All Forum Posts by: J Scott

Quote from @Jordan Northrup:

I'm not trying to do anything illegal. The deal was presented to me in this way...just trying to make some sense of it you know? It's not a standard syndicated deal model. Believe me, I'd prefer to do a traditional GP/LP construct like Jay Scott and some of you have said. That's what makes sense to me.

What struck me as odd was that the other GPs want me to network and raise the remaining $500k, but only giving me 5-10% of the equity. That seemed a little low for bringing that many LPs on board. 

Jay Scott's idea of having a Fund of Funds makes sense. Like I said, I'm trying to make sense of all this and I don't know what I don't know. I'm trying to keep myself out of the hot seat by asking questions. 

First, this sounds like a pretty standard syndication from how you've described it.  In terms of equity amount, if you think the 5-10% isn't fair, why not make a counter-proposal to the other GPs to increase that amount?  What other roles will you be playing in the syndication other than capital raiser, and can you use that as leverage to increase the equity you're being offered?

Also, what type of project is it?  You mentioned, B&B and restaurant, but what is the exit strategy?  Will cash flow/profit come from operation of the commercial businesses?  Or will the property be resold?

If average annual returns is 25%, my guess is that this is going to be a little bit higher risk than a standard value-add real estate syndication.  Are you confident that your investors are going to be willing to come for a lower return than what the project is generating and still accept that risk?

Quote from @Todd Dexheimer:

What you are tying to do would potentially work as a fund of funds model. In this scenario, you create an LLC (Passive, LLC) and raise capital in that LLC. In turn, that LLC invests in the deal (The Deal, LLC). You are the general partner of the Passive, LLC and for managing the fund, you get manager fees/equity.

Agreed with that...

Though I will throw out one more issue to be cognizant of: the Fund of Funds should invest across multiple assets, not just this one.  Otherwise, it may appear to the SEC that you're trying to get around the broker dealer rules and you could still be at legal risk.  Investing across multiple assets provides evidence that you are acting in the capacity of a fund manager, which is completely legal if structured (and registered) correctly.

I'm pretty much reiterating what I said above, but just to clarify and organize my thoughts (and note that I'm not an attorney or tax professional, but I have done this many times and have some very good advisors):

1. No, it's not legal for you to earn part of the equity in return for simply raising capital. This is a clear SEC violation. You can earn equity for other roles in the deal, but unless you are a licensed broker you are not allowed to be paid compensation in return for just bringing capital. (The exception being that if it's your personal capital, that's perfectly fine.)

And by the way, you may know plenty of people who are earning equity just to raise capital, so it seems like a fine thing to do. But every single one of them is breaking the law, and if a deal loses money and an investor complains to the SEC, the consequences could be severe.

When you said that one option was to bring the capital as LP funds, it's not clear to me that there are other options. Normally, any capital invested into the project would come in on the LP side. There might be different classes of shares that have different return structures, but it wouldn't make sense to bring money in on the GP side, as then you're losing the liability protection.

Now, it would be legal for you to raise money in a fund, that was structured legally, and then for you to invest that money as an LP investor in the deal and for you to take a fee/commission/profit share from the fund.

But I don't know of any other way for you to legally get compensated for simply bringing capital to the deal if you're not a licensed broker.

2. The tax implications will be dependent on how this is structured. Your GP equity would be taxed as carried interest, which is short-term gains up to 3 years and then long-term gains after that. LP returns would be structured as a combination of ordinary income and capital gains.

3. With your goal of skimming some of the profits from your LPs, again, I would recommend setting up a fund of funds and investing through that. I don't know of any other legal way for you to get compensated for simply bringing capital.

As for just creating promissory notes with your investors, you're still pulling funds, which is the creation of a security and therefore would be governed by the SEC. So they either need to be investing directly in this indication itself where they would need to be investing through a fund you created. Either way it would have to go through the SEC as an exemption or registration with all the appropriate documentation and paperwork.

A couple thoughts:

First, it's a violation of SEC rules for you to get compensated based on the amount of capital you bring to the deal (unless you're a licensed broker). So, make sure that you play some other roles in the deal that justify your compensation.

