What would be good terms for a partner in an investment?

[Michael Ramirez]

So I made another post asking questions about a hoarding house in San Diego.

my concern now is finding a partner for the capital side of the transaction.

These numbers are not concrete as Ive not had a home inspection or contractor walk through the property with me. So let's consider this an example. 

a home that after the rehab will be worth about 610k conservatively

The seller has a need for long term payments with a 40 year term. This is necessary to supplement her income and not cause a large tax implication. No balloon in sight because of it.

The price we have discussed has been a 300k seller financed mortgage with 3.75 interest.

PMI would be about 1200 a month.

the plan for the property would be to convert the two car detached garage into a 2/1-1 1/2 roughly 750-800 sq feet ADU. With it's own parking spots and 1/3 of the backyard privately fenced in. (Theres a fantastic hospital less than a mile away so maybe travel nurse housing is an option here for more income)

Market rents for the 2/2 house would be between 1900-2200

For the ADU its be about 1500-1800

Total rent range 3400-4000

Property taxes are 500-550 a month

Rough cash flow 1100-1250 (year one)

The inside of the property would need to have: 

-All the flooring replaced. 

-The ventilation system would need replacing. (Indoor smoker)

-Either paint or replace all the drywall (again because of the smoking)

-Replace the water heater.

-Replace the heater/fan.

-Bathroom remodels

-Would prefer to remodel the kitchen because of its layout but also isnt the end of the world to not. 

During this process I'd do all that is needed of me that doesnt require a tradesmen (flooring, painting, drywall work, installs, running materials, etc) 

After all this preliminary info I'd like to know the communities opinions on how this may be structured to benefit; the capital partner, the seller, and myself. I'm new to this process and am open to all the pointers,  criticisms and concerns you all have thank you!

[Justin R.]

Originally posted by @Dan H.:

She needs to consult a tax expert but this is what I believe

• $250k of the gain is tax free ($500k if married) if she has been living in the home (must have lived in home for at least 2 of the last 5 years)
• Any gain above $250k is capital gains.  She would likely pay 15% tax on any gain above the $250k.  
  cap gain is not income.   It likely would not count against her for long term care assistance but possibly the net worth would (outside my knowledge). 
  

I suspect she may not have a need to finance the deal, but that financing is sweet.   That financing would increase my interest.  

Even if it's tax free, the sale still shows up as income on paper.  Many of those senior programs are needs-tested, which means she can't show assets other than a primary residence - that may be what she's talking about.  There's so much variability here, though, it's really hard to give a general answer.  I'm no expert in this area.

To the OP's question, there's a ton of different ways to structure something like that.  I trust based on your question that you don't have $100k (or whatever the rehab will be) yourself and that's why you need a capital partner?  You need to decide whether you want a lender (who just gets a check every month), a partner (who gets money on the backend and shares responsibility), or an investor (who probably gets a blended current and deferred payment, but also provides advice or contacts or helps you along) - at some point, make sure you're very clear on the legal difference between those.

I've been on both of sides of all three of those.  From the OP's side, since this deal's numbers looks strong (let's assume the numbers are accurate for a sec), I would try to find a lender who you could cash out with a refi once it's done.  From the side of someone providing capital, I'd be scared that you don't have the experience or contacts to execute a rehab efficiently or operate a rental property (maybe you do, just an assumption), so I'd want more of a partnership scenario.

Based on the information provided, I would propose something along the lines of these two options:

Option 1 - You Keep Long Term Equity

• Purchase $300k via installment sale of $14,000 per payment, paid yearly for 40 years
• Rehab $100k (or whatever it ends up costing)
• Title to be held in capital partner's name
• All net rent proceeds to capital partner until they get an 18% IRR on invested capital
• Capital parter goes away  

Option 2 - True Partnership

• Purchase $300k via installment sale of $14,000 per payment, paid yearly for 40 years.
• Rehab $100k (or whatever it ends up costing)
• Form a GP or an LLC and hold title in that entity's name
• Do the renovation.  By leaning on someone with experience, this process will go way smoother and you'd learn a ton.
• Split all proceeds X%/Y%.  50/50 is the easy starting point that no one will look at you funny for.  But, negotiable based on value provided by each person.

On a practical level for the seller, doing a 40 year installment sale is really questionable and I'd never suggest to someone I love that they do that.  I would counsel them to do a 5 or 7 year with a balloon at the end (which could be negotiated if both parties agree again into another 5 years of installments), but, anyways.

In your shoes, I'd try to negotiate it so you get help and advice and the partner is along for the ride, but give up as little long term free cash flow and - more importantly - equity in the property as possible.