What is a fair partnership?

Question

I have offered investment opportunities to people with capital.  The deal is they put up ALL the capital while I find the properties and do the analysis to make sure its a worthwhile investment.  I charge the investors 10% of the rent roll for the management fee.  Including my 10% management fees, I have shown investors 15%< returns.  I would like to have ownership in the properties that we are purchasing.  Is there a particular model to follow?  Does it have to be the management fee OR percentage ownership in the property or can it be both? I understand that it may be subject to each individual investor, however, is there a "standard" that you have seen exercised?

Jonathan Makovsky · Answer

Hi Joseph F. ,

I want to preface this with that I have not done this myself yet, so there are definitely better people on BP to help you out. With that said, here is my understanding of structuring deals:

• "How is ownership of the property held?" If you're placing the property in an LLC, then the LLC owns the property. All profit and loss allocations will be based on the operating agreement. It would probably be best to hire an attorney for the Op. Agmt.
• "What percentage of the property is fair for me to own?" Going back to the question above, assuming the ownership of the property is in the LLC's name, then the property will be owned by the LLC, but that is less relevant than the operating agreement which defines the profit and loss allocations. So if your next question is...
• "How should I set-up the profit and loss allocations on the operating agreement?" The first thing to consider is every investor is different and has different appetite for risks - or might even have other considerations in mind - so no two deals need to be structured the same. Try to put yourself in the investor's shoes and run the numbers on a deal based on the different splits you mentioned above and see if you feel comfortable asking an investor to invest based on those numbers. For example, if you find a property that can return 30% cash-on-cash a year, then you might be able to easily find investors to split the profits based on a 50/50 split every year. However, if you find a deal that's returning 3% cash-on-cash you are probably going to be hard pressed to find an investor based on the cash-flow alone.
• Also, as Dion mentioned above and others mentioned on BP, you should always put a management fee in your underwriting regardless of who manages the property - assuming the quality of work is the same. The allocations on the profit should not consider a property management fee. A property management fee is an operating expense.
• Final comments: The best way to get a larger percentage of the deal is to find the good deals, because the better the deal the more leverage you will have with investors.

Hope this was helpful.

Jerry W. · Answer

@Joseph Furmansky , I have done several of these deals and am considering more, so let me explain my thoughts so you have an idea what other investors might think.

First if they take their money and invest in bonds or notes or even the stock market, they are going to make a certain income, a 4% tax free municipal bond is pretty safe and has great tax advantages.

Second they want their money back and a profit before they share their money.

Third the more risk they take the more return they want.  Investing hard money into a flip property had best bring VERY good money due to the risk involved.

Set your deal up to address these concerns.

1.  Give them a preset return after legitimate expenses, and only share in profit if they are exceptional or not share until their money is paid back to them plus interest.

2.  Show them the tax incentive for real estate, their profit and capital return and you take 50% of profits after they get their principal back plus 10% interest per annum.

In the above examples you can entice them and they won't feel you are taking advantage, why should they turn over 50K or 100K or more and split profits?  Stock brokers don't charge that much.  Show them you make 30K on the purchase by getting a great deal, they get all their money back plus a great return BEFORE they share a penny, and you only get what any property manager gets 10%.  However you have incentive to keep the property nice because any profit after they get their money back or when the property is sold is split ___% and ___%.  You defer cash in pocket until later but will eventually get whatever % you agree on say 50%.  This is easier to sale in real estate because most purchases can give a 10% cap rate or more and still pay down mortgage, and you usually get annual appreciation on top of that.  If you want cash now you will have to agree to less ownership later.

Just my thoughts.

Bill Gulley · Answer

I've done similar deals. I like to value my contribution, as to each task required and what it would otherwise cost. Management is 10%, interest on money, shared risk to the % of ownership or skin in the game, etc. It's whatever can be agreed to.

Know this going in, in the minds of partners that perform work performing tasks, a partnership is never fair, one will feel like they are doing more than another, but if that's what the agreement spells out, you agreed, it's fair. :)

Dion DePaoli · Answer

Remember that property management is likely a fee they will pay with or with you being the property manager.  Under the same idea, what is the value add you present to the deal?  
	
	If it is simply property management, then it does not make sense to pay you more or share in upside gain.  So then, what is fair, is you bringing something to the table that is more than what is ordinary for the fee you already charge.  That can be a number of things, you just need to sit down and write them out so you know your worth, if you will.  
	
	Structure with success based incentives are usually the ones that are best received.  You can approach it in a variety of ways one of which is with preferred returns and high water marks.  Not sure how much a high water mark comes in on a single rental but the thought counts.  Another idea might be paying in to buy equity.  It is a pretty straight forward idea, you give them cash and they give you back an ownership share so you both realize gain on sale.  Perhaps you use your management fee income as your pay in, using say 2% to buy in over time. I think the main thing is you have to be giving something whether capital or service or alike that justifies including you in.

Steven Stokes · Answer

Joseph F.

Honestly, I hear this kind of pitch almost everyday. There are literally hundreds of people saying what you're saying and I pay no of them any attention because it's just talk. What gets my attention is your PAST deals.

People talk everyday about what they can do if I give them my money. What I want to know is what have they done in the past. If you have no track record then finding any investors I think will be extremely difficult to impossible outside of friends and family.

If you do not have a track record partner with someone who has a track record and work with them, under them or for them for free if you have to. Then you will have a track record and references to show them you know what you're talking about.

This is just my opinion about what I look for and everyone is different but I hope this helps.

Good luck :)

Jonathan Makovsky · Answer

Happy holidays Joseph F.

I think the answer will depend on the deal you bring to the investors. The sexier the deal you offer to your investor(s), the more negotiating power you will have in taking a piece of the pie for yourself. If you can show that your deal will provide the investor with the desired return that the investor is looking for, and at the same time you can take a piece of the action, the investor might be very happy with the structure. Especially considering that the investor knows that you'll have a strong incentive to keep the property cash-flowing,

With that said there are so many ways to skin a cat and structure your investor deals.

One way that I personally like, is offering an investor a cumulative preferred return and then earning a promote once the return is met. For example, give your investor a 7% cumulative preferred return - which means the first 7% of their investment will always go to them, and if in one year you don't meet that return then it accumulates to future years - then once their (7%) return is met, you can split the profits based on an agreed upon amount, for example 50/50.

Hope that makes sense.

Joseph F. · Answer

@Jonathan Scott,

Thank you for taking the time to reply, especially on Christmas Day.

Joseph F. · Answer

@Jonathan Scott and @Bill Gulley

Happy Holidays to you too.

How is ownership of the property held.  I would like to create an LLC for each property or for several properties purchased among the same group of investors.  What percentage of the property is fair for me to own?

I tell my investors that I get 10% for management.  This assumes that the property can support the 10% and still yield a "decent" return (i.e. 10%).  However, other than the management, I find the opportunity, I do the due diligence and I negotiate the purchase.  In most cases I am able to offer my investors a 10%, including the 10% I get for management.  Would it be fair to assume that I get 50% ownership in the property and in the event the property is sold, the capital investor gets his/her basis first and profits are split 50/50?  Is it also fair to assume that if the investor expects 10% return, and the property is yielding 15% return, that I get or share the amount above the expected 10%?

What is a fair partnership?

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