Best way to structure first deal?

13 Replies

    This is probably the most confusing aspect of multifamily for me and everywhere I look I seem to find different answers. How would I structure my first deal between two other friends and I? I would be the one finding the deal, underwriting and managing the assets while they would be contributing about 75% of the down payment. We would all have equity in the property. All three of us would also be on the loan.

Ive heard lots of terms thrown around and I'm not sure which would apply to a scenario like this. Syndication? Joint Venture? LLC? Member Managed LLC?

     Secondly, would I need to set up this structure after before I apply for the loan or once the property is under contract?

Thanks guys!!

Hi Pablo,

Who is bringing the remaining 25% of the equity? Would that be you? Just trying to understand a little better.

Are your partners going to be actively involved in the operations and/or decision making process driving the ROI? Or will they be totally passive and give you their capital with an expectation of profiting from your efforts as a promoter of the investment?

The answer to the questions above will determine whether or not you are dealing with securities and therefore subject to SEC guidelines/reporting. It will also determine the best way to structure the deal.

Syndication just means pooling resources together, normally financial resources, to achieve a common goal. A real estate syndication IS a Joint Venture at the end of the day.

The legal structure under which the syndication or JV is structured can be an LLC or a Limited Partnership. Whether the LLC, if the deal were to be structured under an LLC, should be member managed or manager managed will depend on other factors.

In a real estate syndication you should get started with the incorporation of the different legal entities (LLCs, LPs, etc) after you are under contract.

Truth is you will (or should) never get a straight answer to the question of How to structure a deal. There is no right or wrong answer to this without really knowing all the details and also what your goals are and what the goal of your investors is.

There are 2 basic approaches to partnership: democracy and a limited partnership. In a democracy, all members are voting members relative to all aspects. In a democracy, you can not limit other partner's voting power. Think basic LLC. FInd an attorney to structure the thing, but if all of you are going to have money in the deal, all of you are going to be on the loan, and all of you will have operational voting power then it's a simple, more or less, LLC.

If, on the other hand, you want to be the sole member running the deal then by default the other partners become limited members. You are taking their vote away - this requires a special structure.

Limited partnerships in RE are often referred to as syndications. The word syndication simply means to combine, which could be money, expertise, or anything else. We generally mean to pool money. And the reason we use the word to describe such a partnership is to draw a distinction between a simple democracy partnership and a limited partnership.

Limited partnerships encroach on SEC regulations. They are exclusions in the code, but they require expertise. Ans they are expensive to put together, as is anything that encroaches on SEC. Personally, I don't see how anything smaller than a $5M deal is worth the cluster.... that is a Reg D syndication.

Finally, the term JV usually refers to people partnering at the sponsor level on large projects, think syndication.

Hope this help!

@Pablo Flores @Lennon Lee gave you a number of great questions as a food for thought to determine the best structure for your deal. Since it's only three people, syndication may not be the most effective way to structure this deal. However this is only my opinion. I'm not an attorney to give you an advice. 

I do recommend you look into TIC (tenancy in common) that allows each member to hold individual undivided ownership interest to a property along with other benefits.

Bottom line, the overall structure should be discussed with a qualified RE attorney that knows the local laws of the state where you plan to incorporate. 

Best of luck!

@Pablo Flores Apart from the great comments provided by the posters above me, I would like to add a simple question: How many cooks do you want in the kitchen?

All other questions around structuring, et. all flow from this simple question. Also, if I was you, I wouldn't get too greedy (i.e. too much equity share) on your first deal if you know these are recurring investor. As an asset manager, you are building your track record. Spread some love, make everyone happy and you will reap the rewards in the long run. 

Some amazing advice here. Thanks guys! Let me elaborate a little further since I wasn't so clear apparently....

@Lennon Lee I am brining the other 25% of the equity. My other two partners would only be financial partners and would not be involved in day to day operations at all. And thats how they want it to be. What is the difference between a member managed or manager managed LLC?

@Ben Leybovich Is there a way to structure this where the other two people are limited partners since they won't and do not want to take part in running the deal, but not have it be a syndication but still receive equity in the deal? Overhead costs would be too big for a syndication and I don't really see the point since theres only 3 people going in on the deal.

@Omar Khan Definitely don't want too many cooks in the kitchen, and they don't aspire to be cooks as well. They just want a slice of the pie. And I definitely don't want to get too greedy which is why I want to set this up the right way where they get a nice chunk of equity without being managing members. I understand the true value in that first deal will be the experience and building that circle of influence. 

@Pablo Flores The difference between the manager manged and members managed LLC is in its' title itself - as it dictates in member-managed LLC - all members are responsible for the day to day operations of the business, where in manager-managed LLC there is a designated manager to run a business.

Keep in mind, in your case due to the fact that the two of your partners plan to be silent, a securities transaction may potentially be happening as a result of this case. You can ask for an opinion here, but RE  attorney is your best bet if you want to abide by the law.

Hi Pablo.

The most simple option is a 1/3 split between all parties.

Another option is to look at the project as a syndication and structure it accordingly. For example, you would offer a preferred return to the people bringing the equity to the deal (for example, 8%). So, all of you would make a percentage based on how much equity you bring to the deal. Then, there is usually a profit split in syndications between the general partner (the person who manages the entire transaction) and the limited partner (the people who bring the money but have no ongoing responsibilities). The split can be 50/50, 60/40, 70/30, etc. (the first number is for the limited partner and the second is for the general partner). Since it sounds like you are the general partner, you would get 30% to 50% of the profits remaining after the preferred return. Then, at sale, you would be 30% to 50% of the profits remaining after the loan is paid off and the limited partners' equity is returned.

You as a general partner could also charge an acquisition fee for finding, evaluating, and closing the deal, and an ongoing asset management fee for managing the project.

I have been playing with Michael Blanks Syndicated Deal Analyzer to see how different splits will affect the return and this is what I came up with. I don't want to get too greedy on this first deal so I am only going to get a small split for being the GP. There would be no preferred return since we are all sharing in equity in proportion to how much money we put in the deal, in addition to my extra 20% cut for managing the asset. My main question isn't necessarily how to structure the splits in  the deal, but what legal entity would be best in this scenario. 

@Theo Hicks Do you think I could do this as a manager managed LLC without having to do a syndication? I want to avoid all the overhead costs since its a small deal with only a few members, but still retain sole control as the GP. That is the dilemma!!

Do other partners have standing relative to voting on all things? If yes, this can be a democracy. If no, this needs to be a limited partnership.

@Pablo Flores Manager managed LLC sounds like exactly what you need based off of the article below: https://www.hunterbusinesslaw.com/limited-liability-company-member-managed-vs-manager-managed/

@Pablo Flores those are all great questions to ask an attorney! They will usually do the first 30-minute call for free. Then, they can help you create any LLC or operating agreement for the deal.