Partnering on a flip

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Partnering on a flip

TJ Thompson
Investor · Danville, KY · Member since 2009 · 19 posts · 1 vote

I'm planning to partner with a local REI on a home flip. As we've worked it out so far, here's how it stands t play out:

1. She found the house, presented the comps, and proposed the repairs which I've agreed to.
2. I pay the full purchase price of the house and half the repair fees.
3. She pays the 2nd half of repair fees.
4. She closes on the house with my money (because that was the initial deal) and then turns over the note and deed of trust to me. She legally owns the house, but I own the note and it's secured against the deed.

Is this the right way to handle this? Anything I should look out for? I guess I should get the note when I first lend the money, right? But it won't be secured until she closes on the house, right? I trust her, but let's just assume I'm wrong, what's my exposure? In general, what else should I look out for?

One other thing I was thinking about is that the money I loan for the repair work will be unsecured. Should I do it "pay as you go" so there's no chance of that money disappearing?

Thanks!

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Jon Holdman
Rental Property Investor · Mercer Island, WA · Member since 2008 · 22k+ posts · 14k+ votes
15y

You should insist the closing be done with a title company. You send your money for the purchase to the title company. They do the paperwork and distribute the money. They generate a deed with the seller as grantor and your partner as the grantee. They also generate a deed of trust with your partner as the grantor (borrower) and you as the grantee (lender). Both get filed with the county. You probably want your lawyer (independent of your partner) review both the note and the deed of trust. You definitely want to review these before the closing.

In your position, I would insist she bring in her chunk of money to closing. The way you do this is to include the full amount of the repairs as a "repair escrow" item on the HUD-1. You bring in the purchase price plus half the repairs, she brings in the other half. You instruct the title company to issue one or more checks made out to her for the amount of the repairs. Those checks are given to you, though, not her. She does the work and once you inspect and approve it, you hand over the checks.

Typically, this would be at least two checks, but could be more than that. You might consider giving her some small portion (no more than one third) of the money up front. But I would not do this for the first deal.

By having her put her money in up front, you reduce the risk of her disappearing with your money and leaving you holding the bag on a house that's worth less than what you put in.

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  • Chris Colvard
    Wholesaler · Dallas, TX · Member since 2009 · 308 posts · 92 votes
    15y

    first and foremost is that you need a real estate attorney to ask these questions and close the deal for you. Get title insurance & fire insurance.

    I don't see any reason for having any of your money unsecured. You should be in a first lien position for purchase price and your portion of the rehab.

    Even if you are secured you should escrow that rehab money and pay draws. If she is paying for 1/2 the rehab then let her pay the first half.

    If you are using IRA funds you need an attorney to tell you what you can and cannot do.

    2Reply
  • George P.
    Real Estate Investor · Baltimore, MD · Member since 2008 · 1k+ posts · 268 votes
    15y

    How are you splitting the proceeds?

    0Reply
  • TJ Thompson
    OP
    Investor · Danville, KY · Member since 2009 · 19 posts · 1 vote
    15y

    me 40, her 60. The deal was 50/50 if I paid 100% of the purchase price and repair.

    FYI: PP is 76K, repair is estimated at 33K, and ARV is estimated to 145K

    0Reply
  • Jon Holdman
    Rental Property Investor · Mercer Island, WA · Member since 2008 · 22k+ posts · 14k+ votes
    15y

    You should insist the closing be done with a title company. You send your money for the purchase to the title company. They do the paperwork and distribute the money. They generate a deed with the seller as grantor and your partner as the grantee. They also generate a deed of trust with your partner as the grantor (borrower) and you as the grantee (lender). Both get filed with the county. You probably want your lawyer (independent of your partner) review both the note and the deed of trust. You definitely want to review these before the closing.

    In your position, I would insist she bring in her chunk of money to closing. The way you do this is to include the full amount of the repairs as a "repair escrow" item on the HUD-1. You bring in the purchase price plus half the repairs, she brings in the other half. You instruct the title company to issue one or more checks made out to her for the amount of the repairs. Those checks are given to you, though, not her. She does the work and once you inspect and approve it, you hand over the checks.

