My good friend (and business partner) and I master leased a college student rental property with an option to buy about 3 years ago. We have 2 years before the expiration of the option. The current cash flow on the property is fantastic at about $2500/month.
However, we're having some pretty significant management and CapEx issues that would be much, much easier to manage effectively if the property was owned and not leased. The master lease calls for the owner to spend on CapEx but he's not willing to do so. He knows we're going to buy it anyway so he's not interested in buying a new roof or painting the exterior. I'm not willing to call him on it because we have a great deal now. Also, he's probably willing to give a 5-10% discount for an immediate purchase. There are plenty of practical and financial benefits to purchasing it now and I'd like to do so.
So both my partner and I have signed the lease and are jointly responsible for it. We also used our business capital (about 15k) to put down on the property. So we are in this deal 50/50. The problem is that my business partner brings no value to the table on the deal. I found the deal, manage the property, lease it, deal with the all of the college student drama. I handle everything. I obviously should've done this on my own looking back on it.
Even though I'd like to buy this property now I don't want to tie up my credit and or down payment money to split this deal 50/50. Because it would likely be in the LLC's name and a 50/50 partnership, my portfolio lender would require me to sign and tie up my credit is well. For what it's worth, I don't think he would buy this on his own if he had the choice to at the end of the option period.
Most importantly I don't want to damage the friendship that we have. What would be a fair way for me to make him whole? I would MUCH rather be too generous than not enough in this situation.
Some thoughts I have:
1) Offer him a lump cash sum if I can buy it on my own
2) Allow him first right of refusal to buy it (and pay me a lump sum)
Anybody have any experience in splitting up a deal with a close friend or family member?
@Mike Dymski Any thoughts on this?
@Will Gaston I don't have any specific experience in splitting a deal or joint venture; but to me, an obvious place to start is to talk to your friend/business partner about it and see what he says. Maybe if he knows the specifics on it and know that you completely deal with it on an everyday basis, he will offer to put in more for either the down payment or cap improvements? So it's still 50/50 but on the front end, he's putting in 70 to your 30.
Or maybe you split it 50/50 all the way but you, personally, take a management fee out of the monthly cash flow for your efforts. Is this something that's been discussed before?
@Michael Lee No it hasn't and it obviously should have been. I've also thought about allowing him to continue to do a 50/50 split if he can get a conventional mortgage in his name solely and then we just run it through an LLC. That way it's not tying up my credit.
Will I'm no expert and I actually am in a partnership myself, so can I ask you a few questions?
Was your LLC with your partner created prior to this deal or for this deal?
Of the $15K, how much would you say your partner was responsible for creating?
Does your partner bring nothing to just this deal or any deal?
1) LLC was already created prior to this deal.
2) The 15k came from our one other rental which is the only other property in the LLC. The mortgage is in his name but I've managed the property for the last 12 years. It's also a 50/50 split.
3) He's an attorney so he can provide some legal help but RE and/or Landlord tenant law is not his speciality. It's not his fault, per se, it's just that it's not in his industry or market.
Your suggestion about your partner getting the mortgage solely in his name might work. May take some additional maneuvering tax-wise but your CPA can prob figure that out. Big picture-wise, does this still resolve the issue that the property is in this partnership, all proceeds/benefits are split 50-50, and yet you still do all the work? If not having your credit tied is worth it, could be the solution.
You said you didn't want to tie up your credit... Having the mortgage in his name is bring something to the table, as is putting up some of the funds. If something happens, god forbid, he's on the hook for the whole amount, that't not "nothing".
It sounds like the post acquisition workload is unbalanced, I like the suggestion from @Michael Lee re: have a frank discussion and just ask the question. Doing more of the management is certainly worth something, I think taking a management fee is a great way to account for it and it also firmly formalizes your responsibility for it.
With a partner you don't want things to go unsaid, he sounds like a professional, I would talk to him and see what he says. Maybe he'll balk at first and then just let it sit with him, then maybe he'll see after some time to consider.
@Michael Lee I'm not sure that him taking the mortgage on his own would resolve everything unless we had a different split on the down payment and cash flow. That's the current situation with our other rental and I wouldn't say it's fair either.
