New Construction 50/50 JV?

Question

A friend of mine owns a lot and wants me to build a spec home on it to sell and we split the profit 50/50. He works a full time job so I would be in control of 100% of the project. If he puts up the lot and gets the construction loan, what's the best and easiest way to structure this so that we are both 50/50 partners?

Thanks !

Whitney Hill · Answer

"Best and easiest way to structure" brings up several points in my mind: deal structure + legal structure + tax implications (listed in the order in which I feel more versed, not necessarily their importance). Here's my opinion:

I'd start with getting a deal structure on paper:1) Agree upfront how much value you assign to his land, and agree that your shared LLC/trust (or whatever you set up) will owe him that amount when you ultimately sell. That value could be zero if you think that your project management time/expertise is just as valuable as the land... that will all depend on whether his undeveloped land is worth $5K or $50K or $500K!

2) Agree who will be putting up the capital required (your partner?) and exactly how much is needed - even if 100% construction financing, there will be interest & closing costs, insurance, plus often fronting the construction costs before the draws are disbursed, drawings/plans/permits that may not be covered by lender's loan...

3) Agree who will pay for any budget overages. Possibly you, since you will be on the hook for running the project? I find it aligns incentives best if the project manager-type partner is on the hook for any shortfall...  you could also agree to each contribute 50/50 or whatever split if you need more capital in the project.

4) When structuring the profit split, consider paying the capital partner a preferred interest rate on the invested capital, something like 8%. Up to you if you also want to pay any interest on the agreed value of the land over the deal holding period. And if you end up putting any additional capital in to cover budget overages, that capital would also have interest paid back on it.

What this all looks like when you sell the property: calculate your net deal profits after all your expenses like usual. Then pay back his land value (plus interest if you agreed that), then pay back his capital contribution plus an 8% annualized return on that capital, as well as reimburse yourself for any capital you had to add to the pot + interest. Finally, split the remaining profits equally. This structure first compensates either partner for skin in the game (kind of like you would otherwise need to pay for private money), then splits rest.

On the legal structure, sounds like you'll want to set up an LLC, along with an operating agreement that specifies the different duties you each have, all the stuff you agreed on deal structure above. Since he already has the property (presumably in his name?), you'll also want to iron out if he transfers the property at a zero/low value to your joint entity vs holding in his own name. Lender may make you transfer it to an LLC anyway in order to get the construction loan. All of this will have legal/tax implications and so I will stop there and suggest you find someone to take that piece on for you after you have the basics of your deal agreement on paper.

Roberto Gutierrez · Answer

Couldn't have said it any better than @Whitney Hill

I pull together this type of deal frequently. If you need example documents to get some ideas I am happy to provide.

Manny G · Answer

Wow! Thanks alot for that great response @Whitney Hill !!!

Roberto I just may take u up on that offer.

Let me ask.....what about financing?... Let's say we get the loan in only his name because he has a better credit score and well documented income. Is there a way for me to legally be a 50/50 partner without being on the loan? Just wondering about that.

Thanks!!!