Second, if you're looking to bring funds into the LP and take a fee/profit off of the top, you might want to consider creating a fund of funds, raising LP capital into your fund, and then deploying that capital into this deal and other deals.

The structure of your fund will dictate what's returned to your investors versus what you keep, and there will be no commingling of funds that will make taxes complicated.  

Also, that way you can be sure that your LPs have received the proper disclosures and there will be no confusion as to your role or the promote structure.

Finally, I would most certainly consult with a good security's attorney to ensure that all this is being done legally and that you are not violating any SEC rules.

Quote from @Sara Malka:

Quote from @J Scott:

Start here:  https://store.biggerpockets.co...

 Thanks J.. i have read your book, "By the num." and it's been realy usfull.. 

Question about the rehab book (couldnt understand from the previwe): does it includes kind of check list with prices on items?

 The estimating rehab book will not give you exact numbers for each piece of the renovation. Nothing can, simply because every area is going to be different, every contractor is going to be different, pricing changes seasonally, material prices change monthly, there are different levels of contractors and quality, there are different levels of material and quality, etc.

What the estimating book will give you:

* A step-by-step methodology to learning how to walk a property and assess its condition and the repairs that are needed.

* A step-by-step methodology to creating a scope of work for the renovation.

* A step-by-step methodology for how to inspect various systems of the property to determine what is working and what is not.

* A set of templates for the line items that will end up on your scope of work.

* A ballpark range of pricing for each of those line items. Though keep in mind that this edition of the book was written just before COVID, and much of those price ranges are on the low end these days thanks to inflation and supply side constraints.

* Tips for getting each of the line items on the scope of work priced out, both from a labor and materials perspective.

Basically, the book will teach you how to estimate a rehab. But it won't do the work for you. Unfortunately, nothing can.

Start here:  https://store.biggerpockets.co...

Quote from @James Hamling:

 I am sorry but this is just so bodgered up I just can't, my OCD won't let me walk away, it's just such a mess I gotta fix this: 

1 Gross Revenues: This includes all rents, be it on unit, storage locker, garage etc.. Revenues received on coin-op laundry should be SEPERATE, the coin-op laundry need be viewed as a SEPERATE business, and should be structured as such, with the rental property leasing these to create a fixed cost to better comprehend the property performance itself.

If we really want to get pedantic about it...

We should be separating this into Gross Potential Income, Rent Loss and Other Income, as Gross Revenue is likely to change seasonally and over time, and by attributing all income/loss to a single number, you lose the granularity of how the property is performing. 

For example, if my gross revenue is down this year, is it due to market rent decreases or increased vacancy (or lower other income)?  How is loss-to-lease impacting my numbers, and how will that be rectified (or exacerbated) at lease renewal?  And how are concessions factoring into revenue loss either on a one-time or on-going basis?

You don't get that level of detail with just a Gross Revenue number.  And if you have a larger rental property (more units), a buyer will most certainly want that level of detail to determine the true current and forward-looking NOI.

As for Other Income being separate, it really depends on why you're doing the calculation.  If the goal is to determine a value of for the property, you're going to want to include (and capitalize) all income generated by the property, as that all goes to NOI and ultimately to the valuation.  

I've written five of the BP books and would highly recommend that anyone start with Real Estate By The Numbers.

You left out capital expenses.

Quote from @A Carter:

Quote from @J Scott:

What happens if he doesn't perform on the renovation? What happens if he goes over budget? What happens if his quality is bad? What happens if he walks off the job?

Do you have the ability to fire him if he does a bad job or slips the schedule? Who pays to bring in new contractors?

I've seen the situation happen plenty of times, so make sure you discuss this contingency. I'm sure he will tell you that there's no chance that he won't get the project done on schedule, on budget and high quality. But until it's done, that's only talk.

 I understand what you are saying, we have contingencies in place for moth the things you mentioned. I guess my exact question is, if everything goes right does the above partnership seem even. Is it in line with most partnerships of this type. 

thanks!

 There's no right or wrong way to structure a partnership, as long as both sides are happy with the agreement.

In general, I like to think that in a partnership, the money is worth 50% of the deal and everything else is worth 50%.

So, if you guys are for the most part splitting the cost and splitting the effort, and 50/50 is about right. If one of you is putting in both more money and more effort, then consider modification.