Partnership Buyout
Real Estate Investor · Grand Rapids, MI · Member since 2008 · 33 posts · 8 votes
Hello,
I was wondering if someone could give me an unbiased opinion on my current situation. My business partner and I invested on a duplex together a couple years ago and all the sudden he decides he wants out. He asked me if I want to sell but with the current ROI and monthly profits we are making I think it would be unwise, so leaving me only one option to buy him out.
What would you consider a good/fair buyout for the situation listed below;
Purchase Price: 20K
Loan: 45K
Downpayment: 12K
Profits up to this point: 5K (joint savings)
loan term: 20 year (mind you its an arm and will adjust after next year pending we/I can get it adjusted to fixed)
years left on loan: 16 years
Thanks in advance and let me know if you need more info. I trade to be as vague as possible so I wouldn't influence any opinions
This is the problem...
Without a formal agreement upfront, you're in a situation where both of you are looking for what you consider to be a "fair" deal, but unfortunately, what each of you considers fair is wrapped up in an emotional attachment to your goals.
Ultimately, you guys are going to have to try to negotiate until you come to terms...in the end, it sounds like your partner is in a more desperate situation than you are, so ultimately he'll need to compromise or be forced to keep an investment that he doesn't currently want.
In your partnership agreement, did you have any provisions for when the partnership would end naturally? As in, after 5 years or when you sell the deal?
If he wants out early and you don't want to sell, then he should be the one making you an offer for his half of the deal. You said you are happy with your ROI so you could at the very least pay him half of the down payment. If there is any equity, this is where it could get tricky but again, he is the one who wants out so he should be willing to negotiate on this.
Is there anything in your operating agreement for this situation? If so, do whatever it says.
One option is to just pay him back the money he invested, plus some nominal return for the time his money was in the deal.
Another would be to have the house appraised to determine its current value. Then, subtract out all your expenses and costs, both ones you've actually incurred and ones that would be incurred if you sold. Then figure out his cut of the profit. That's what he would get if you actually sold, so pay him that amount. Also give him his fraction of any cash you have on hand.
This is kind of a complicated ordeal. We never finished our OA so we aren't bound to a contract at all. He proposed he wanted half the profits to this point plus his down payment, which was half (6K). I'd agree to profits, but not with down payment.
Please correct me if I'm wrong or if I just have my head in an emotional state, but I don't see how any of these options would be fair for me.
The way that I see it is we both made an agreement on a long term investment, 20 years to be exact and he decided this isn't for him. Just like any investment out there, ie 401k, cd's, just to name a few, you have to pay a penalty if you wan't to pull your money out early. I don't know what this penalty would be, but I do feel it should be expected.
Plus, I'd be taking on all the risks associated with the property from this point and with this being an older house, anything could go...
Honestly, what he is asking for is precisely what I would ask for if I were in his situation. And if I were in your situation, I probably wouldn't accept it outright, either.
If you don't want to pay the full 6k, then you need to negotiate. He is the one who wants out so he should be willing to make you an offer.
This is the problem...
Without a formal agreement upfront, you're in a situation where both of you are looking for what you consider to be a "fair" deal, but unfortunately, what each of you considers fair is wrapped up in an emotional attachment to your goals.
Ultimately, you guys are going to have to try to negotiate until you come to terms...in the end, it sounds like your partner is in a more desperate situation than you are, so ultimately he'll need to compromise or be forced to keep an investment that he doesn't currently want.
The way that I see it is we both made an agreement on a long term investment, 20 years to be exact and he decided this isn't for him. Just like any investment out there, ie 401k, cd's, just to name a few, you have to pay a penalty if you wan't to pull your money out early. I don't know what this penalty would be, but I do feel it should be expected.
Plus, I'd be taking on all the risks associated with the property from this point and with this being an older house, anything could go...
I agree with you. I don't think it's fair if he just gets "his half" and walks away. As you said, you entered into an agreement for a long term partnership, and he wants out out of that arrangement. I think there should be a penalty for early withdrawal. If you take your money out of a 401(k) early, that penalty is 10%. I don't think that is an unreasonable amount, especially since you would be inheriting all the future risk.
Just an idea I thought I’d throw out. Would it be possible to find another investor who could buyout the current partner who is wishing to leave?
This illustrates why it is so essential to have that OA sorted out BEFORE the problem arrises. When you're thinking this through ahead of time, each can consider the decisions from either side. You have a much better chance of agreeing on what's "fair". Once the problem is on the table, each of you now has a position and its very unlikely you will both consider any offer as "fair".
The most realistic option may well be to sell. That lets the market set a value on the property. Very tough to argue with the market. It lets each of you get the profits to date out of the deal. It avoids saddling either of your with all the risk of the deal in the future.
It does also eliminate the possibility of any future profits, either from the rental income or from the eventual sale.
