Buying out a Partner

Buying & Selling Real Estate
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Buying out a Partner

Thomas Smith
Member since 2019 · 16 posts · 5 votes

I am in a partnership in which we currently own 11 units together.  A couple single family and a few multifamily.  I put myself into the unfortunate position of being in a partnership that is 95% me and 5% the other guy in terms of workload (we are both 50/50 financially).  We have only owned our properties for a couple of years.  Luckily we purchased them all well below market.  So my idea to end the partnership but preserve a friendship was to list our properties.  This way we both make a little cash and the friendship remains in tack.  Unfortunately, his dad is the realtor and this is his part-time gig.  So you can see how effective this has been.  

Yesterday, my business partner asked me to buy him out.  However, his buyout number was well above the amount we would get even if we sold the properties today (since we still have mortgages to pay off first).  

There are a few of the properties that I would love to still own but now that I know his "buyout" number, there doesn't seem to be a way to pay him off and keep the properties (he's a bit inflated with his thinking).  Does anyone have any suggestions for handling this situation?  How should I determine a buyout number considering we are very early into our mortgages?

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DJ Scruggs
Rental Property Investor · Denver, CO · Member since 2019 · 12 posts · 7 votes
7y

But with such a large gap, I wanted to make sure that like minded people were on the same page as myself.  He is in the mindset that I should buy him out based on the future value of the properties if we were to hang on to them (even though he wants bought out now).  

There's an old saying: "You name your price; I’ll name the terms."

If he wants to value the his ownership based on future value, ask if he's willing to be paid in future dollars.

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  • Anthony Wick
    Rental Property Investor · Ankeny, IA · Member since 2017 · 2k+ posts · 3k+ votes
    7y

    @Thomas Smith

    Do you not have legal paperwork or an LLC in this partnership? Barring that, I'd say a fair value would be to get actual appraisals (perhaps obtaining a discount for multiple units) and then taking those figures less about 8% (which is what you'll pay in the future to sell them. So, if each property is worth $100k, the buyout is 50% of $92k.

    And make sure the appraiser is an independent person that does not know either of you. This could cost you upwards of $5k or more though, so I wouldn’t fight over an amount if you can get within $10k of an agreement. How far apart are you?

    1Reply
  • Thomas Smith
    OP
    Member since 2019 · 16 posts · 5 votes
    7y

    @Anthony Wick We do have an LLC on this partnership but we do not have any paperwork to support it outside of our verbal 50/50 agreement. Young investors shooting for the stars out of the gates, we figured it would never go wrong. Lessons learned.

    When you say the buyout should be 50% of the 92k, would the mortgage first be subtracted from the 92k?  

    The way I looked at it was would get an appraisal, take that appraised amount and subtract our current mortgage debts, and then take 50% of that to come to our number.  Because although these properties will one day be free and clear of a mortgage, they currently aren't, and sooner or later they will need improvements to them.  Especially since he approached me about a buyout and not the other way around.  I'm looking more in terms of present value vs future value just based on him wanting bought out right now.

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  • Anthony Wick
    Rental Property Investor · Ankeny, IA · Member since 2017 · 2k+ posts · 3k+ votes
    7y

    @Thomas Smith

    Yes yes yes. 50% of the equity currently in the home. But I would subtract 8% of current value, thus mimicking the sale as of today.

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  • Thomas Smith
    OP
    Member since 2019 · 16 posts · 5 votes
    7y

    @Anthony Wick  Thanks!  I hoped I was on the right track with my thinking but he came in at about $150k higher than where my number would have been had he asked me for a buyout number so I wanted to get some confirmation.

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  • Anthony Wick
    Rental Property Investor · Ankeny, IA · Member since 2017 · 2k+ posts · 3k+ votes
    7y

    @Thomas Smith

    That’s a pretty healthy gap at $150k. Was this just the opening salvo that the two of you threw out? Either of you producing tax records/assessments, comps for the area, Zillow estimates (pause for laughter), etc?

    What happens if the two of you are unable to agree upon a number? Can he sell his shares in the partnership? Maybe that’s what it would take for him to realize the real value. Or maybe you’re the one way off, I don’t know. Ask him if he will give you rights to match any offer he finds first.

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  • Caleb Heimsoth
    Rental Property Investor · Durham, NC · Member since 2016 · 7k+ posts · 7k+ votes
    7y

    @Thomas Smith I just went through this earlier this year but 1 it was less property and my business partner (who I bought out) was reasonable on his price to do so. Lesson learned be careful who you partner with as life circumstances can change very quickly as you’re not realizing. I am still friends with my business partner, so it ended amicably.

    The actual logistics of it was have an attorney draw up a buyout agreement for the llc. We both sign and have it notorized. Then I gave him the money. That was it really

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  • Thomas Smith
    OP
    Member since 2019 · 16 posts · 5 votes
    7y

    @Anthony Wick I almost choked when he told me his number but yes this was just the opener to discussion.  But with such a large gap, I wanted to make sure that like minded people were on the same page as myself.  He is in the mindset that I should buy him out based on the future value of the properties if we were to hang on to them (even though he wants bought out now).  We have not had our properties appraised and the bank did an in-house "valuation" of the properties when we purchased them.  There are a couple of the places that were valued much higher than what I know the market would have been (happy at the time of purchase) which has given him this inflated mindset.  The properties aren't selling at the prices he listed them so I figured that would have been his first indicator that his numbers are way off.  

    The good news in this whole thing is that if we don't agree upon a buyout number, we have agreed to pay me as the property manager and he stays in as a 50% equity partner.  This is not a terrible scenario but I still would rather be able to move on with this partnership.  Again, wanting to save a friendship.

