What is an equitable structure for REI partners?

Question

My business partner and I began REI about 6 months ago.  The way the partnership works is he supplies the investment capital, money, and I do all of the acquisition and property management.  Our strategy is simply buy and hold as we build a portfolio of single family residences.  Another aspect to the relationship is that my partner is my brother.

So, I want to be completely fair in regards to an equitable return of his capital, but also not discount the work involved in all that I am responsible for.

I have asked some REIs locally and the common theme seems to be a 50/50 split.  Here are  my main questions.

1.  Is that typical and fair?

2.  Specifically, how are these splits done?  On first dollar or on returns, growth in equity, etc.?

3.  Should I take some sort of a management fee? Do others do this and then net the fee from the split?

I'm sure there are numerous ways to structure a partnership.  I'm really just looking for solid advice on a straightforward structure that is fair to both partners.

Mathew Paul · Answer

For years I asked myself "how can I create an enticing partnership with investors on rentals?". Here is the structure I came up with and I have two different partners that have agreed to these terms...

Investor supplies all capital for purchase and construction. (i pay one investors interest on his line of credit and pay the other investor no interest)

Once property is generating income, we build up an emergency fund and then begin paying all extra income toward the loan.

As long as this property has a loan on it, I agree to manage it for free(I pay people to perform repairs or maintenance). Once the entire loan is paid for I can either take a management fee for the current market rate or we can pay a management company.

I use the 2% rule(monthly income = 2% of purchase price). By sticking to this rule, if I buy a house for 100k and it brings in 2k per month then I should pay it off in around 6 years.

I also add a clause that if the investor wants to sell early, we split the profit.

To make the investor feel safe I sign a promissory note(I wrote up myself) and a file a deed of trust.

Hope this helps!

James Miller · Answer

Go talk to a lawyer; it sounds like you're a prime candidate to form an LLC or two with your brother. In this kind of relationship, I typically advise my Texas clients to be 50/50 on ownership and profit and loss BUT the manager takes a reasonable management fee of the gross or net revenue, but, I also advise to pay a small amount of interest on capital accounts so the money man gets some compensation for fronting the money.

Brent O. · Answer

Thanks for your input.

At this time we have 6 properties leased and will acquire another later this month.  The money he provides is the capital to acquire and update/prepare the property for the rental market.  Usually between $17k - $20k, so yes the money is relevant.  I'm currently not taking a management fee.  More interested in growing the portfolio and equity at this time.  Would like some cash flow down the road, but that could be from dividends or pm fees.

My brother likes the returns available and hard assets in REI compared to stocks & bonds.  As you stated, without my efforts he wouldn't be able to invest in real estate, at least not in this manner.  He truly is a passive investor too.  I just keep him aware of what we are doing and provide periodic financials, that he probably doesn't even read.  Ha!

So yes, it is a pretty mutually beneficial agreement.

Joe Villeneuve · Answer

We give the finance partner 65% total...15% if a cash partner, and 50 for the refinance partner.  Keep in mind that the cash partner gets all their cash back within a month or two, and has no financial reponsibilities.  If the cash and credit partner are the same person/group, they get 65%.

This is after we take out 10% for a PM...so if you're going to be the PM, take out 10% right up front.  This way, if you decide to pay for one down the road, you've already got it covered.

Rob Beland · Answer

If you are getting management fees is he getting interest on his money? If you need his money and he needs your pm work it sounds like a mutually beneficial relationship. 50/50 down the middle on everything. Think about the value of your pm services as compared to the value of the money he is investing and compare that to the big picture. What kind of $$ are you talking here? Is it even worth discussing?