When you buy rental properties, you're locked into owning the property. If you want out, you have to sell. That may require spending money you don't want to spend (selling costs) and may reduce or eliminate any profit, or in a worst case create a loss. But just saying "I want out" and quickly getting rid of the property is never an option.
I can see both points of view. He want's out. You don't want to have to pay him off. My second suggestion is essentially the partnership selling it to you. Note that I have included the selling costs, which right now would be about 11% of the value (6% commissions, 2% for closing costs and 3% for seller concessions). Including those costs is, to some extent, accounting for the pain created by his early withdrawal from the partnership. There may be less profit there than he thinks.
If he insists, can he force a sale?
First off thanks to all that have replied to this post. I understand that having an OA is important whenever dealing with a partnership. I have worked on an OA for us, but being two years into the partnership it turned out to be a lot harder than I thought it would. We were/are, depending on what comes out of this, best friends for a long time. We had laid out our goals on the table before we ever started investing. He knew I wanted a career and I knew he was short term. Looking back at it now, that should've been my "ahh ha" moment to develop an OA, but I never would've guessed it come down to this. I hope this doesn't ruin our friendship and I attend not to let that happen, but I also don't want to own a property that will ruin myself or my marriage with my wife. Consider lesson learned here.
Our involvement in this property is soo messed in here I don't even no where to begin. From the start we were doomed to fail, and I'm sure I've made some posts about this years ago, but with a little hard work, dedication, and diligence we were able to make this into a highly profitable situation using the 2% rule. Not to mention our ROI is around 35%, I'd like to think that is a win for us on our first property.
He really wants to sell, and to his credit I understand why. It's the only way we'll be able to make this fair for both parties. But me being the stubborn one or realistic however you want to put it, the money just won't make sense to sell. The area is up and coming, but we're talking years and years away. We'd never be able to get this house to appraise for what we have invested and we'd make way more money renting then we'd ever make selling right now. We would need the appraisal to comeback around 56K just to break even, this includes us getting our original 12k invested back. With all the foreclosures in MI, especially DT Grand Rapids that would be a stretch. During the 4 years of ownership 3 houses within 200ft radius have went under, our neighbors twice. These are the kind of comps we are looking at.
To be truthful, I never wanted this property in the first place. We viewed a week before the auction and then purchased it for 5K over our bottome line which was 15K. Just 25% over our budget...but like I said we were able to make it work. Since then, I've done nothing but adore this property b/c it has provided extra income and that was exactly what I was looking and still am looking for.
But enough of me and my emotions right now ;) I haven't thought about another investor and that is a great idea. I think that would be something I will tell my partner as an option. If he wants to go that route I have no problem with that at all.
And to answer the other question, YES he could force a sale if he wanted. I don't think it will come to that, but he does have the final say due to some unfortunate circumstances.
I think the amount he is asking for is fair. Why don't you give him half the profit now and the $6k on a 5 yr note or something, maybe $100/mo.
If you're making 35% on your money, that's pretty good. You could also find someone else to buy his half for $8,500?
This is exactly what I was thinking I would have to do know matter what the buyout cost would be. I don't want to give 8K, 6K, 4K, cash up front or whatever it may be.
Here are some of the options I'm considering, but not offering until I hear back from him.
1. Short term buyout: Half profit, plus 2K of original investment.
2. Investor: He finds investor to buy him out plus half profit.
3. Long term buyout: Half profit plus if I sell within next 5 years, he retains 75% of his DP, after 5 years it decrease X% per year until the 10 year mark. After 10 years nothing.
4. We sell. Not ideal and probably the worst option.
I like Steve's idea. That will allow him to get out now, you can keep the property, and he still gets his equity. You can offer him a number of options for his equity too:
1. Cash now at a discount
2. Some cash now and the rest over time at a smaller discount
3. All of the cash over time with no discount to face
If you do it this way you can calibrate the discount and pay him both his profit and down payment back. Use 20% to discount the cash flows and tell him that is your required ROE as an investor.
Will something like that work?
BTW...Selling a fractional interest is going to be very tough and the buyer will almost certainly demand a discount. Tell him that your offer is better than what he will get in that scenario and that you are trying to be fair while accomplishing your goals as well.
Ditto on the importance of having an Operating Agreement. Moreover, it is really nice to have a Buy/Sell agreement that is designed for exactly these type of exits.
One approach that I have used assumes facts that both parties want out of the deal, both have the ability to get out (re-fi if necessary) and you can bring this to an end quickly.
Figure out a number (and you can include terms), write it on a piece of paper and give it to your partner and tell him......His choice. Either he pays you and takes you out of the deal, or you will pay him and take him out. One way or another, the property is coming out of the partnership and to one of the partners.
No negotiation required. Be prepared for either answer and act accordingly.
Sounds like too small of a deal to get tied up on for too long.