Question on JV Agreement

14 Replies

Need some guidance:

A few partners have put up $150K for non-refundable earnest money on a 31-unit apartment to condo conversion...which was paid to the bank this past Friday.

From what the GM just told me, after they used our pooled funds for earnest money ($150K) the major investor "pulled out at the last minute" ( he did not put up any earnest money) and the GM (who is getting 50% ownership for putting the deal together) called me today to tell me he now needs me to guarantee the entire loan -- since his credit is not good enough for the bank (roughly $2.25 million.) We will have $600K raised by the remaining investors by the end of May when the deal is supposed to close.

This predicament was just thrown at me late last night, after the earnest money was paid.

I'm just a 1/4 passive investor on this deal (1/8 ownership after splitting profits 50-50 with GM) -- and not sure I want to be on the hook for the entire loan amount..but I do not want to lose my earnest money.

That being said, what would a fair compensation structure for me to ask for this risk?

I strongly suggest you see your attorney. You also need to get rid of that GM as they can't carry any water and has no skin in the game.

You can fry that GM, move him out and look to others who have the ability to perform to move in, a PM should not be in the mix of ownership without the ability to carry off their share.

You and the others may end up buying, but you need to see your attorney IMO. :)

Wow what a mess.

Just for future reference (from what I have seen) banks always want a personal guarantee/ recourse. They have auditors breathing down their necks and must show they received the most layers of security on a loan and underwrote it properly.

This is why with partnerships with clients I have they are not going in on small balance loans of a few million. They are doing larger projects where you can land an insurance company etc. that will give non-recourse/ no personal guarantees and longer hang out times on the loan.

If you are doing apartment to condo conversion then this is a shorter term hold to cash out equity profit right? Do you have a blanket loan provisions to release the mortgage down each time you sell off one??

Is your loan interest only?? For turn arounds of a few years you can use interest only to reduce the loan payments. This helps things cash flow better while doing a turn around and then you refi or sell down the road. Since this is a value add type play then paying the principal down for a few years isn't the main goal.

50% is outrageous especially if they have no money into the deal. If they didn't want to use their credit or be on the loan then most lenders say they can't have more than a 20% equity interest in the deal.

So you each have about 37k non-refundable in now. You might want to tell the GM at 50% they will have to reduce their ownership way down because they are not bringing as much value to the deal anymore.

You definitely need to not take this lying down and either get out of the deal and cut your losses or renegotiate it. No legal advice.

10% of the deal has been the going rate to sponsor a non recourse loan. I would expect more on a recourse. The problem is if you still believe that he can perform. Not only are the funds in the deal at risk, but your other assets as well.

I am curious as to his ability to get a loan with the GM not signing in blood.

This all needs to be cleared up before the earnest money goes hard.

Agreed with all above. I don't have syndication experience, but 50% for putting it together is crazy. Since the EM was met without the "major investor", obviously he was Never putting any EM up, IF he ever existed at all. You may have a real shyster here. First stop to your attorney, then dig out All the details of this, including who they're dealing with at the bank, and the seller. Do you know who the other 3 investors are? You guys need to talk, fast.

@Robert Piller

Most syndicators will at least front their own money for earnest money (or at least the people I know). That isn't necessarily a red flag however I would be asking him why he isn't fronting the money while he puts the deal together. You say non-refundable earnest money...can you clarify? Did you go hard from day 1 on the 150k? Or do you have contingencies in the contract? What is your closing timeline?

It's strange to me that the bank would tell him that only one person needs to guarantee the entire loan. For bank loans generally it's anyone with more than 20% ownership (including the sponsor). And banking regulations are such that each guarantor is responsible for the entire amount. You use to be able to guarantee your portion of the loan however that isn't the case anymore (you can still ask).

How well do you know the sponsor? What is his track record? Has he been through any bankruptcies or foreclosures both personally or professionally? I would ask him if you can pull his credit and get a background check. If he pushes back that is a red flag.

A 50/50 deal split could be completely fine if you are happy with your return. Is he handling the rehab? Making any other fees i.e. developer fees, acquisition fees, asset management fees? From your quick story it sounds like this syndicator lacks credibility and/or experience. If that is the case then a 90/10 split still might not be the right decision. It's extremely hard to state what a fair split would be without all the information. If he is a credible syndicator and you don't feel comfortable with the split then push for a larger share. You need to feel comfortable with the return based on the amount of risk you are taking. That is different for every investor. Also compare this investment to other opportunities in the market place.

And as many have could have a crook on your hands so be careful and do your due diligence. No legal advice.

