triplex underwriting and JV questions

[Mike Carr]

I need some help overlooking the #'s before I present this to a potential JV partner. I have been marketing to small multi-family properties in my market (Delaware) and have wholesaled two so far. Id rather be buying these but I am having a hard time with banks and creative financing methods so I want to approach a few people in my market to JV. Any help is greatly appreciated.

My background: I have helped managed and maintain my parents' rental properties for over a decade. I started my business a few years ago after college by flipping and wholesaling properties. I just started to build my rental portfolio a year ago. I currently have three cash flowing properties. Short-term goal is to have 30 total units through multi-family properties in the next 2 years with a JV partner.

JV Structure: 60/40 split. Jv partner gets 60% and my company gets 40%.

My roll would be to find the property, perform due diligence (cover costs), manage the property manager, inspect when necessary, make repair/operating decisions, and provide monthly statements and updates. 

JV partners roll would be to provide funds for down payment, fund operating account (15% of gross rent), fund mortgage escrow account (if bank requires one), and cover closing costs.

We will open an LLC/LLP to purchase and manage the property through.

Property: Triplex with FMV of $145,000-$155,000 range. Gross rent is $26,400. I have not seen the inside of this one yet. But this is a typical deal we have been coming across.

     Purchase

Price                                $120,000 

Down payment            $30,000 (25%)

Closing costs                  $6,000 (5% estimated)

Mortgage escrow            $3,618 (6 months of payments)

Operating account          $3,960 (15% of gross rent) 

TOTAL initial investment $43,578

Expenses

Taxes             $957

Insurance       $800

Management  $2,640 (10%)

Utilities           $900 (sewer and common area)

12% misc       $3,168 (covers repairs, lawn, snow, etc)

TOTAL           $8,465

Mortgage

$90,000 balance at 5.25%. 20 year amortization. 5 year balloon. $7,236 ($603 per month). I am looking for 30 year fixed financing as well. 

60/40 split

$26,400(gross income) - $8,465(expenses) - $7,236(mortgage) = $10,699 Net (pretax)

60%= $6,419 which is a 15% cash on cash return from the initial investment.

40%= $4,279 for my company. 

Questions: Is this something you would present to a JV partner? How is the structure of the deal?...is there an easier ways to structure/operate this? Are there numbers I am not factoring in? How would you go about asking a potential JV partner? Thanks for any insight on this process.

[James Masotti]

The only call out I possible have is that your partner is getting a 15% return on their cash and you are getting significant higher return for that, essentially an infinite return on money invested. Now you can say that your time is worth money, and while that is true if the project goes belly up...you're out time and your investor is out a substantial amount of money. As an investor my question would be is this fair? 

Now if you were to do a 75/25 split...then your investor would have an 18% CoC return and you would still make $2675...for basically doing nothing, since you'll have a property manager in place.

There are a lot of investors out there who put in the $43k, set up a property manager on their own and then enjoy the full $10k in profit...Now I'm sure that this approach will work for someone out there, but you'll need to make it worth their financial risk. 

Flip the table and think through it from your JV partner's perspective. What questions would you ask and how would you react and respond given the same set of information and circumstances?

[Mike Carr]

I would explain that there is risk with any investment vehicle. My name is still full recourse on the loan so I technically do have skin in the game. Buying below market and performing rigorous due diligence is how we minimize that risk. 

A 75/25 split would not be worth my time at all. Infinite return or not, $2,675 is still $2,675 at the end of the day. The only way I would accept 75/25 is if they hadsignificant funds and would want to grow into larger properties together. 

To justify 60/40

1. Knowledge and track record of success.

2. Access to off market properties through our own marketing.

3. 15% is a pretty solid return compared to whats currently on market. 

4. Equity in the deal....FMV is in the $145k-$155K and with a bank loan at $90,00 that puts the equity at roughly $60,000. 60% partner would have $36,000 which is almost what they put into the deal.

5. Systems and relationships that I have created over time to properly manage and maintain rental properties. Even though the property will be in the hands of a property manager, I still overlook every detail to make sure everything is running smooth. I still keep records and dates as if I am managing the property myself. 

6. Grow a rental portfolio with an experienced partner without the hassle of finding and managing the property. This alone provides a ton of value to people who do not have the time to do this on their own.

I definitely like your idea of looking at this from the jv partners eyes. I've already thought of a few questions scenarios that a jv partner might want to know or ask. 

Thanks for the in depth response. 

[Jonathan Godes]

I don't really know what you bring to the deal @Mike Carr. Not to be a jerk, but you kinda lost me on the "mange the property manager." 

I have very rarely heard of buy/hold JV deals that seem equitable for the funding partner as every function that the ground partner brings they can get without giving up any equity. So you find the off market deal - great, but can't I just pay $10k to a wholesaler to do the same thing? You are not property managing the place, but managing the manager. I am pretty sure that I could manage the manager myself. Look at it this way, for $10k more I could have the exact same situation but without you taking 40% of the deal.

I could possibly see giving up 20% of the equity IF you found a screaming off market deal that provided instant equity AND you were doing the property management yourself AND you oversaw a small renovation (around $20k) to make it rent ready. That is a value add on the front end (rehab oversight and wholesale price) and ongoing (saving 10% annually on management) that I could maybe see giving up 20%.

I think you overvalue reports and making sure everything runs smoothly. I can find my own rental off the MLS and overpay by $20k (vs what you could theoretically get it for), find my own professional property management (who should provide reports as part of their services) and still be better off in 3-5 years by not giving up 40% of the deal.

Don't get caught up on what the partner's return will be and work back from there. Figure out what value you bring to the equation that can't be easily replicated by googling someone else and try to justify an equity percentage around that. 

[Mike Carr]

You don’t see value in injecting money into a system that’s producing 15% returns? Whether I manage it myself or have 100 people on my team, 15% return is still 15% return. How I run my business should not be how you judge value. In fact, more people overlooking and managing a property the more secure the investment will be. There is much more to owning rentals than just hiring and handing it off to the management company…class C and D properties come with their fair share of headaches so you have to stay on top of management/maintenance.

Months and even years of experience are needed to create the correct systems and processes to find, manage, and maintain these types of properties for the long haul. If you think you can do all of those tasks better on your own to earn a few more dollars then by all means go ahead. Having someone else do all of that work for you outweighs the few percent you might save by doing all of this on your own. A simple google search will not find you discounted off market properties that you can easily manage or maintain….average returns on similar properties on MLS( in my area) are 8-12% without factoring in management. To have a sustainable business that will last for many years you have to know and do more than just buy some crap on the mls and hand it to a manager.

Im providing a win-win scenario for both partners involved and will only purchase deals that do so. This will provide a great value for introducing new people into the business and for people who don’t have time to do this on their own.