I have a financing partner for potential rehabs I plan on doing and wanted to get BP's input on how to structure the profit split of these deals.
Some background information - I will be doing all the work from start to finish, so my partner will essentially be "silent" throughout the entire process. Given this structure, do most people split the profits 50/50 (half the profits for providing the capital and the other half for the work involved in the deal)? I plan on contributing a significant amount of my own money into these deals as well (at least 25% of the total costs), but wanted to see if the 50/50 split is a good base to start from when determining profit splits.
Is this in line with how other people have structured deals?
Thanks,
Kyle
In an effort to accomodate Bryan, lets use one of my deals i have in the works as an example.
Acquisition price is $1,150,000
rehab is $300,000
ARV is $2,400,000
Lets also say that resale costs will be $150,000 and holding costs (not accounting for any leverage costs) will be $25,000. We will also say that the total hold time will be exactly 6 months.
The spread based on these numbers above comes out to be $775,000.
Now, I found the deal, will manage the deal, and sell the deal. I will also guarantee that the money partner does not lose a dime and do so with a personal guarantee of which I actually hold assets with equity to cover any potential loss.
Lets also assume that both the rehab investor and the lender are both equally saavy in RE, but the money partner wants to remain completely passive, make no decisions on rehab or anything, just wants a good return.
Based on what Bryan laid out, the money partner would get $620,000 (80%) for a total cash investment of $1,450,000 which is a 42.8% return. Based on 6 months, that is an 85.5% annual return. Return for rehab investor partner is $155,000 (20%). Now, the rehab investor put up zero dollars so many can and would argue that is one hell of a return, I would argue that I took on quite a risk just to make $155,000, not to mention my 6 months of time which i value greatly.
Even if you made this a 60%/40% where I receievd 40% ($310,000), I would not do the deal under such terms and here is why: Without me, this money partner would not have the opportunity to be in this deal (yes Bill, he could find any RE agent to easily hunt down a deal with same spread, hire a GC to run the deal, and hire another agent to sell the deal and make all the money, this again assumes he/she cares to take on such an endeavour of time and risk) and would not have their funds guaranteed, nor would they have the ability to be 100% passive.
Now, let me go on the flip side just to be fair on non-bias as i too can be on the lender side. I am the lender and at 50%/50%, I would do the deal so long as my money had a minimum return guarantee. So long as the numbers hit as posted, i would make $387,500 on $1,450,000 investment, do so in 6 months, and be 100% passive (this would ONLY be done if the investor was as experienced as me as i did state in this example to keep apples and apples here.
So, in summary, many have argued the 50% split is not how it should go and under the circumstances I have laid out, i believe it is the most fair.
- Will Barnard
Bill Gulley you have a very high opinion on Realtors don't you lol. Not saying any of them aren't bright or anything but a lot of them aren't in the business of finding below market properties and a lot of them don't even know how to analyze any deal. Some don't even know what ARV stands for or what the 50% rule is.
Now there are investor Realtors out there and yes they know their stuff but they're far and few between and you need to dig for them if you want them to find deals.
And besides in a lot of markets the MLS inventory is bleeding dry due to either Hedge Funds scooping up the deals or an influx of investors coming in so finding deals on the MLS is becoming more difficult is some markets these days.
I suppose I do and for good reason. I don't use the 50%, 2%, 70% or any % rule. Many investors can't figure out closing costs, per diem interest, tax arrears, title insurance premiums, or the APR either. Most can't audit a HUD-1. I'd think that if one would simply say "after repair value" they would catch on pretty quick. Realtors, more so than most can pull comps and assess value, but before you or they know it's what investors call "below market" you need to know what is being asked for it or what a seller is willing to take before you know it's a good deal. I've seen many ads that say "below market" horsepuckey, market value is what it sells for if the conditions for a market value price exist, which many investors can't define. I suppose I lean toward Realtors because they have at least gotten formal training in RE compared to the investor types who learned guru stuff and think they know what they are doing (no offense).
Usually the one that brings the most skill to the deal is the rehab guy, not the finder or the money guy.
For Realtors who deal in new construction, they know what ARV or CMF is from plans and specs, certainly appraisers do. Then you do a final inspection and validate the 'estimated market value' that rehabbers or investors call ARV.
