I've been reading for quite some time, but finally decided to make an account given my current situation.
I have been presented with a partnership opportunity for a real estate investment. For a bit of background on myself, I currently work in finance and have little experience within RE. I have some limited exposure to the industry, but am currently looking to get involved in the form of a passive limited partner. The person I would be working with currently works in the space and owns a number of units. He currently does a lot of contractor work and spends most of his time with his original portfolio.
In regards to structure, the initial equity contribution would match with the purchase price of the property. The one thing I am getting hung up on is that he is proposing to alter the equity mix by including his own contractor work into the value of the property. As an investor, I respect that he will spend more time rehabbing and renovating the property, but I don't know if I understand the concept of adding that work to the total value of the property. I feel like that is something that would be hard to track and a very arbitrary calculation that could significantly dilute my equity ownership in the property. I'm sure many people on the forum have run into similar situations, is this a standard clause or am I potentially getting hosed here.
The property does need some work and that is a key factor (it is being purchased at a significant discount and is not producing income) and the fact that my partner is a contractor already is a huge benefit (renovations done nearly at cost). As a result, I could understand throwing a higher portion of equity in that direction assuming we invested the same amount, but I'm not sure what the protocol is here. Should I be pushing for a 50/50 structure? I'd love to hear any and all advice, thanks in advance for the help!
Such arrangements always make me a bit nervous, as it creates a rather fuzzy arrangement. Do you know the person you are looking to invest with well? I would really hesitate doing such a thing with someone I didn't know well. Regardless, if you do move forward, spell out explicitly what the arrangement is and how he will be compensated for his work beforehand. It will save you a lot of grief if things go sideways.
Thanks for the response. I know him fairly well, but I'm not sure I am fully comfortable with this concept. I'm really trying to gauge if this is a standard practice or not.
Here's an example (from how I understand it would operate):
$80K purchase price ($40K from each partner). If there were $20K done in "contracting manhours" and $10K used towards capex, my understanding is that his ownership stake would then be worth $60K/$100K (60%) while mine would be $40K/$100K (40%). The $10K towards capex would be split evenly between the two of us.
I believe there are still some items that need to be hammered out, but does this sound like a poor arrangement (it seems like it is off a bit to me). Wouldn't it make more sense to add an equity kicker in upfront, say 55%/45% given the extra incremental work that he would put into the property?
Welcome to BP, @Bryan Johnson ! You mentioned that you were seeking to get involved as a "passive limited partner." It is common in this type of arrangement for the general partner (the one "doing the work") to get a percentage of the profits in exchange for those services, and the limited partner(s) getting the rest (pari passu as to their relative capital contribution).
It sounds like your partner is not only managing the renovation but also managing the asset and the management team. Did he also source the deal and negotiate the acquisition? Who will manage the disposition? If you are to be truly passive, those tasks would also be his responsibility and deserve compensation.
Compensation for services can come in the form of profits, fees, or both. Rather than adding the subjective "value" of his renovation services to the equity contributions, I suggest that you pre-define the value of your partner's services so that you avoid disputes later.
Let's assume that you decide that "work" is worth 30% of the deal, and "money" is worth 70%. Let's also assume that your partner contributes 1/2 of the money, and you contribute the other half. In that scenario, your partner would get 65% of the profits, and you would get 35%.
All of the details should be clearly defined in your partnership agreement, and you should have an attorney draft that agreement for you. Good luck!
Thanks for the response. That is very helpful. Your points are spot on and exactly what I was looking for in regards to figuring out how to think about the deal structure. I imagine this is something you allocate initially (per your comments) versus a variable figure that is quite arbitrary throughout the investment period. This partnership is still "in the works" and we have yet to purchase anything, but I think these are the kinds of things that need to be ironed out before getting too far down the line with any potential investment.
Yes, agree to it up front. If your partner plans to actually swing a hammer himself rather than simply managing an outside contractor, you might consider an additional hourly fee for his time outside of the profit split to allow for the variability of time required, but that wouldn't be my favorite way to arrange the deal.
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