Need advice on setting up a JV where I manage the funds/assets

[Nayt Grochowski]

I am working with a small group of investors and we are putting our funds together to purchase properties that we will sell with seller financing to generate cash flow. The plan is that my LLC will be managing the assets, basically handling the acquisition, marketing, sale and collection/distribution of cash flow. Plus when we sell a note, or get refinanced out, I will take those proceeds and get more properties back in to keep generating cash flow. This is a long term investment/hold strategy we are building up as a group. I plan on taking a fee as a % of the cash flow disbursements for doing the work, along with putting my own capital in for the initial funding.

I would also like to repeat this with more people and create new partnerships down the road. Want to make sure I am setting up the JV correctly between my LLC and the other people/LLCs and that it is easily replicable. Each partnership will be its own group, the assets of each would be completely separate from each other. Once a group is formed and each person has their % of the relationship, it's locked in.

Some of the key points for the partnerships to still be worked out:

• How to exit the partnership – plan is to put a value on the assets/cash we have at that time and allow the other members of the JV to buy out the partner. And if current partners don't have capital to buy out, open it up for a new partner to replace them. Anyone have other ideas/issues with this thought?
• Taxes on sold properties that we then reinvest into more – Do we take the tax hit, or is the purchase of additional properties counted as a business expense, or if not is a 1031 possible. We could have this happen multiple times a year too, so looking for something not too complex.

Obviously the JV has much more in the agreement, but these are the main areas I am not sure about.

Has anyone set up JV groups like this and have experience and tips you would be up for sharing?

[Karen Margrave]

Paging @Bill Gulley

[Brian Gibbons]

@Brian Burke

@Bryan Hancock

The syndication joint venture guys

[Christian Brodin]

How to exit the partnership – plan is to put a value on the assets/cash we have at that time and allow the other members of the JV to buy out the partner. And if current partners don't have capital to buy out, open it up for a new partner to replace them. Anyone have other ideas/issues with this thought?

This is fairly standard clause called right of first refusal. you definitely want to make sure that you as the GP or Managing member has control over who the interest is sold to, and when it is sold. The best advice I have for JV groups is to pick your partners with great care. it will make or break your business.

Do you have a clause for voting on major decisions. when property is sold, financed, budgets, tax appeals etc.??

Another thing to consider  is a Tenant in Common structure so that each ownership is totally independent of the other investors. YOU SHOULD CONSULT A LAWYER OR ACCOUNTANT TO MAKE SURE YOU DONT MISS ANYTHING SETTING THIS UP!

Taxes on sold properties that we then reinvest into more – Do we take the tax hit, or is the purchase of additional properties counted as a business expense, or if not is a 1031 possible. We could have this happen multiple times a year too, so looking for something not too complex.

This is a pure business decision in my opinion. do you take money off the table and pay taxes vs keep on rolling over the investment using a 1031 exchange. in 2007 we decided to do a 1031 exchange to save taxes, but had to reinvest into a falling economy. in hindsight we could have done better by just paying the taxes.

- also dont forget transaction costs. with such a heavy rotation of investments you will pay huge transaction costs in addition to any taxes. Lawyers, accountants, broker fees, stamp duties etc. etc. (have you modeled everything in your IRR analysis)

1031 exchanges can be really tricky if you haven't done them before and have good access to new projects. you could even be forced to take on unprofitable projects to meet 1031 deadline and not risk your money AS ALWAYS. YOU SHOULD ASK A 1031 PROFESSIONAL!

[Bill Gulley]

First, check into a SEC 506d as to pooling investors, both Brian's mention by the other Brain will have more to that.

You are absolutely describing a mortgage brokerage operation, originating seller financed notes, selling the notes (?) and distributing interests in factionalized notes. Selling to owner occupied homeowner's means your brokerage will need to be compliant with Dodd-Frank, the SAFE Act, Reg. Z, C, D, Truth-in-Lending, Equal Credit Act, RESPA, Fair Credit Reporting Act, as applicable as you will not be just a homeowner seller financing but a dealer, brokerage operation. 

Need to look at Dodd-Frank as to seller financing a property that has any construction accomplished, it's not allowed  for dealers generally.

Forming an investment pool does not grant licensing as a mortgage operation, that will require registration and licensing. 

Your idea in general is not a new one and it carries some other concerns of old operators doing seller financing. You will now have predatory lending and dealing issues with underwriting your buyers as well as the sale price being at fair market value. To make money you'll need to buy right, if you work on the property you'll have the issue mentioned with construction/rehab. There may not be much room to profit buying general inventory.

It's a simple idea really, might realize that if things were that simple, everyone would be doing it. Doing a few seller financed transactions would be fine, at the scale you mentioned and implied, financial compliance is going to cost you. Additionally, being "in the business of" is not simply investing for you (and perhaps partners) and you will also have loan servicing requirements. While there are exceptions for small portfolios, there are still basic areas of compliance and servicing practices that will need to be followed, so, more compliance. 