I think Will may have misunderstood what I was saying previously, not that the money guy IS hiring out any alternative service but only valuing the service that is usually commanded for the same or very similar service.
I don't think we can really say investors or Realtors, there are brilliant ones and stupid ones, if everyone had equal knowledge and skills we'd have a real mess. :)
These days it seems that there is a ton of private money, as everyone wants to be a lender secured by RE, so it makes it more of a borrowers market. I'm not so sure that same competitiveness applies to larger JVs.
Pre Bubble, I was an assistant to two RE investors, who were the working partners in their JVs, and I was privy to the numbers on their projects. There were 3 that I remember, all needed $10M+ for purchase. No development or construction, no rehab. The investors had a special skill set and were masterful at getting a property to its highest and best use. The money partners always got more than 50%.
The money is in the money. The person who controls the equity is always going to be worth more than the laborers. I can hire any number of brokers, accountants, architects, project managers, attorneys, etc. to make my deals work. I also keep several of each to keep them honest with their pricing and let them know that they're not the only show in town.
I have never understood the 50/50 deal. I suppose this may work well for some scenarios, but the person with the capital is worth WAY more than the person performing the labor in almost every scenario I have seen.
The rule of thumb on larger deals is 80/20 with 80% for the capital and 20% for the labor. A lot really depends on value delivered by the operator, their track record, and how the deal is structured.
All interesting viewpoints on this topic. The concensus seems to be a 50/50 profit split for a deal. Bryan Hancock, I understand your point, but I don't think the situation you outline describes the situation I'm in (not saying that you're trying to do so either). For the rehabs I am looking to accomplish, my partner will be completely "silent." He won't have any responsibility overseeing the project nor does he want any.
I would be interested in hearing if that changes your perspective at all.
And to everyone else who commented, I really appreciate all the feedback.
I guess it is hard for me to put myself in the passive money shoes.
Private equity generally pays something like 8% preferred returns with a split on the back of something like 70/30 or 60/40. Investors in these deals are completely passive by definition and thus that is what sophisticated equity is worth. Experienced operators pay this much so someone with less experience should be expected to pay more for equity in my opinion to account for the extra risk. Thus I would say an 80/20 arrangement is probably more suitable.
There is no shortage of unsophisticated money out there though. Depending on the deal structure it probably makes more sense to use hard money if you're equity-constrained. Hard money is cheaper for many deals than having another mouth to feed; albeit more risky in many cases too.
I think you'd need to list out the specifics of a given deal for someone to comment intelligently. Talking about things like this in the abstract is hard because it is hard to see who is delivering value and how.
Bryan Hancock, interesting comparison to private equity. I think a primary difference however is the expected rate of return for each type of investment. Private equity funds will target an annual rate of return in the 20-30% range, while I think a rehabber will want a much higher return on a house rehab. For example, if I put $100k into a home purchase and repairs, and make a $15k profit in around 4 months, my annual return will be about 45%.
Obviously an oversimplified example, but in general, I assume rehabbers will expect a higher rate of return on their money than PE investors. So that could possibly be a justification for a 50/50 split.
Rehabbers also fail to account for their time properly in the rehab transactions in about 99% of the cases I see. Thus their AROI is often grossly exaggerated because it imputes their time in their "return" figures.
The part that needs to be compared is what yield the person placing their capital is receiving solely on their money working. In your example if the person that places the capital (I hesitate to call them an investor) is receiving $7500 on $100k invested that is a decent yield in a vacuum. However, what happens if the deal makes less or you somehow lose money? On a risk-adjusted basis I don't think this is a very good deal for the investor who is assuming all of the financial risk. There are also alignment problems with the laborer putting up no money.
A fairer arrangement would be for the investor to receive a preference on their money that gets paid BEFORE the profits are split. As the deal promoter you ultimately want the lowest cost of capital possible along with the most flexibility.
In an effort to accomodate Bryan, lets use one of my deals i have in the works as an example.
Acquisition price is $1,150,000
rehab is $300,000
ARV is $2,400,000
Lets also say that resale costs will be $150,000 and holding costs (not accounting for any leverage costs) will be $25,000. We will also say that the total hold time will be exactly 6 months.
The spread based on these numbers above comes out to be $775,000.
Now, I found the deal, will manage the deal, and sell the deal. I will also guarantee that the money partner does not lose a dime and do so with a personal guarantee of which I actually hold assets with equity to cover any potential loss.