@Jeff Greenberg

What do you mean 10% has been the going rate for sponsoring a non-recourse loan? You mean a 90/10 split with 90% going to the investors and 10% going to the sponsor? In my opinion it takes way too much work to put together a project for only 10% equity. A lot depends on syndicator fees and the size of the project however I'm seeing most spreads at the 70/30, 60/40, & 50/50 level. I know a lot of hotel management companies that will get 5-10% sliver equity in a deal for finding/managing the deal however it's more a business model of adding hotels to the management portfolio. And those deals can be quite large.

@Robert Piller,

As you know, the $150K is gone the bank will not refund it. I don't think a lawyer can help you on getting your non-refundable earnest money back but might be able to help you if you had a written agreement with the investor who back out.

Joe Gore

@Chris Winterhalter Here is where we clarify some terms.

As you know in the syndication world we call the person or persons establishing the syndication "the sponsor"

In the lending industry a person signing on a note to boost up the borrowers qualifications, is also called a "sponsor".

I was referring to the latter receiving 10% for the assistance with the loan qualification. I completely agree with you on your other points.

I also disagree with those that feel that ownership should be based on capital contribution. Just capital would not make these deals happen, and we as syndication sponsors should be appropriately rewarded for the work involved in the entire process. If a syndicator brings a product that is of desire to the investors, his share should not be of concern. Is anyone really concerned about, how much the CEO of Pepsi makes when you buy a soda.

Are the investors getting a return commensurate to the risk? They can decide this, and invest or not.

Wow-great thoughts. I appreciate it.

I wil talk with the other investors tomorrow to see what recourse we may have to salvage the deal.

Thaks for all your help @Bill Gulley

@Joel Owens What would be a fair percentage of his half to ask for? After all, this deal probably does not go through, and he risks serious legal issues, if it falls out.

From my understanding, he may have taken 2 investors' entire funds ($50K each for 1/12 "ownership") and used for earnest money--since his "big investor that pulled out", was supposed to kick in his pro-rated share of $50K for earnest money.

Each investor was supposed to kick in $12.5K of the earnest money per 1/12 ownership. I kicked in 3X that for 1/4 interest ($37,500). The balance ($37.5K per 1/12 ownership) was to be kicked in at closing next month.

Note: When I say 1/12 ownership--I mean 1/12 of our half--so, in actuality 1/24th ownership.

@Robert Piller,

Do you have everything in writing from all parties?

Joe Gore

I would have to review the whole totality of the deal. This is where your attorney will earn his big bucks hopefully to save more of yours.

This is like an Onion that from far away looks healthy and strong. You get closer and it starts to smell funny and you notice some spots on it. Then you start peeling back the layers hoping you find a level to start from that doesn't have any rot to it. You might just get all the way down to the core and it's still rotten with nothing left to do but throw it in the trash.

That's kind of where this deal is at.

There is a reason this big investor has backed out. You need to find out what it is.

Per Chris Winterhalter:

"For bank loans generally it's anyone with more than 20% ownership (including the sponsor). And banking regulations are such that each guarantor is responsible for the entire amount. You use to be able to guarantee your portion of the loan however that isn't the case anymore (you can still ask)."

This is why the larger loans that are non-recourse are more favored instead of banks. If you had net worth in the millions the last thing you want to do is be on the hook for all of the debt in a deal in the millions. If you are going to do that you need to control the project over 50% with majority control and have everyone else in first loss position or just own the thing outright. Why would you put substantial risk exposure up for a small sliver of something?? It's not about that the amount is small it's about the bank is wanting to take everything you have if it goes south and you stand the most to lose versus the smaller investors that have the capital for their share but not as many considerable assets to go after.

That would change the game for me where the property would have to be a grand slam and not just a good deal.

I declined being a guarantor so the GM will probably bring in some hard money to get the debt ratio to where a bank will not require a guarantor.

I also sent him this link so he can see what others are saying about the deal..but left his name out of the discussion to "protect the innocent".

I also want to clarify a mistake I made in the initial description. The GM gets 50% of the profits, not a 50% ownership of the entire pie. This oversight was not intentional -- and probably wouldn't have changed all the opinions expressed.

Thank you to all the people who have chimed in.

I'll keep you posted as it gets closer to closing at the end of June.

Free eBook from BiggerPockets!

Ultimate Beginner's Guide Book Cover

Join BiggerPockets and get The Ultimate Beginner's Guide to Real Estate Investing for FREE - read by more than 100,000 people - AND get exclusive real estate investing tips, tricks and techniques delivered straight to your inbox twice weekly!

  • Actionable advice for getting started,
  • Discover the 10 Most Lucrative Real Estate Niches,
  • Learn how to get started with or without money,
  • Explore Real-Life Strategies for Building Wealth,
  • And a LOT more.

Lock We hate spam just as much as you

Create Lasting Wealth Through Real Estate

Join the millions of people achieving financial freedom through the power of real estate investing

Start here