My Contractor/Investor Relationship - Opinions?

Question

So I'm in the planning stages of a full rehab in Portland, OR. I'd like to describe the agreement that I came up with for what I believe is an equitable split for the proceeds and see what some more experienced rehabers & investors have to say.

ME: I am the GC on the project. I found the deal, did the research, closed it, and assembled the team. I'm providing my own labor, and managing my crew as one would expect. I'm doing preliminary designs before handing it off to my architect. I am working with the community association to get approval through the historic district that we are in. I am doing A LOT of after hours research and analysis prior to starting construction to avoid hiccups and delays once full construction is underway.

INVESTOR: Supplied the cash to buy the house. Funding the entire renovation project. Has some input on design and scope of project. They have done a few rehabs in the past but don't have the time to be very hands on. They trust me implicitly and are allowing me to ultimately set the scope and schedule. They would like to continue this relationship on future projects.

This is what I have proposed:

The Spit: Base split on net profits is 60% to Investor 40% to me with conditions.

Conditions:

1. I am paid as the GC Company for the cost of the rehab plus my overhead (no profit) on the project.

2. The Investor gets a minimum ROI of 10% before the 60/40 split kicks in.

3.My GC Company makes profit out of the 40% with a cap of 10% of construction costs.

4. I personally receive the remainder of the 40% as long as the above conditions are met.

So essentially it works like this: After all of the work is done and the house is sold and the costs are tallied, the Investor is paid FIRST. THEN my contracting company makes profit, THEN I make profit as long as the first two entities are satisfied. IF the project is less profitable the Investor has the lowest risk. I have skin in the game to keep costs in check and deliver a finished product that will sell for top dollar.

Anyone have comments on this or similar arrangements?? I'd love to hear what others are doing. Thanks!

Mike Nuss · Answer

Isaac, I've got some thoughts that I'm going to tally below. Hopefully they make sense and give you some good insight from another investor in Portland. Side note, what neighborhood? I love historic neighborhoods.1) Some back ground on the numbers would help. My initial thought is what would hard or private $ have cost you for this project? How does that cost compare to the expected returns of your investor? Having other sources of $ gives you more leverage in negotiating these types of deals. 2) Is the investor's 10% a simple interest per annum or flat rate ROI? Structuring this as "simple" interest versus a flat 10% ROI works better if the project is under 12 months. It is in your favor if the project is over 12 months. Just a point I would consider, similar to factoring hard $ points versus interest rate.3) What's your "overhead" attributed to the project? Insurance, office space rent, phones, workers comp, etc. etc.? This is a very smart line item to build into the "cost" of the project, just as the investor's 10% return is a cost of the project. Good job here.4) Historical design review is a serious process. Very serious process. I just bought a duplex in Irvington. The seller sold the neighboring 6plex to another investor before my company was ever part of the duplex sale (that investor backed out of the duplex purchase, he was going to purchase that as well). I met the other investor last week. He purchased the 6plex for just over $600K and plans to resell over 1.2mil. His comments. "You can have Irvington, I'm never working here again".I hear that a lot from investors working in historic neighborhoods. The returns are very appealing, but the design review is legitimate. In my experience we would build some sort of management cost into the profit share for the design review process. This is going to be a head against the wall session. Hopefully it will be your architect's head.5) Project management should be a line item "cost" to the project. Every GC joint venture we have done has included this type of line item, albeit a small one (we want the GC invested, but we also want him to enjoy the project). 6) Did you consult a CPA as to your projected income on the project? Would it be best to remove your company profit from the 40% and take that all as gains? Would it be better to remove your personal gains and take it all as income for the construction company. This may be a minimal consideration, but one thought that came to mind. 7) We have done this same exact profit split where the GC got 40% of profit and we got 60%, with our private $ being a cost to the project, so your split could be considered a "market rate" split.8) How did you structure ownership? We always own the project and use joint venture agreements. Control is key!9) Breakdown of some other "profit split" deals we have done locally:We have done a hand full of investor/contractor projects where we were basically the glue. Our deal, our due diligence, our design, our ownership. But, not our $ and not our construction company. We've partnered with a GC having skin in the game. We paid out net profit equal to the amount of "skin in the game". The GC used private $ as well so our cost of funds were our own private expenses. We have done similar profit shares where the cost of funds was a cost of the project. Our latest profit share deal is a recent purchase in Wilshire. We approached the investor as a private $ loan. We had our investment packet with all due diligence completed. The packet always includes scope of work, purchase price, appraisal, rehab budget, break down of expenses and an LTV, showing our estimated resale. That out of area investor offered a profit split rather than a straight interest rate. He offered a 70/30 percent split. We get the 70, he gets the 30. In this scenario his simple interest return of 10% was changed to a projected annualized return in the low 20s. Our cost of funds increases and projected profit was reduced, but it was well worth it. The loan has 0 interest so our risk is very low. Also, we are not penalized if the timeline gets extended (something to consider in historical design review). The investor's return is actually a higher cost than hard $. We could have done this deal without him. However, the lower risk on the project and ability to do more in the future persuaded us to go the profit share route. Hopefully this helps your thought process on your deal. Happy investing.

Isaac Frost · Answer

Chip, That is definitely a good thing to remind people of who want to act as their own GC. I am a fully licensed and bonded General Contractor in Oregon with workers comp insurance. I have been doing remodeling in Portland for a long time ; )Cheers

Laureen Youngblood · Answer

@Isaac Frost Being in similar circumstances, albeit a different price bracket, I think it sounds like you are taking care of all the parties' interests with this split. As I have heard a number of times here and in other REI arenas - part of something is better than all of nothing. I am excited to see how this works out for you.

Isaac Frost · Answer

Aaron, We do a 10 and 10 for OH & P. The 10% overhead is already accounted for in the construction budget. What do you use in your area?

Aaron McGinnis · Answer

Does your GC firm always target under 10% in profit? Seems very thin to me for the kind of work you're proposing.

John Weidner · Answer

What is the acquisition price?

Isaac Frost · Answer

@Aaron McGinnis - Target sale price is $675k to $725K. Rehab budget is $200k.

Aaron McGinnis · Answer

@Isaac Frost - Not to be too nosy, but how big is the project?

Isaac Frost · Answer

Aaron, I can see why you would think that. I am being conservative with my approach. The numbers do work in this case and I'm getting a lot of capital to work with on this project. The theoretical payout for me is 18k profit for my GC company and 23k to me in profit split. On top of that I already have my PM and labor covered in the construction budget.Yes I could do better with other sources of money perhaps, but I'm new to this type of investment project and this money was available now and it was a "jump on this deal or lose it" scenario.Anyone have recommendations for reliable funding at a decent rate in Portland, OR? I prefer not to have to make payments on the property while the project is underway and want to payout after the rehab/sale is complete. It seems like from what I've seen in Portland you need to be able to buy the house with cash to get the deal and then there is rehab cost on top of that. Pulling together $500k in funding is difficult for me a this stage with my limited investment background. Hopefully this will change as I grow.Isaac

Aaron McGinnis · Answer

I don't understand why you would want this relationship. It sounds very expensive to me... surely you can find a cheaper source of money than this? (It looks to me like your investor is basically just acting as a money lender)