the most used structures.
 

PS: I do not include a Contractor/Labor option in the optional business structures, we've already discussed that and that would most likely be at a later date, but not now.

Please take some time and read through Options 1-3 , I have placed them in preferred option order, please provide some feedback if you have some. 

Option # 1 to me seems like the obvious best option, but the other options can also work.

Also, here'a key to help your brain while you read through:

NT/MJ : refere to individual parties
NT LLC/MJ LLC : refer to individual held LLC's

xxx LLC : refers to jointly held LLC (50/50)

Option 1

A.) Finance Backing Option- Structured around Private Money Lending

1. NT forms NT LLC (example name) for property acquisition.
2. NT LLC acquires line of credit from MJ LLC (example name).
3. NT LLC acquires and secures property using line of credit for down payment, and conventional/creative/etc financing.
4. NT LLC pays MJ LLC on principal and interest at a fixed rate, amortized and with a due date/balloon payment, and or until refinanced/cashed out.
5. MJ LLC places first lien on property to secure interests.

• Pros:
  • Creates legal entities that protect all parties assets
  • Simple structure
  • Allows for passive income to money lender
  • Structured cash flow to investment financier
  • Can easily be repeated with other parties

• Cons:
  • Less day to day partnership in nature/ownership of property

B.) Property Management (Option/Addition) - Structured around 50/50 ownership and Management of properties

1. NT and MJ form MGMT LLC for shared property management purposes of their own properties, with 50/50 stake in company ownership.
2. NT LLC (referenced in A) hires MGMT LLC to manage property(s) acquired through financial investment.
   1. MJ LLC can also then place properties into management with MGMT LLC for supervisor/management.
3. Payment/reward in MGMT LLC can be based on partner activities such as:
   1. Tenant placement
   2. On call responses/duties
   3. Facilitating repairs/maint
   4. Management of specific properties
   5. etc
4. Additional funds generated through MGMT LLC could also be used for other joint/partnership ventures.

Pros:

• Creates structure to engage MJ with operational success of personally financed investment property(s).
• Creates consistent management structure for each others private properties success.
• Creates financial reward/incentive for partners involved with management activities.
• Creates legal entity to protect assets
• Creates 50/50 joint venture
• Can generate its own cashflow to be used for investment

Cons:

• Add’s additional layer of complexity

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Option 2

A.) Property Partnership - Structured around variable cash flow returns

1. NT and MJ form Property LLC, owned 50/50
2. Property LLC acquires line of credit/loan from MJ LLC/MJ/etc
   1. Allows MJ LLC to place first lien on property
3. Property LLC secures and acquires property through NT acquired mortgage.
4. Property LLC pays principal and interest at a set rate on line of credit to MJ LLC, amortized and with a due date/balloon payment from gross income (setup as expense).
5. Net Cash Flow split at determined rate related to partner risk & activities.

Pros:

• Creates legal entity to protect assets
• Creates financial liability & expense for business through loan
• Structured cash flow to investment financier
• Can easily be repeated with other parties

Cons:

• Complicates conventional lending bringing two parties to the table.
• Ties MJ returns on investment to property performance and involvement with operations.
• No Principle and Interest payments to MJ
• No tax write off on financing of down payments
• Not passive for financier of down payment.

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Option 3

A.) Property Partnership - Structured around associated Risk and set % cash flow returns

1. NT and MJ form Property LLC , owned 50/50
2. Property LLC acquires cash for down payment/acquisitions from MJ
3. Property LLC secures and acquires property through NT acquired mortgage.
4. Net Cash flow split at 50/50
5. Equity at Refi split 50/50
6. Equity at Sale split 50/50

Pros:

• Partner reward/payout simplified.
• No principal or interest costs on cash to acquire property.
• Risk associated with each partners legal or financial obligations
  • MJ Risk associated with down payment/cash
  • NT Risk associated with Mortgage liability

Cons:

• Complicates conventional lending bringing two parties to the table.
• Does not secure financial interest of MJ against property (no lien).
• Ties MJ returns on investment to property performance.
• No Principle and Interest payments to MJ
• No tax write off on financing of down payments
• Not passive.