    Typically, this would be at least two checks, but could be more than that. You might consider giving her some small portion (no more than one third) of the money up front. But I would not do this for the first deal.

    By having her put her money in up front, you reduce the risk of her disappearing with your money and leaving you holding the bag on a house that's worth less than what you put in.

    3Reply
  • Jon Holdman
    Rental Property Investor · Mercer Island, WA · Member since 2008 · 22k+ posts · 14k+ votes
    15y

    Also, you should seriously considering hiring an appraiser to give you a better opinion of the value of the house. This is not something you need to just trust the borrower about.

    1Reply
  • Ali Shah
    Real Estate Investor · Las Vegas, NV · Member since 2008 · 127 posts · 10 votes
    15y

    as for the splits obviously you have to feel good about getting what you have agreed to as a money partner. There is no set % rather than what the partners agree to. Using a real estate attorney to draw a tight contract and using escrow to distribute all funds as Jon says is the best way to go.

    0Reply
  • Jon Holdman
    Rental Property Investor · Mercer Island, WA · Member since 2008 · 22k+ posts · 14k+ votes
    15y

    Some replies while I was typing (and getting interrupted). Chris' suggestion to let her spend the first money is find. I would still do the escrow for your half and I would not hand that over until the work was completed.

    1Reply
  • Ibrahim Hughes
    Real Estate Consultant · Bloomfield, NJ · Member since 2010 · 2k+ posts · 1k+ votes
    15y

    If #4 is being handled by an attorney or a closing agent then everything should be fine as the money will be loaned to the REI for purchase and a deed of trust will be given to you in exchange. All done simultaneously. I work these tyypes of deals often. The first time, my investor was at the closing table to make sure he got his deed of trust (mortgage here in NJ).

    HOWEVER, how is your equity share (the 40%) being protected? I use a joint venture agreement to protect my investor's share of the profits. And the mortgage/DOT secures the JV agreement.

    Also, how much money is the mortgage securing? Just the $76k? PP and rehab money? My mortgages secure the purchase price and rehab monies.

    But I'm more concerned about your 40%. How is that protected?

    Also, for $17.5k being lent out I would spend a few hundred extra $$$ and hire a licensed contractor to go in and inspect rehab work before releasing draws. Actually I would have had this built into our JV agreement.

    And as suggested - HIRE A REAL ESTATE ATTORNEY!

    1Reply
  • NA Foster
    Real Estate Investor · CA · Member since 2009 · 174 posts · 39 votes
    15y

    My!My!My! You did all this on a handshake and zip in writing? You sure a trusting soul. The spanking you get here is worth $$$$$$$!

    0Reply
  • Rob Gillespie
    Specialist · Cleveland, OH · Member since 2011 · 1k+ posts · 852 votes
    15y

    I would need more info, but if I were doin the deal, I would fund the entire deal, have her bring her money for the repairs to the title company for her down payment and be secured by a mortgage and keep a deed in lieu in escrow if she ever misses a payment. Spell out the terms of the deal. I am assuming that you are just doin this for 12% or somewhere near that. If you are doing it for part of the profit, you should take title in an LLC that has you holding 51%. Just my opinion with the limited info. Good luck, be careful. It sounds like a disaster waiting to happen to me! :mrgreen:

    2Reply
  • Sherry Lewis
    Rehabber · Fort Walton Beach, FL · Member since 2011 · 240 posts · 48 votes
    15y

    I agree with Rob. I did a rehab for investors back in 2003 with very similiar circumstances, only I was the one with no money. I did all of the work and my partner put up the money. We formed an LLC with him as the managing member. He owned 51% of the llc and we did the profit split 50/50. It all worked out nicely. Of course I guess he was even more trusting as he would send money in increments for repairs. I kept an accounting of all the receipts and sent him original receipts and accounting monthly on expenses paid. In the end, we purchased a property for 56k spent 85k fixing it up and sold it for 185k. The property was completed in 4 months so it all work out quite well. I do know he made sure to have the property appraised before we began to assure his money would be well spent.

