Hello BP Community,
I've started building a small portfolio of 4 properties and 15 units. I'm interested in expanding, and one way to do that is to bring in additional investors. I'm struggling with coming up with how to structure deals with additional partners/investors.
What are some examples of successful partner / multiple investor deal structures? How do you determine equity and ROI per investor?
When I think of partnerships I cringe. I guess my experiences haven't been very good. But I wish you the best. How many partners total? Are you considering only equity partners? What are the roles of each partner. If you are financing and bring in new investors, remember they will be required to sign loan documents if 20% or greater member of company. Additionally most lenders do not allow second lien positions which your investors may want to secure their funds. The last partnership I was involved in, we set up a joint venture. Since I was funding the entire construction and they were handling construction only, I felt my level risk was to great to offer anything close to a 50/50. I offered 10% of rents and equity in addition to paying 20% mark up on construction. My company was the only firm on title. I'm not sure where your level of risk lies to offer any additional advice.
This is a great question. Being in a situation now where I'm on the cusp of making my first move, I'm considering all my possible strategies, and lots of players have come my way wanting to buy the property I have as is, some willing to form a JV and provide funding for the investment. And so far haven't been able to secure a loan.
I definitely have found that simply figuring out what 'gotyas' to watch out for is most complicated with JV's. Any advice on this matter as well would be appreciated and I think relevant for the OP as well.
Specifically, how can one get scammed in a JV?
- misrepresented rehab budget/costs, misrepresented final return.
that's all I've got so far
Here's a hypothetical scenario:
- Purchase price for multi-family property: $1,000,000
- Down payment: $250,000
- My sole member LLC is the only firm on title
- I contribute: $50,000
- 1 other investor contributes $200,000
If we do a proportionate split the equity will be 20/80.
What other ways would you structure it if I am taking the risk by being the only company on title AND I bring some degree of experience and knowledge to the table, while this other investor is entirely new to real estate and wants more of a passive role?
I understand there are countless ways to structure a deal, but I am trying to leverage my experience, knowledge and time spent on the deal going forward. For example, I would make all decisions related to the deal (i.e. property management company, rehabbing, selling, etc)
I wouldnt do it in an LLC you currently own, Confirm with your lawyer of course but it seems to me that you should form a new entity that the two of you co-own in some fashion. If I were doing that deal i would have the investor give the new company the $200K and have you give the company $50K then pay each of you a preferred rate at like 6% interest only from the company. I would then take as much equity as the investor would agree to give me. Id probably ask for 75% for me and 25% for him/her. This would mean the first 15K would go 12K to them and 3K to you (each year) and then after that youd split it according to your equity positions. I alway pile those preferred returns so if one year you only make 10K you get 2500 they get 7500 but the next year the amount owed before equity based split is 20K (the unpaid 5K and the 15K preference from the current year ie. they get 75% of the first 20K and you get 25% of it and then after you are back to the 75% for you and 25% for them.
Or something like that
@Jon Kelly Since you're planning to bring partners into a deal, keep in mind if they are all going to be completely passive then you're selling a security and would need to talk to a securities attorney.
Your best bet is to consult with RE attorney about your options in general.
Making sure I understand because I think I like that structure:
It's a split of 80% them / 20% me up until the 6% preferred rate (i.e. $15K). Anything over the $15K is split according to the equity arrangement, 75% me / 25% them. Is that the idea?
Would this structure still hold for any potential appreciation made? For example, if the property is sold for $1.5M in 5 years, we make $500K. 80/20 split until $15K, and then equity split (75/25) for anything over?
@Jon Kelly You got it right but as long as the annual interest rate was paid the equity would be split 75% / 25% if the annual interest had not been paid yet then yes everything after the 15K per year would be split 75/25 in your favor. Obviously this was just an example but something along those lines would be where I would want to do the deal if I was you
@Jeffrey Holst , that's really helpful, thank you. I've heard of offering a guaranteed minimum %, and then sharing profits above that. But, instead of the guarantee, I like the pile-on or roll-forward idea you mentioned. If we make less than 6% in any one year, we carry the shortage forward.
Do others have any successful partnership / investor deal structures that they would share?
From my experience, I would say to itemize each partner's responsibilities within your operating agreement, (which you definitely should create for your NEW LLC, and have it notarized by both parties), and that should give you a pretty good idea of how much equity should go to each partner.
You're thinking of long term partnerships, which can be very rewarding, in terms of resources and relationships, as well as financially. Just make sure your partner is as intrigued about holding real estate as you are and you should be fine. I love partnerships for a number of reasons.
Is it more common for partnerships to last many years or for people to usually do shorter term arrangements with the expectation of getting their principal investment back after say, 1-2 years?
Most common is to offer a preferred return, which is a threshold return that passive investors are offered before you make money. Then, the remaining cash flow is split. For value-add deals, an 8% preferred return and a 70/30 or 50/50 split (passive investors/you) is the most common. Riskier deals will have a higher return (i.e. a highly distressed deal would have a 12% pref that is paid out once the property is stabilized).
Essentially, pick a competitive structure based on your business plan. Then, when having conversations with investors, ask them what their return goals are. If they are in alignment with your structure, great! If not, then they either aren't the right fit or your compensation structure is wrong.
To better answer your question, I would need to know they types of deals you plan on raising money for.
Hey @Theo Hicks that's super helpful thank you! So as to avoid hijacking the thread, may I message you privately to answer your question?
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