Need advice on structuring equity partnership for flip

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Need advice on structuring equity partnership for flip

Page Huyette
Real Estate Broker · Bozeman, MT · Member since 2012 · 220 posts · 52 votes

I have a SFR under contract that I plan to rehab and sell within 6 months. Hard money has not worked out since I don't have the fast-flip experience to justify the risk (all of my rehabs have been much longer time frames).

I have qualified for conventional, but need additional funds for the rest of the 25% down and rehab. Not my first choice, but I am working hard to make this deal move forward, as I believe it is a good one.

I have one person who has agreed to pony up 10k towards what was originally a buy and hold rental deal we were looking at, but I'd like to approach him with this deal instead, as it could offer faster, higher returns. My thinking was to offer two options to the investor:

1. Given return on money for fixed period with points paid at closing or...
2. Profit sharing after sale. Percentage relative to amount given.

I'm going in asking for more than the original 10k that was offered for a previous deal we passed on (perhaps 15-18k) , and want to structure the proposal so it looks as attractive as possible. If he sticks with just 10k, I'll also need to put together this package so I can present to some other individuals as well.

Assuming I'm able to pull this off, I would also expect to hold the property in an LLC with the investors paying the LLC upfront, and receiving their profit through the LLC.

Should I set up an LLC just for this one?

Did I mention I have a signed contract? Would have preferred to have complete financing in place beforehand, but this was a situation where the property came on market, and I knew for sure it was a great deal, so decided to jump on it and get it under contract.

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Dion DePaoliPro Member
Real Estate Broker · Northwest Indiana, IN · Member since 2011 · 2k+ posts · 2k+ votes
13y

The conventional financing is going to require you to have the capital for down payment, 6 months reserves (as I assume you take this properly as an investment property) and still cover the rest of your debt service from your income while supporting the subject property note.

In the event you join a person in an LLC, any member with 10% or more ownership in equity will need to be underwritten on the loan.

It sounds like the seller is not willing to accept conventional financing. Perhaps they are aware of the needed repairs and do not want to mess with conventional financing. Another barrier. Leaving $70k on the table by not injecting $30k into the property seems a bit rash, but seller's do weird things. On a side note, there may be a way to have the seller hold the property and you pay for the rehab and create a split with the Seller for the upside, as an alternative to your alternative.

Additionally, in the conventional financing you will not be able to 'borrow' the down payment. That will go against your combined LTV.

As far as the private money deal goes. I would start with all the dollars needed for purchase and rehab. I would then try and simply strike an equity deal with the investor. If I am in for 50/50, I am not too sure I would offer any preferred rate of return or interest payments. If you loose that conversation, you will want any payments to come off the top and not your portion of the equity split.

You can charge for the construction management and perhaps even a small finder's charge. Provided the investor agrees. Point is, that is not unheard of.

Conventional lenders are not big fans of putting money out to be returned quickly. The administrative costs to create the loan out run short term prepayment in most cases. There are some more conventional type lenders, likely more like a local bank, that may have a mortgage product for this type of deal. ("may...")

In the last post, there is mention of title seasoning issues. I didn't fully understand what was being referenced there. A private lender will not likely have any such restriction. A conventional lender, may have such a restriction where your seller may have to have seasoned title. Then your exit buyer may also have the same restriction if they require financing which would cause you to hold the property for the typical 90 days. You then will also go under scrutiny for the resale price. If you document the rehab well, you may be able to get past this.

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  • Bill Gulley
    Investor, Entrepreneur, Educator · Springfield, MO · Member since 2009 · 21k+ posts · 12k+ votes
    13y

    Page, #1, individuals may not be able to collect points on private loans, there will also be usuary rate issues so check that out.

    Your other route would be better in an LLC both of you as members, then the money guy can contribute whatever without the issues of #1.

    Caution, when you have a hip pocket lender (just a RE operator type that is willing to jump in) they will often limit what they will contribute. That is a problem! Knowing it's not enough sets the stage for the deal to fall through and the lender takes the property. Not being real lenders they will move in and finish the job and then try to profit, that is an old game plan. (Yes, the are not to do it but they do).

    Anyone who says they won't advance any more money is a good indication of future problems. A lender really has no choice to finish a project unless they can sell in its as is condition. They realize this and what they are saying is that they won't lend you any more, not that they won't put more in the project. Knowing lending less than is reasonably required can be predatory.

    If they go into an LLC and you split the profits they may go there, but as you indeicated you lack experience, that will be an issue with a partner as well.

    You don't have any real information here, value, ARV, costs of rehab, or relationship to the money guy or who he is (HML, just a guy, Realtor???) no way to judge the deal. :)

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  • Page Huyette
    OP
    Real Estate Broker · Bozeman, MT · Member since 2012 · 220 posts · 52 votes
    13y

    Contract purchase price: 224k
    Estimated repairs: 32k
    ARV: My conservative is 320k, sold comps showing 385k +
    Average DOM for this type of property and associated comps: 2-3

    Money guy is a friend, other potential money people are friends as well.