    If you decide to do this again with someone let me know. I loved it!

    0Reply
  • TJ Thompson
    OP
    Investor · Danville, KY · Member since 2009 · 19 posts · 1 vote
    15y

    @everyone except F Foster- Thanks! This was very helpful and consistent with strategy I'm taking via my partner's advice.

    @F Foster- did I give the impression that I was working off a handshake? That is simply not true. I was looking for advice on what documentation I should pursue which this group kindly provided.

    On the other hand, you're right that I am a trusting soul, but I've found that in the long run that being trusting attracts trustworthy people.

    What were you hoping to add with your post? I missed it...

    0Reply
  • TJ Thompson
    OP
    Investor · Danville, KY · Member since 2009 · 19 posts · 1 vote
    15y

    Rob/Sherry,

    We discussed an LLC but it seemed like it was an unnecessary partnership that could be better served in a JV agreement and a note. What was the advantage of the LLC? Aren't there risks with an LLC, that a bad decision by your partner could put you in a bad position?

    0Reply
  • Justin S.
    Residential Real Estate Agent · Chandler, AZ · Member since 2009 · 1k+ posts · 928 votes
    15y

    You can put the repair money in the 1st DOT or create a 2nd DOT like Ibrahim suggested. I would also not release it until they spend their money on rehab first. Once they prove they did, then you release additional funds. Aldo make sure the note is due in 6 or 12 months.

    0Reply
  • Sherry Lewis
    Rehabber · Fort Walton Beach, FL · Member since 2011 · 240 posts · 48 votes
    15y

    With the llc, if anything went wrong it could not affect either of us on a personal financial level. It also gave him controlling interest and position within the llc since it was his money on the line. I am not very familiar with jv agreements so I cannot speak to pros and cons, I just know that it seemed to be the best way to protect his assets and give me re-assurance in writing that the labor I was going to put in would pay off as long as I stayed within our budget and we would profit.

    1Reply
  • Chris Colvard
    Wholesaler · Dallas, TX · Member since 2009 · 308 posts · 92 votes
    15y

    There are a lot of good ideas floating around here.

    The deal is it's beginning to get to complicated for what it is. He is acting as a private lender and needs to be protected.

    In another hat he is sharing in the profits on the deal.

    As he stated earlier, he wants to do this gral. So, in the the most simple way possible, protect himself and insure performance of the rehabber.

    TJ, I think if you explain this to your real estate attorney, then present specific escrow instructions to the title/escrow company it will be professional and straight forward. You will be protected, the partner/borrower will be happy and you guys will probably do many successful projects together. If it goes bad, you will be protected. Keep it simple.

    1Reply
  • Chris Colvard
    Wholesaler · Dallas, TX · Member since 2009 · 308 posts · 92 votes
    15y

    Type above "deal"

    0Reply
  • Scott Hubbard
    Rehabber · Tucson, AZ · Member since 2008 · 1k+ posts · 802 votes
    15y
    Originally posted by TJ Thompson:
    I'm planning to partner with a local REI on a home flip. As we've worked it out so far, here's how it stands t play out:

    1. She found the house, presented the comps, and proposed the repairs which I've agreed to.
    2. I pay the full purchase price of the house and half the repair fees.
    3. She pays the 2nd half of repair fees.
    4. She closes on the house with my money (because that was the initial deal) and then turns over the note and deed of trust to me. She legally owns the house, but I own the note and it's secured against the deed.

    Is this the right way to handle this? Anything I should look out for? I guess I should get the note when I first lend the money, right? But it won't be secured until she closes on the house, right? I trust her, but let's just assume I'm wrong, what's my exposure? In general, what else should I look out for?

    One other thing I was thinking about is that the money I loan for the repair work will be unsecured. Should I do it "pay as you go" so there's no chance of that money disappearing?

    Thanks!

