Do you think this is fair partnership? creative deal

Question

Good day everyone!

I wanted to run this creative deal by folks and get some input as to whether or not it seems fair for both sides.

A partner and I are going to invest in a short term rental together. We are looking for a property with a large house to be the rental as well a small unit for her to live in (adu, cottage, etc.).

She will live on the property keeping an eye on everything, as well as doing all the cleanings, assisting with check in/ check out if need be, and any light maintenance. Since this will be her primary residence we will utilize an FHA loan at 5% down.

I will be supplying the capital for all down payment, closing costs, furnishings, and reserves.

Instead of rent, she will pay me back for half of the down payment and closing costs over 2 years at 0% interest.

After 2 years we will both be 50% owners of the property.

With this arrangement, does it seem fair to split the profits of the rental 50/50?

Me: --All start up costs  --listing, web based messaging with guests  --good income and credit

Partner: --FHA loan  --looking after property  --cleaning  --listing, web based messaging with guests

Of course there are many other factors to keep in mind but these seem like the major ones.

Thanks for any insight, advice, or concerns.

Stay Well

Chris Seveney · Answer

@Wesley McDavid

Seems fair. Question is what happens if it does not cash flow or someone wants out. Agreeing to the good terms is the easy part

Agreeing to what happens if you know what hits the fans is the hard part

Mark Miles · Answer

No way. Would I give my cleaners & handyman 50% ownership of my properties? No way! Be the 100% owner & hire her or someone else to clean & fix stuff at a reasonable hourly rate!

Ricky A. · Answer

@Wesley McDavid

I suggest considering various scenarios in which this could go downhill and make sure you have good, mutually agreed upon resolutions/off ramps.

Some that quickly come to mind are:

>>  What happens after 2 years and she's paid back her half of the down payment?  Does she continue to live rent free in exchange for providing the property management?  If so, are the values of those two similar?  If not, one of you may feel you're not getting a good deal the long term.

>> What happens if she's not good at the property management piece or simply decides she doesn't want to do it anymore? Is there a way to exit the deal or some other way to replace her that's fair to both ? Do you have a pre-determined way to measure her performance?

>> What happens if she wants/needs to move?  Does that affect the mortgage?  How is title being held and does that affect this answer?

>> What happens if you two want to go in separate directions?  Can one party buy out the other?  How is buy out price determined?

Having the tough conversations up front and memorializing them in your operating agreement will help save a lot of heartache and hurt feelings in the future.  Basic advice is that, what seems like a good deal to both of you today (because it helps you both get into the game when you couldn't separately), may not seem like a good deal to both of you in the future, so plan for this now.

FWIW, I'm considering doing something similar to help some relatives get a jump start investing.  Basically, they would provide property management to pay me back for their portion of the upfront costs.  PM would be "charged" at a specified market-based rate (like 20% of gross) and that would be used to pay back a promissory note between us.  I think this makes things very clear.  In the rough numbers I'm thinking, that would probably be 4-6 years for full payback.  After that, they could decide if they want to keep doing the PM (and start taking those dollars home) or if they would rather move PM over to a 3rd party.  Either of these is fine with me because I'm already paying 3rd party market rate.

I plan to have specific metrics for performance (e.g., maintaining an average rating of X.Y on Airbnb and VRBO, maintaining a certain SLA on guest response time, etc.).  The Operating Agreement would spell out what happens if they don't hit the metrics (or if they just don't want to continue doing the PM).  Basically, PM would be moved to a 3rd party.  If they're not "fully vested" at that point, they could continue to pay the  promissory note until they're fully vested.

Operating Agreement would spell out issues like this as well as probably a hundred other things.

Good luck!

Nathan Gesner · Answer

My gut response is that you are setting yourself up for failure.

She's living there for free. What's the value on that? $1,000 a month?

She is going to pay you back for the initial capital invested, but you're giving her two years to pay that back and then she's an equal owner? Meanwhile, you have to wait two years to get your money back (is she paying interest?) and carrying the financial risk for the deal. What happens if she fails to pay? What if your partnership breaks up and she can no longer pay, live in the property, handle cleanings, etc?

There are more problems with this, but I'll stop there. I wouldn't sign up for it.