As to you "buy out" you need to define those events that trigger a partner's option to sell or buy, it may not be a simple FROR but a priority of which partner has the first opportunity too. Check state laws carefully as to liquidation of an entity with partners, contributions generally dictate priority on a % basis, unless you specify differently, state law will govern.

As to taxes, it's generally ordinary income from business operations, you can defer taxes with the principal as it is received. I hope you have accounting experience too, it can be a real bear and you'll need a CPA familiar with "banking". I'd suggest too that you not try to employ 1031 transactions, since you're flipping and there is additional costs involved, it just wouldn't pay. Bite the bullet and just make money!  

If you're serious, you really need to find 3 attorneys,  one dealing in securities law, another in finance and another in real estate, these are all specialty areas, I've never met one guy/gal that can cover all three areas in the level of detail you will require. Good luck :)    

[Bryan Hancock]

A good securities attorney can do all of this for you.  Brian Korn in NYC is a good choice.  I am sure there are plenty of others that can help with this.  

Tread carefully.  Securities law is NOT an area where you ask for forgiveness instead of permission.  If things don't work out properly you can get thrown in jail.  You want proper disclosures and documentation if you're going to do things properly.  

[Austin Moran]

@Bill Gulley If Nayt were to originate and sell notes and partials to other business entities only would he be exempt from many of the compliance requirements?

[Bill Gulley]

@Austin Moran

Finance is not real estate, unlike being in a business to business transaction in real estate and calling it commercial, finance does not look at it like that at all. 

Loans are commercial or consumer. He is speaking of consumer lending since the collateral are dwellings. 

Next, having a business entity in finance certainly defines you as being in a finance business, not acting as an investor as an individual, being in the business kicks in the compliance issues ten fold. 

If you are doing things a finance law pertains to, then you need to comply with that law. :)

[Steve Vaughan]

I have been buying, selling, renting and financing (pre Dodd-Frank) for years and this is way too far into the deep end for me. I would listen to the pros here @Nayt Grochowski.  Ignorance is not an excuse.  "But your honor, I didn't know. I didn't mean to do it wrong" won't fly. 

I would keep it simple and avoid these highly sophisticated, high hassle-factor (managing 'partners'), high transaction cost at high tax-rate ventures.  RE just works too well as-is, in simple form!  

[Nayt Grochowski]

@Christian Brodin @Bill Gulley @Bryan Hancock @Steve Vaughan

Thank you all for the great feedback - and yes I do have an attorney setting up the initial JV - looks like going down this road will may be more steps to get setup. I already have a number of properties I am already doing this for on my own and have been sharing the experience with a few people that now want to join me in getting more, so that is where this all started from.

Christian - all asset management decisions will be handled by me - this is more a hands off process for the other investors. Plus, most of the time we will be refinanced out, so no choice there but to get the funds back to work - and based on most of what I have been reading, we will just take the tax hit and keep going.

Bill - as I am using a 3rd party to handle the sale of the property and setting up the note, does the broker obligation fall under them (I pay a service fee for them to handle it), or something our group will still need to do? Plus I use another 3rd party to handle servicing the note, so no problem there.

Not at all worried about the work involved in getting it setup - just want to make sure it's done correctly.

The other option here, create a new company (LP, LLC or SCorp...) with the investors that want to join and we all contribute the initial capital for our membership % - and the new business handles everything with me as the managing partner. Of course that is a more expensive setup for future groups with the initial setup, filings each year, etc - but I could see it as just be a cost of doing business and may be less complicated. I have setup and run quite a few businesses over the years so very familiar with that process, may be a cleaner way to go too... Thoughts?

[Bill Gulley]

Nayt,

If you are the owner, seller financing, you are the lender, if you are in the business and doing multiple transactions, it does not matter that you sub-service underwriting or servicing, you are still a dealer and a lender. Sub-service is subbing out work the lender is required to do, it certainly helps from your work load and you can hold others responsible, but they are working  for you,  you are the lender. The compliance falls on your business entities, each one.

Your partners are basically table funding as lenders if they are buying the note at settlement. 

"Investors" that form business entities to buy and sell notes are probably messing up from the get-go, they are much better off dealing as individual investors rather than forming a "finance company" doing brokerage activities......whatever! When they have some legal issue they will probably find out.

I'm guessing your attorney might be a corporate type that sets up entities, you better ask if s/he ever represented a financial institution in  banking or mortgage operations, if not, find one. Same with the SEC requirements (that they may be more familiar with). 

In your approach, with partners, this would be fine if you were developing or in a buy and hold, your complications come in by financing the sale of your homes and you can't avoid that past the exemptions allowed. I'd think there would be a better way, lending among your entities on a commercial basis and having sales through a primary lender-dealer. 