    We have construction/rehab experience and I'm extremely confident in my numbers and the marketability of this project. The other thought that's come up: if I do sell this quickly, say in 3 months, will that negatively affect my relationship with the conventional lender?

    Back-up plans: Market as lease to own or rent for approx $1600-1800/month. Current vacancy rates are under 2%. What to do?

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  • Bill Gulley
    Investor, Entrepreneur, Educator · Springfield, MO · Member since 2009 · 21k+ posts · 12k+ votes
    13y

    A friend, that means they musy have cold feet, not getting to you.

    I'd hit them up to a 50/50 deal, sell them on the potential profit especially with that DOM of a few days, that's a hot market/property!

    See what they say, they may say let's but and rent it, but it's easier to sell the money guy on quick in and outs with a profit.

    Looks good! :)

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  • Page Huyette
    OP
    Real Estate Broker · Bozeman, MT · Member since 2012 · 220 posts · 52 votes
    13y

    Finished our inspection and came up with some revised repair numbers, along with a 10% contingency. I've got another friend interested as well, so my current options:

    1. Discuss hard money loan from a friend, int. only payments until close, then split profits 50/50. With this option, I'd like to split profits after subtracting some $$ for labor done by us. Say, $4-5k. Seem reasonable?

    2. Conventional financing (will be hard since contract states private money and fast close, and seller may just go to next back-up offer, but we are pre-approved) with us putting in 1/3rd of down and repair costs plus labor, with one OR TWO private money/friend contributers for other 2/3 of cash.

    Problems I'm having with #2 (and will need to clarify with attorney) is how to structure agreeement. My plan is to set up an LLC with all parties, then pay out profits upon sale. But, if back-up plan comes into play and we need to Lease option or rent, how to make this option look attractive to those looking for fast returns.

    Also the seasoning required for the down, best way to handle that part.

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  • Jeff S.
    Lender · Los Angeles, CA · Member since 2009 · 1k+ posts · 2k+ votes
    13y

    I see few problems here, Page Huyette, and I also think you're overcomplicating it. If you take tile in an LLC and include your friend as a member, then they immediately have an ownership interest. You could structure it so they own a small percent, but it's ownership nonetheless and strictly speaking, they would have a say in all matters. Plus, by taking on silent investors in an LLC, you likely created a security subject to all state and Federal laws and possibly requiring a registration.

    Why don’t you make it easy on everyone and simply take the money as a loan secured by the property. Since you already have conventional funding lined up, this would be a second on the property. You could pay interest and points, as your state laws allow, and structure the loan to require all payments when you sell the property. This would conserve your cash.

    Alternately, since this is a friend, you might consider an unsecured loan, which requires nothing more than a promissory note. Check with your attorney, of course.

    Jeff

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  • Page Huyette
    OP
    Real Estate Broker · Bozeman, MT · Member since 2012 · 220 posts · 52 votes
    13y
    Originally posted by Jeff S:
    I see few problems here, Page Huyette, and I also think you're overcomplicating it. If you take tile in an LLC and include your friend as a member, then they immediately have an ownership interest.

    Jeff, I believe you are correct on many counts. My thinking behind the LLC formation was to provide in interest, as conventional financing won't allow a second prior to closing. Would it be reasonable to a) close on the property b) quit claim to an LLC that we control with no other partners c) add the second to the property with the friend/lender in place.

    That still doesn't resolve the seasoning issue. I think the promissory note to the friend would work.

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  • Dion DePaoliPro Member
    Real Estate Broker · Northwest Indiana, IN · Member since 2011 · 2k+ posts · 2k+ votes
    13y

    The conventional financing is going to require you to have the capital for down payment, 6 months reserves (as I assume you take this properly as an investment property) and still cover the rest of your debt service from your income while supporting the subject property note.

    In the event you join a person in an LLC, any member with 10% or more ownership in equity will need to be underwritten on the loan.

    It sounds like the seller is not willing to accept conventional financing. Perhaps they are aware of the needed repairs and do not want to mess with conventional financing. Another barrier. Leaving $70k on the table by not injecting $30k into the property seems a bit rash, but seller's do weird things. On a side note, there may be a way to have the seller hold the property and you pay for the rehab and create a split with the Seller for the upside, as an alternative to your alternative.

    Additionally, in the conventional financing you will not be able to 'borrow' the down payment. That will go against your combined LTV.

    As far as the private money deal goes. I would start with all the dollars needed for purchase and rehab. I would then try and simply strike an equity deal with the investor. If I am in for 50/50, I am not too sure I would offer any preferred rate of return or interest payments. If you loose that conversation, you will want any payments to come off the top and not your portion of the equity split.

    You can charge for the construction management and perhaps even a small finder's charge. Provided the investor agrees. Point is, that is not unheard of.

    Conventional lenders are not big fans of putting money out to be returned quickly. The administrative costs to create the loan out run short term prepayment in most cases. There are some more conventional type lenders, likely more like a local bank, that may have a mortgage product for this type of deal. ("may...")