Michael Baum · Answer

So I am not sure, but can you even have a partnership on an FHA loan? Would you be on the title? You should really check with the lender to see if FHA allows it at all.

If it doesn't, then it her FHA is a moot point.

Bruce Woodruff · Answer

No, this is not fair to you IMHO. I used to do 50/50 splits with a money partner, but I did everything, including all construction work. The scenario you're describing sounds like a 65/35 to me. Maybe 60/40 at the best.

Leo R. · Answer

@Wesley McDavid  this IS a creative deal...that's what I love about real estate--no matter how long I'm in the business, I'm always learning about new approaches!

I don't really have a good answer about whether this deal is "fair" (for what it's worth, it doesn't necessarily seem UN-fair at face value).

@Ricky A. outlines some EXCELLENT considerations--I'd definitely suggest reading his post carefully...

I don't think you mentioned this, but if you are both beginner investors and/or beginner STR operators, then you'll want to be pretty conservative, because learning to invest in real estate, manage a property, and run a STR operation are all pretty big challenges when you're operating on your own, and they presumably become significantly more challenging when there are two parties involved. Personally, I don't have any partners with my properties, so I can run them with absolute authority without having to work around anyone else's interests/requests/personality/etc....  ...this isn't to say that succeeding at the partnership you describe is impossible, but it will probably take a lot more effort/preparation/thought than simply buying and operating a property on your own...

Another important factor is the state of the STR market right now--which is changing rapidly (in a way that makes it significantly harder for new STR operators to succeed). Specifically, there's a lot of data indicating that many STR markets are way over-saturated with supply. Plus, demand is diminishing quickly as we head into recession ...so, that could be a perfect storm to put a lot of STRs out of business. ...Also, air bnb recently changed their platform to focus on top-tier, highly unique properties (think: luxury beach front tree house)--as a result, a lot of the more "typical" units are getting pushed down in priority on the platform, and are having problems with vacancy.  ...so, these are issues you'll definitely want to read up on carefully (if you haven't already); there have already been a number of podcast episodes / blog posts / articles on this topic for you to check out...at the end of the day, you'll want your financial models to include some really serious "worst case scenarios" (e.g.; extended vacancy) to stress test your model before you do the deal...

If you do the deal, you'll definitely want a thorough contract that outlines all the responsibilities, authorities, obligations, etc. of both parties, and which outlines processes for as many eventualities as possible (for instance, her/your rights to remodel parts of the property, her/your decision making authorities if one party decides they want to use the property differently than originally planned, or if one of you decides you want out of the property, her/your responsibilities for repair costs, processes for dealing with unexpectedly high vacancy, etc., etc., etc.)   ...I'd suggest listing out as many of these issues as possible, coming to an agreement on them, then drafting a contract and sending your contract to a contract attorney for review before you sign...

If you do this deal, definitely keep us updated on how it goes--it sounds like an interesting one!

Good luck out there!

Zachary Beach · Answer

@Wesley McDavid I think your biggest problem hasn’t even been mentioned. Cash-flowing on a two unit property with only one unit rented with a 95% LTV loan with what 7% interest maybe 8% with PMI. Also you haven’t mentioned if this partner has STR management experience at a high level but my guess is no if they don’t have any money of there own. It seems to me as a STR management expert with multiple top properties in one of the biggest STR markets in the world that your partner would need to be exceptionally good at running STR’s to make this work. I’m not even sure it could work in most markets. It seems to me the most likely outcome is you have a property with negative cashflow in a market likely going down not up in value in the short run. That said if it’s cashflow positive and you get your money paid back in 2 years then own 50% and it goes well long enough for the market to keep going and loan being paid down. The return/potential up side is very large.

What you need is numbers and a business plan(specifically how they will make it a top STR and the steps they will take.) from the partner and if they make sense and you have the money and don’t need it you could choose to bet on them.

Drew Sygit · Answer

@Wesley McDavid not fair at all.

1) First, you'll need to be added to the deed somehow.

2) Also get added to the insurance policy

3) You'll need a solid partnership agreement

4) Have her sign a lease and pay market rent, just like any other tenant would

5) Pay her for managing the property with a separate agreement

6) Let her figure out how to pay you back half of the cash you invest

BIGGEST mistakes people make investing with family & friends is not planning for when the relationship goes sideways!

Do you think this is fair partnership? creative deal

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