Equity Partners In A Rehab, How To Structure? What is a good ROI?

Question

I've decided that I would like to expand my REI into rehabbing and I've started to educate myself around it with the intention of doing a rehab before the end of the year. I have three close friends/family members who are interested in being equity partners. One would cover the purchase cost and the other two would cover the rehab costs. How would you structure the equity split? What is a good ROI? Here are my thoughts and I would appreciate some feedback.

Partner # 1 65K(purchase) Equity Share 40%

Partner # 2 15K(Rehab) Equity Share 20%

Partner # 3 10K(Rehab) Equity Share 20%

Partner #4 Managing Project (myself) 20%

My ideal first project is:

3/2 SRF below 65K with an ARV of 115K or More

Max Rehab Budget 25K

Target ROI=25%

Does this make sense or am I totally dreaming?

Anthony Dadlani · Answer

Hello All, Rehabbing is a great time tested strategy as you are adding or forcing value upon a property by bringing it up to date. Also by sprucing it up, you are also making it more desirable for a renter hence good cash flow always increases value. From my experience one of the easiest ways to structure a deal whereby partners may not be contributing the same amount of capital is to set a cost of capital rate on the project. For example if the cost of capital rate is set at 12% annually, each partner would get a rate of return on the capital he has invested before any profit split. Will use round numbers in the following example. Cost of project including repairs = $100,0000 Partner 1 contributes $75,000 Partner 2 contributes $25,000 Property takes 12 mos to sell for $150,000 ( for ease of example) $50,000 total profit Partner 1 is entitled to $9,000 Interest Partner 2 is entitled to $3,000 Interest $50,000 - $12,000 = $38,000 left to share 50/50 Partner 1 makes $28,000 on the deal total Partner 2 makes $22,000 on the deal total In the above scenario partner 2 is most likely the working partner ( finding , managing, and selling the deal) whereas partner 1 is the passive financial partner. This of course is just one of a million ways to structure a real estate joint venture which I have found quite successful. Best of luck in all your endeavors.

Patrick G. · Answer

Double Check my calculation but investing 65k and getting back 18.4k in 6 months is 57% ROI. Which is effing insanely huge, so heck yeah it's well worth it. Is all the time you are going to spend on this worth only 4.5k? That seems a little light. I really like your idea to work with equity partners instead of taking out a loan. I hope to follow suit one day. You have a bit of trouble with the fact that you have 3 money partners. But you (hopefully) have a bit of grace in the fact that they are family. Hopefully you can sit them all down and get them to work together. Mathematically I would approach this in the following steps: If you took Bryan L.'s advice and split half the profit between yourself and the three money investors it would look like this: Partner 1) $10.8k profit Partner 2) $2.5k profit Partner 3) $1.7k profit That is still 33% ROI. which is pretty darn good, and you walk away with 15k. Maybe one partner would accept less profit if he got paid out first? Or more profit if he got paid out last? There are ways to get creative if need be.

Patrick G. · Answer

I hate to call it wisdom, its just math. I dont actually have experience doing what you are talking about. Look at it and work backwards. Your last scenerio is still unfair to partner one. He invests more money and gets less roi. Plus his money comes first. If you assume 30k profit and assume partner 4 gets 4.5k that leaves 25.5k to split for the money partners. Should be as such #1 $18.4k #2 $4.26k #3 $2.83k That is fair to the portion of risk they took and the same roi for each.

Mike G. · Answer

Also, while this is not necessarily relevant to how you divide the equity, your original numbers only specify purchase price and rehab costs. There is no mention of purchase closing costs, holding costs, or sales costs, which will eat into a lot of your expected profit. Make sure you estimate those before committing to a deal.

Justin Morris · Answer

Patrick G. Thanks for the input, I like that idea and you are right 33% ROI is pretty darn good. Plus, 4.5K isn't very much for finding, managing and completing the project, I think 15k is much better. Now, I just need to find a deal that's I can put in 90K and yield a 30K profit, that maybe the hard part. :-)

Justin Morris · Answer

Got it, Thanks Patrick G.....How would you more experienced investors work with these three money partners in a way that is going to make them decent money? To you is investing 65k and getting back 18.4K in a 4-6 month period well worth it?

Justin Morris · Answer

Patrick G. thanks for the wisdom, let me just ask you a question though because I'm a bit unclear about this. Lets say that the total profit after its all said and done, ends up being 30k. Is giving Partner #1 40%=12,000 Partner #2 25%=7,500 Partner #3 20%=6,000 Parner #4 15%=4,500 Not a good return for all investors? I mean making 12,000 on 65,000 after a 4-6 month period I would think is pretty good? No?

Bryan L. · Answer

I think most REI investors split it as follows: You see, the most valuable part of the deal is "finding" the deal. Therefore, even though he puts in no money, the RE investor who finds the deal and manages the rehab often takes 50%. The money partners then split the other 50% proportionally. Even so, if I were to be one of your money partners, I would want some language in the contract that starts to shift equity from you to me after a certain period of time. I wouldn't want my money hanging out there in the breeze if you are slow getting the rehab done.

Patrick G. · Answer

The equity share is pretty far off from a straight math stand point. Why would Partner #2 agree to give you $5k more than Partner #3 for the same amount in return? with your numbers, Partner #1 gives you 65k and gets back $46k. That is a big loss. With your 90k total investment and assuming you want the manager to get 20% (which means he has basically done $22,500 worth of work, compared to the partners investing money.) The break down should be: Partner #1) 57.8% Partner #2) 13.3% Partner #3) 8.9% Partner #4) 20.0% So partner #3 invests his 10k and gets back $10,235 after how many months? Not worth while at all.