Lets also assume that both the rehab investor and the lender are both equally saavy in RE, but the money partner wants to remain completely passive, make no decisions on rehab or anything, just wants a good return.
Based on what Bryan laid out, the money partner would get $620,000 (80%) for a total cash investment of $1,450,000 which is a 42.8% return. Based on 6 months, that is an 85.5% annual return. Return for rehab investor partner is $155,000 (20%). Now, the rehab investor put up zero dollars so many can and would argue that is one hell of a return, I would argue that I took on quite a risk just to make $155,000, not to mention my 6 months of time which i value greatly.
Even if you made this a 60%/40% where I receievd 40% ($310,000), I would not do the deal under such terms and here is why: Without me, this money partner would not have the opportunity to be in this deal (yes Bill, he could find any RE agent to easily hunt down a deal with same spread, hire a GC to run the deal, and hire another agent to sell the deal and make all the money, this again assumes he/she cares to take on such an endeavour of time and risk) and would not have their funds guaranteed, nor would they have the ability to be 100% passive.
Now, let me go on the flip side just to be fair on non-bias as i too can be on the lender side. I am the lender and at 50%/50%, I would do the deal so long as my money had a minimum return guarantee. So long as the numbers hit as posted, i would make $387,500 on $1,450,000 investment, do so in 6 months, and be 100% passive (this would ONLY be done if the investor was as experienced as me as i did state in this example to keep apples and apples here.
So, in summary, many have argued the 50% split is not how it should go and under the circumstances I have laid out, i believe it is the most fair.
- Will Barnard
Thank you thank you Will I was going to say this but you beat me to it.
I found the deal,I have the deal under contract,I will hire everyone that needs to be hired. I will see this project through from start to finish and I will handle the closing. I will do all of the work while the lender/partner sits on his a$$ and twiddles his thumbs and watches the ball game on TV and collects a nice return.
I control the deal that way. And as Will said if it wasn't for the investor finding the deal and getting it under contract than the lender/partner would not see any returns. So I believe in that regards that a 50/50 split is more than fair.
I mean if you don't like the split than that's fine. There is always someone who's making pittance in CD's,savings accounts,etc who wants to make better and much higher returns on their investments.
I would not got as far as to say money partner only sits on his rear, without the money, a deal can't close either and it is likely this person worked hard to acquire said funds, thus they deserve a good return for working too. I just don't believe that 80%, 70, or 60% is fair on the part of the other investor UNLESS the rehab investor is not equal or greater than the money partner as far as experience goes. If the rehab investor is more of a newbie, then the money partner is taking on more risk and that may call for a higher %!split to the money partner.
Sure they worked hard for that money but in a sense that's all they're doing is funding the project while the rehab investor is doing 99.9% of the work while the lender/partner is at home doing whatever.
Maybe sitting on their a$$ was a bit presumptuous. More likely making love to their spouse :)-
I think it's funny that people are arguing over percentages (including me :).
Let's face it -- this is supply and demand at work. One person can keep repeating that the money guy deserves more; one person can keep repeating that the worker-bee deserves more; but in the end, a money guy and a worker-bee are going to come together at a split that works for both of them. And whatever that split is, isn't going to be "wrong." By definition, it's going to be the appropriate split, as both parties freely agreed to the deal.
I've seen situations where the money guy and the worker-bee agreed to a deal where the money guy gets 70% of the profits. Clearly that was a fair deal, because both sides agreed to it.
Likewise, I've seen LOTS of deals where the money guy provides debt instead of equity at a rate that ends up getting the worker-bee 70-80% of the profits. Again, clearly it was a fair deal, because both sides agreed to.
Additionally, I see plenty of deals where it's 50/50. The fact that those deals are being made says that it's fair to both sides.
These days, I'm finding that guys with lots of money want to give it to me at great rates/splits. That tells me that they are running out of opportunities to achieve higher returns. That tells me that we're somewhere different on the supply/demand curve than we were a couple years ago.
We can argue all day over what is the *right* split between money and worker, but ultimately, whatever you can negotiate is what's right for you and for the other guy at that particular time and for that particular deal. There's no one size fits all answer to this question.
Leave it to J Scott to actually make more sense than most of us here in this thread lol!