    In the last post, there is mention of title seasoning issues. I didn't fully understand what was being referenced there. A private lender will not likely have any such restriction. A conventional lender, may have such a restriction where your seller may have to have seasoned title. Then your exit buyer may also have the same restriction if they require financing which would cause you to hold the property for the typical 90 days. You then will also go under scrutiny for the resale price. If you document the rehab well, you may be able to get past this.

    1Reply
  • Page Huyette
    OP
    Real Estate Broker · Bozeman, MT · Member since 2012 · 220 posts · 52 votes
    13y
    Originally posted by Dion DePaoli:
    The conventional financing is going to require you to have the capital for down payment, 6 months reserves (as I assume you take this properly as an investment property) and still cover the rest of your debt service from your income while supporting the subject property note.

    In the event you join a person in an LLC, any member with 10% or more ownership in equity will need to be underwritten on the loan.

    In the last post, there is mention of title seasoning issues. I didn't fully understand what was being referenced there. A private lender will not likely have any such restriction.

    Thanks Dion, I appreciate your response. By seasoning I was referring to the cash injection by a private party if I go the conventional route. In other words, I structure a note between me and the private party, they deposit the funds into an account to be used for the purchase. This is where the seasoning comes in.

    The seller is an elderly woman not interested in participating in any aspects of rehab or financing. I have information packets on the property out to several people, two which may offer hard money for the purchase, with about 3-4 other individuals interested in participating with about 15k in exchange for a percentage of profits.

    Thanks also for the point on documenting the rehab to justify a higher sales price and appraisal if it flips quickly.

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  • Jeff S.
    Lender · Los Angeles, CA · Member since 2009 · 1k+ posts · 2k+ votes
    13y
    Originally posted by Page Huyette:
    My thinking behind the LLC formation was to provide in interest, as conventional financing won't allow a second prior to closing.

    I don’t understand what you said here, Page. What do you mean by, “in interest?”

    The bank can control escrow, but they generally can’t/won't keep you from recording a second after you close on the first. We allow our borrowers to record a first, and a second if they want, at closing. Our lender instructions are very clear about this. Of course, we’re not conventional lenders.

    Even though they have no issue with charging you out the nose for every fax and phone call, some conventional lenders might also get upset if you pay them back quickly. Private and hard money lenders would generally have no such concerns. Of course, I don’t know whom you’re dealing with.

    In theory, your conventional lender could balk at quit claiming to an LLC and they could call the loan due. This rarely happens and you'll be in and out quickly anyway. Why do you feel you have to do this? Liability protection or is it something else? I assume you are not taking title in the LLC because your conventional lender won't allow that?

    Jeff

    0Reply
  • Page Huyette
    OP
    Real Estate Broker · Bozeman, MT · Member since 2012 · 220 posts · 52 votes
    13y

    Jeff S, I meant "an interest" not "in interest." To clarify, the thought was to give them security attached to their money via the LLC since I can't add the second until after closing.

    Oh, to find a hard money lender for this deal....we are ready to rehab, have our costs and now I am second-guessing the conventional lender approach. Too many fees, money seasoning requirements and documentation for other party contributions.

    I AM overcomplicating this I believe. I had the numbers worked out for HML and it was ready to go, now we'll have to see what happens with other options.

    2Reply
  • Page Huyette
    OP
    Real Estate Broker · Bozeman, MT · Member since 2012 · 220 posts · 52 votes
    13y

    Update:

    Hard money options for funding the purchase not working out.

    I could use some more advice. After running our numbers, and, based on the time frame we'd want to get this property out on the market again (before winter) its looking tough one. Trying to follow the numbers and not get caught up in the fact that the market is hopping. Our inspection period ends in the next couple of days. I'm mulling over this idea:

    Ask seller to revise buy/sell contract to include 15-18k earnest money, carry the note for 6-8? months at which time I can have the property reappraised and be eligible for a refinance, using the anticipated equity and rental income instead of cash. This scenario was given the thumbs up by my mortgage banker, and I'm still convinced this is a solid property.

    Exit strategy would be to refinance and hold, continuing upgrades over time if rental market stays below 2% vacancy. Or do a lease/purchase with a solid party. Or sell if the market continues its climb.

    Good idea? Too complicated? Even though the property likely has at least one back-up offer on it (not sure though) my thinking is that since we are already under contract, we could write a personal note through our agent proposing the amendments, which would still satisfy several of the attractive parts of the original offer: 5k over asking, fast close, release from property responsibilities. Seems like its not likely they'll bite, but I'm wondering if its worth everyone's time.

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  • Phillip Dwyer
    Real Estate Agent · Henderson, NV · Member since 2011 · 1k+ posts · 550 votes
    13y

    The numbers don't seem attractive for a buy and hold stategy. Why does it have to take so long to flip?

    0Reply
  • Page Huyette
    OP
    Real Estate Broker · Bozeman, MT · Member since 2012 · 220 posts · 52 votes
    13y

    Wouldn't take that long, except we would be doing the work and have full-time jobs. As for a buy and hold, I was thinking more along the lines of one year max--do some rehab this summer, then finish up the rest early spring 2014 in time for spring selling season.

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