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Jason L.
  • SF Bay Area
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Determining Profit Share for Spec Home - Risk vs Capital/Other Contribution

Jason L.
  • SF Bay Area
Posted Feb 12 2024, 19:41

Hello BP,    I'm looking to build a spec home on a piece of land I own in a relatively affluent Bay Area neighborhood. I'm negotiating with a prospective partner who is an experienced developer/RE Agent in the area.  I've known him for 8 years and he has a good track record of flips and spec projects.    

 I've extensively researched BP forums and have spoken to other developers, builders, atty's, and CPA's about how best to determine profit share between partners based on 1)Risk, 2)Capital Contribution, and 3)The Role of Each Partner in the project . . . BUT, I've yet to find a cohesive "formula" or "rule of thumb" for weighting these factors and determining profit share. Hence my request for help . . . 

I'll sketch out the (current) terms first and then lay out my concerns/questions:

Proposed Terms/Assumptions:

- I contribute my land to the project receiving accrued interest at end of project (at rate similar to hard money rate). Land is used to secure a hard money construction loan (CL).  My land "loan" is subordinate to the CL. 

 - I Co-Sign with the developer on an interest-only construction loan (ideally a "no payments" loan).

- The developer acts as owner-builder-GC and is responsible for securing financing, managing all subs as well as overall Proj. Mgmt. Basically he does all the work.   

- We hire a third party CPA for project accounting

- The developer (who has RE license) gets the sell-side commission (paid before profit share).

- After the CL and Land are paid off the developer is proposing we split the remaining profits 50/50.

- Hypothetical Numbers*: Land value = $1M, project costs= $2M, sale price=$4m, profit=$1M

* These numbers are approximations.  We've done a thorough proforma which I've vetted and feel comfortable with.  "Project Costs" are comprehensive and include arch/permits/site prep/contingency/financing etc. There are strong, recent comps on which to base the target sale price. 

My Questions/Concerns:

1) The developer is asking me to co-sign on the CL.  Is this standard practice or a red flag?  If I agree, how should this factor into profit share?

2) With my land as the only real asset in the LLC (and second position to the CL) I'm assuming a lot (all?) of the risk should things go horribly wrong. How should this factor into profit share?

3)  Is it common for the developer not to have any upfront "skin in the game" (no $$ capital contribution)? How should I reflect this fact in the profit share?

4) The developer wants his RE commission paid before profit share.  Is this common and/or should it be reflected in lower profit share for him?

5)  If I were to value all of the services the developer is providing I could probably get to a figure of $300K - $400K (15% GC fee, 5% proj. mgmt).  How should the value of his contributions affect profit share?

I'd love to hear any and all  thoughts on how these different variables factor into determining fair profit share.   Many thanks!!

Jason  

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