@Ken Rishel deals in a similar area with seller financing dealers, different collateral, but the financing arrangements are very similar. Good luck :)

[Nayt Grochowski]

Thank you @Bill Gulley

The deals I have done so far for myself have been sold as-is with a Land Contract and a Promissory Note. If I keep doing these, even if just by myself, I suspect the same requirements will apply after some threshold (8 in the works right now) - appreciate the direction, time to get some more research done!

[Ken Rishel]

There is no acceptable threshold when you are not the owner who occupied the home or perhaps inherited the residence the deceased resided in. People who advise otherwise do too much internet reading with no understanding of regulatory law.

[Daniel H.]

Originally posted by @Bill Gulley:

Nayt,

If you are the owner, seller financing, you are the lender, if you are in the business and doing multiple transactions, it does not matter that you sub-service underwriting or servicing, you are still a dealer and a lender. Sub-service is subbing out work the lender is required to do, it certainly helps from your work load and you can hold others responsible, but they are working  for you,  you are the lender. The compliance falls on your business entities, each one.

Your partners are basically table funding as lenders if they are buying the note at settlement. 

"Investors" that form business entities to buy and sell notes are probably messing up from the get-go, they are much better off dealing as individual investors rather than forming a "finance company" doing brokerage activities......whatever! When they have some legal issue they will probably find out.

I'm guessing your attorney might be a corporate type that sets up entities, you better ask if s/he ever represented a financial institution in  banking or mortgage operations, if not, find one. Same with the SEC requirements (that they may be more familiar with). 

In your approach, with partners, this would be fine if you were developing or in a buy and hold, your complications come in by financing the sale of your homes and you can't avoid that past the exemptions allowed. I'd think there would be a better way, lending among your entities on a commercial basis and having sales through a primary lender-dealer. 

@Ken Rishel deals in a similar area with seller financing dealers, different collateral, but the financing arrangements are very similar. Good luck :)

Thanks for the advice Bill.  Would it be simpler to have investors individually purchase their own properties and then offer to sell them as-is via lease-option?  

[Brian Gibbons]

@Daniel H.

Or a lease and a rofr (right of first refusal) or lease purchase.

[Bill Gulley]

@Daniel H.

A straight option to purchase separate from the lease agreement would be fine, just don't credit rents toward the sale price or take required payments toward the option. That's another thread and it's well covered here on BP.

Investors are happy when they are making money, not so much when they are implicated in an illegal financing scheme or operation. 

There was a recent case in Florida where a BP member did an option that wasn't properly made, it was gurued up, and the contract was deemed to be a sale contract, he had to repay the option price as that turns into a deposit, besides the costs of the case I don't know what else he lost.  

As to any first right of refusal in a lease or as a separate agreement, a standard FROR would be fine, not doctored up to color it as something else or financing such agreement. Since they are contingent on a seller agreeing to sell, they hold very little water, but might make a tenant feel warm and fuzzy. 

There is a way to do seller financed homes, become compliant as a lender. 

@Ken Rishel thanks, sorry to bug you again, but is there anything new as to RMLOs being compliant in seller financed originations and/or under served financing markets? :)  

[Ken Rishel]

@Bill Gulley: It depends what "new" means to you or whoever else is reading this.

RMLO's for the most part have never structured the deal correctly because they did not understand how to do it. A few years ago, RCG was teaching and training them how to structure the deal and supplying them with the necessary relationship documents to establish the correct structure. We also helped them build their Compliance Management System which most of them had (but not all) into a lender's compliance management system instead of the broker's system which was insufficient. 

We stopped doing this early in 2013 when Jim Grey (a staff member) discovered in a conversation with CFPB personnel that they were writing a rule proposal on servicing that required that anyone buying loans - such as a retailer or community owner was going to be required to have the same licenses as the RMLO/MLBs - and that MLBs were also going to need state issued lending licenses to retain service.

In January of 2014 the new rules on servicing went into effect. 

Could a RMLO still originate loans? Yes, if the structure was correct and they sold those loans to a properly licensed lender. They could also license their own organization as a lender and retain ownership and service of those loans under a complicated agreement with a retailer or community owner or Lonnie Dealer.

The better question is, "Why would they do that"? Given the complex structures, the additional costs for licensure and compliance, and the additional record keeping and reporting requirements, along with liability for examinations, they would need to charge the associated company far more than that company would be willing to pay. The charges would get higher for Lonnie Dealers/Community Owners/Retailers who were only doing a low volume of business if the MLB even understood what they were getting into.

It would take more time than I am willing to devote to explaining why, but the very few legal and legitimate servicers out there would turn down the chance to service portfolios under $5,000,000. While I am aware of at least 100 MLB (and that could be vastly underestimated) who are offering to originate loans (only) only two that I know of are legal and compliant in the methods they use to do so. Both of them charge in excess of $1,000.00 to originate and transfer the chattel loan to a legally licensed and compliant servicer. I believe they charge double that amount to originate real estate mortgages. These numbers are not applicable for MLOs and Brokers finding and servicing loans for other lenders  and depositories they have an ongoing relationship with where they are also paid on the loan itself.