    @Caleb Heimsoth big lessons have been learned along the way but I'm much more knowledgeable than I was when we purchased so if I walk away with anything, it'll be plenty of knowledge for the future

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  • Anthony Wick
    Rental Property Investor · Ankeny, IA · Member since 2017 · 2k+ posts · 3k+ votes
    7y

    @Thomas Smith

    Hey, I want my partners to buy me out at inflated future prices as well! Lol. He can’t be serious about that. I’d love to hear his reasoning on that.

    What's your agreement on paying you as the Managing Partner? I'm curious because that is the role I am acting in as well. The LLC pays me 7% of all collected rents. My partners know they are getting a very good deal on that.

    We just bought another duplex this week and I spent 3 days of hard labor making that place look great. $0.00 for me this week, but the property is improved and I’ll be collecting my fees in the coming months when there is little work done (hopefully).

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  • Thomas Smith
    OP
    Member since 2019 · 16 posts · 5 votes
    7y

    @Anthony Wick 

    Our agreement is very much the same. I will handle any and every issue and the LLC will pay me 7% of gross rents. I did 7% because it is a good deal for us as a partnership but it finally pays me for the work I have been doing since we began investing together. Basically covers personal expenses while allowing the LLC to continue to grow in value. This will be placed in writing (as I have learned things need to be). However, I have begun pursuing deals outside of the partnership on a solo basis for the time being. Closing on an owner finance single family within the next couple of weeks.

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  • Anthony Wick
    Rental Property Investor · Ankeny, IA · Member since 2017 · 2k+ posts · 3k+ votes
    7y

    @Thomas Smith

    Excellent! Same deal as me. Good luck to you as you move on without a partner!

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  • Thomas Smith
    OP
    Member since 2019 · 16 posts · 5 votes
    7y

    @Anthony Wick Thanks for the insight!

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  • DJ Scruggs
    Rental Property Investor · Denver, CO · Member since 2019 · 12 posts · 7 votes
    7y

    But with such a large gap, I wanted to make sure that like minded people were on the same page as myself.  He is in the mindset that I should buy him out based on the future value of the properties if we were to hang on to them (even though he wants bought out now).  

    There's an old saying: "You name your price; I’ll name the terms."

    If he wants to value the his ownership based on future value, ask if he's willing to be paid in future dollars.

    3Reply
  • Allan C.
    Rental Property Investor · Member since 2018 · 826 posts · 810 votes
    7y

    @Thomas Smith it appears that he isn’t willing to preserve the friendship as much as you are. That may give you pause to consider whether the path of keeping this partnerships will result in other issues down the line, even if he is willing to pay you for PMing.

    However, I suggest that you don't react to anything yet unless you hear his rationale for his buy-out calculation. He may be equally offended at your valuation, so you'll both have to have an open discussion first. I do believe the disagreement is how you treat the future cash flows of the properties. The multifamily homes should be straight forward in that they price on a cap rate and already account for future income. The SFH should not be based on future income since that is not how SFHs price in the market.

    IF you decide to continue the partnership, you should address the exit strategy and not kick the can down the road. Good luck.

    1Reply
  • Sam Shueh
    Real Estate Agent · Cupertino, CA · Member since 2016 · 4k+ posts · 1k+ votes
    7y

    Get more than 2 appraisals not selected by his father through a valuation company. Based on the data you two can decide.

    0Reply
  • Lynnette E.
    Rental Property Investor · TN · Member since 2018 · 2k+ posts · 2k+ votes
    7y

    Once you agree on the value of the properties, if you do not have the $ to buy him out, perhaps you can split the properties as in you take full ownership of a few properties and he takes full ownership of a few properties.  

    If you reach agreement on the value of each property and figure out the equity it should not matter to your partner which properties he takes as he will sell his.  You could choose which you take as you will keep yours.  

    As you decide who gets which property, you are just balancing the equity --your agreed value minus the mortgage, taxes, etc. owed on each property--and not their value now or later.  

    If you each take full ownership of a few of the properties it avoids you having to find a lot of money to buy him out.  Hopefully you can figure out how to divide who owns each property so that only a little cash is changing hands and you are each getting close to the same equity.

    That process also lets him decide at what price to sell, and what realtor to use so you avoid that conflict.

    0Reply
  • Bryan S.
    Rental Property Investor · CA · Member since 2018 · 225 posts · 180 votes
    7y

    I recommend immediately listening to “Never Split the Difference”

    1Reply
  • Thomas Smith
    OP
    Member since 2019 · 16 posts · 5 votes
    7y

    @Bryan S. Will do! I’ve heard of it but never looked into it. Thanks!

    0Reply
  • Lucas Holcomb
    Member since 2020 · 1 post · 1 vote
    6y

    I know this thread is old but I have some questions... I am in nearly an identical situation although my partner is being more reasonable on the pricing. (We are ~40k off on 11units.)

    1. Where did the -8% come from on the valuation for the offer? What normal expenses do you mean? Agent fees and such?  

    2. How is this handled on taxes? I have always done my own taxes, he took over doing the business taxes last year and I check them over. So we each get a K-1. Here is my concern. One reason I want to buy him out is to stop managing my properties and these separately (I no longer want to do double line accounting/corporate accounting since it won't be an LLP). My concern is about transferring these properties to my schedule E when they have been filed as an LLP before, transferring depreciation, cost basis etc is what I don't understand for this. Can I even switch that? I am buying out the LLP.

    It is a mystery to me since I only ever bought properties, in this case I'm buying an LLP that contains properties.

    I won't take anyones answer as accounting or legal advice, I am just looking for information on how it would work and what it would look like. I will of course talk to a tax pro, for the first time ever! 

    1Reply
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