Could someone double check my math???

Question

Hello,

I am investing with a partner that I trust, and we are trying to work out the proper agreement that will make this a win-win for both of us. For context, we both live in Los Angeles, he has all the capital, and I will be finding the deals in the midwest (and setting everything up). This is for buy and holds, and both of our goals is to cash-flow as much as possible and (hopefully) not sell for 10+ years.

Now, onto the details:Since he's providing all the capital, we were thinking of structuring this where he gets 7% interest every year on his money first, and then we split the monthly cash flow 50/50. All small expenses/repairs would immediately be paid for through the rental income. If there is a larger repair needed (e.g. new HVAC), he will pay for it and then add that amount will be added to his down-payment capital, and then he will receive all of it back when we sell the property.So, lets say we buy a Duplex in the midwest for $80K, and it rents for $1200/month. This means he would put down $20,000 (25%) + maybe ~$4k for closing, for a total initial investment of $24k. If I'm paying him 7% interest every year first, does this mean that every month he will receive $140 first ($24k * 7% / 12 months) until we sell the home? And then we split the monthly remainder cash flow?Also, if we buy a new HVAC for $5k after 3 years, he would have a total of $29k invested. 10 years from now if we sell the property for $100k, would he get his $29k first and then we split the remainder profits?

Victoria Townsend · Answer

Yeah I think you're right Account Closed.

My challenge is that his opportunity cost is investing his cash in a vanguard index fund, which returns him roughly 7% for doing nothing. This is why I'm trying to come up with something that clearly shows it would be better than investing in an index.

However, I guess I could also do 60/40 and guarantee 7% for a certain period of time... we should be able to easily cover it. I think that sounds enticing...

Account Closed · Answer

Victoria I think you're overcomplicating things with the 7% interest clause. Maybe makes more sense if you just say give him a slightly higher cut (ex 60/40) and go from there? If this was a planned quick turnaround/flip then I'd say when you cash out you can first pay him back his initial investment from earnings then split the remaining proceeds 50/50, but doesn't work so well for a buy and hold.

John Leavelle · Answer

Howdy @Victoria Townsend

Let me see if I get this right.

Your partner wants a Return better than his mutual fund (over 7%).  Right?

He can fund down payment, closing,  and some Rehab.  Right?

You do not have cash to put in, but, will do all the work (excluding loan applications).  Right?

If all these assumptions are correct then here is my suggestion.   Use the BRRRR strategy or a variation of it.  Treat your partner as as Private Money Lender.  Pay him 10 -12% interest.  Use his money along with another Hard/Private Money Lender to pay for the acquisition, rehab, closing/holding costs.  Get property rented.  Then refinance after seasoning and pay off both lenders.  Win Win.  Partner gets 10 - 12% return on his money.  You get a long term Cash Flow property.

Of course you must find the right property to do BRRRR strategy and you must be able to qualify for the refinance loan.

Hope this helps.  :)

Sam Shueh · Answer

Suggest 50-50 on everything.  10 year is a target not a clear cut date.  It looks like someone willing to toil with you so he/she needs to have deep pocket. For midwest after 10 years you two could have little equity in duplex do not appreciate like in west coast.  Duplex is for income or tax write off.

Suggest a trusted relative or friend to invest together.

Maxwell Lee · Answer

Hi @Victoria Townsend this sounds very similar to our deal structures we've done often in the past, however those were always for flips or BRRR. We would give an 8% preferred return and then a 50/50 split on profits, but these never lasted beyond a year. Your scenario may be a little messier but I think it makes sense and can work well. Obviously due diligence must be performed on the property's condition, location and tenants, or your cash-flow may get flipped upside down. Good luck!

Victoria Townsend · Answer

He would easily be able to take out a loan for the remaining $60k.

Christopher Phillips · Answer

@Victoria Townsend

That's an okay start before getting details.

So, what are you doing for financing on the remaining $60,000?

Victoria Townsend · Answer

@Christopher Phillips 50% of rent rule going towards expenses?

Christopher Phillips · Answer

@Victoria Townsend

What assumptions are you using for your analysis?