    1. What you need is a JV agreement where (you)get title in your or personal or your entity's name. In this agreement the roles are clearly defined as you stated above, but you should not allow her to close in her name with your funds. Since you are also funding part of the rehab, what guarantee do you have that she will put her portion in. What happens if she off the roof and ends up, in the hospital?

    A JV agreement will address all of what if scenario's. They do not cost any filing fees to set-up and are legally binding in a court of law.

    2. Using a DOT with a DIL is problematic. What happens when the REI fails to perform? What if she runs out of money and does not complete the project? You will be left holding deed to a property that you will likely have to finish. Instead, do a JV agreement and have her put $$ in first Then, you can fund her the portion you agreed to. If cost overruns occur, then put that into the agreement that she has to come up with the additional capital or you will loan her the deficiency amount with interest.

    Deed of trust are a terrible tool to use for rehabs unless you have prior experience with the REI.

    I do JV's all the time and they are very good to use in the situation you just described.

    0Reply
  • Chris Colvard
    Wholesaler · Dallas, TX · Member since 2009 · 308 posts · 92 votes
    15y

    Scott

    What if the money is coming from SDIRA?

    0Reply
  • Justin S.
    Residential Real Estate Agent · Chandler, AZ · Member since 2009 · 1k+ posts · 928 votes
    15y

    SDIRAs allow JVs.

    1Reply
  • Sherry Lewis
    Rehabber · Fort Walton Beach, FL · Member since 2011 · 240 posts · 48 votes
    15y

    Can someone explain a JV to me?

    0Reply
  • Scott Hubbard
    Rehabber · Tucson, AZ · Member since 2008 · 1k+ posts · 802 votes
    15y
    Originally posted by Sherry Lewis:
    Can someone explain a JV to me?

    @Chris

    SDIRA's are allowed as long as it is a arms length transaction. In fact, the JV agreement can be submitted to the trust administrator.

    @ Sherry

    A joint-venture agreement is a form of a closely held partnership specific to one type of investment. In real estate, it would be used for the acquisition, management and disposition of a single piece of real estate. It defines the roles of the principals as well as the split. It is much like an operating agreement for an LLC. Think of it as a limited partnership agreement simplified. The positives are that it does not need to be made public and avoids the high costs of an LLC set-up like in California.

    If there are more than two entities or individuals in the collaboration, then a JV agreement may not be well suited for this.

    I have a very simple JV agreement example in the Fileplace of this site.

    http://www.biggerpockets.com/files/user/bokman/file/jv-agreement-where-owner-is-partner-docx

    0Reply
  • Sherry Lewis
    Rehabber · Fort Walton Beach, FL · Member since 2011 · 240 posts · 48 votes
    15y

    Scott thank you so much for the info. With this I would be able to have my LLC be a JV with another llc or individual then correct? Second question, does that leave myself or company liable for any action that could be taken against the partner that had nothing to do with our deal?

    0Reply
  • Scott Hubbard
    Rehabber · Tucson, AZ · Member since 2008 · 1k+ posts · 802 votes
    15y
    Originally posted by Sherry Lewis:
    Scott thank you so much for the info. With this I would be able to have my LLC be a JV with another llc or individual then correct? Second question, does that leave myself or company liable for any action that could be taken against the partner that had nothing to do with our deal?

    To answer your questions, yes your LLC would be the partner which should help protect you personally from liability. You should also have an umbrella insurance policy on your LLC.

    The JV does not offer anyone asset-protection, however, since you can record a memorandum or notice, you can notify any would be claimants that you have a vested interest in the assets.

    I do not know the details of your situation and there are pros and cons to partnering. You should take certain precautions to help mitigate possible claims. Having an attorney look over any document is also critical.

    0Reply
  • Sherry Lewis
    Rehabber · Fort Walton Beach, FL · Member since 2011 · 240 posts · 48 votes
    15y

    Scott,

    Thank you for the info. I currently do not have an agreement pending at this time. I just needed a further understanding so when I do one I can be sure I do it properly. I greatly appreciate your help!

    0Reply
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