@Tyler Mullen Thanks for the input. I hear you on the mortgage. We have the same arrangement with the other rental and even though his name is tied to the mortgage we both are on the hook for it financially from our standpoint (although obviously not from a credit standpoint). We both have put additional capital into the property when the market was down.
You're both on the hook financially in your agreements between you two, got that, what I meant was right now all is well, you're both standup pros doing your duty and so this all works. But from his perspective he is taking much more risk in the event that you decide not perform as agreed. Or if you're injured for example and can't work for 9 months... from an attorney/contracts POV, what's his next move legally?
From his point of view under a worst case scenario, you could be unable to work, the rents could go to zero and he would still have to make the full mortgage payments while the property is sold or leased back up. You might think that's never going to happen, if WCS never happened we'd need far fewer attorneys, contracts and courts.
Again, I don't believe you're wrong overall, it just sounds like he is considering the WCS because he doesn't want to get knocked out of the game based on one bad event. You SHOULD be compensated for deal sourcing and prop mgmt, by wage or higher equity ratio, but just make sure to give the elements on both sides fair measure.
@Tyler Mullen Agreed. All strong points.
Originally posted by @Will Gaston :
@Mike Dymski Any thoughts on this?
Hey Will. It's nice to see a real question rather than what to charge for a late payment or what holiday gift to give a resident. Kidding aside, this is a tough one and hopefully some members with partnership experience will reply. I don't have that experience; so, take my feedback with a grain of salt and I will take a stab at it purely from a business sense.
You are going to have to decide what is more important to you (1) separating or (2) keeping your dry powder. My vote is for your option #1 above...it's telling that you list it as an option and I can tell from our conversations that a separation would be best for both financial and personal reasons.
I imagine he would prefer to stay in the deal though. It's a good gig...very little capital outlay, hands off, and a cash flow monster. If you continue to split the capital outlay and the partnership 50/50, I would expect the property to pay the active investor an acquisition fee and a management fee. You can simplify and convert those amounts to incremental equity instead for the active investor. Having the loan in the passive investors' name would go the opposite direction...loan guarantee fee/compensation.
I hope this helps...tough one. Keep us posted.
As mentioned above by Tyler, charge a management fee. My business partner manages the unit so we decided that he will get a management fee outside of the partnership split (before we split the funds).
@Mike Dymski Thanks for the input. All great advice, especially the equity idea.
@Will Gaston, This post has generated some very thoughtful discussion. Of course in just a few sentences it is impossible to convey the entirety of discussions, expectations, and assumptions that went into this partnership. But it sounds like both of you went into your partnership intending to grow it together. Most of the folks here are speaking to helping you get to where you want to be as you see fair at this moment. But relationships and partnerships have ebbs and flows. That's why paper is king. And why Robert Frost told us that, "good fences make good neighbors".
There's so much unsaid in the relationship and inception dynamics. Maybe what needs to be addressed first is the set of assumptions (hopefully memorialized) that went into the beginning of the partnership.
He has tied up his credit for you (legally officially) on the first rental. This seems to be the main issue you have with this second property. I don't think it matters that you're both ethically and philosophically on the hook for it. The same could be said for this second opportunity couldn't it?
If I was the passive partner on this deal I'd be wondering why as the manager of the property you weren't holding the seller accountable to his contract with you. Again, I get the feeling that both of you entered this deal expecting a longer term before purchase (the whole lease). The urgency now stems from non-compliance with the terms of your master lease from the owner. And as the managing partner aren't you responsible for that? Seems to me that seller is playing you. And jeez if you've got a free attorney for a partner you need to be all over his keister for specific performance.
I totally get that things change and opportunities arise. But one big question would be what the benefit is now of a 5%-10% discount (I'm guessing that's somewhere between 10K and 25K) vs forcing compliance with your lease and waiting till the original expected term. If you want to keep your powder dry like @Mike Dymski said then it would seem that getting the owner to maintain the required cap ex and delaying the need for capital outlay for acquisition until the end of the term of the option would far outweigh the discount offered today given all of the other "stuff" going into this decision.