Accounting NERDS! Help! :)

11 Replies

I mean the nerd term affectionately. I say it with pure humor and respect for math way over my head. Help with the below...

The idea of someone investing in my property investing came up. Although in this case it is a relative, let's not focus there because it will be a business relationship. They don't want to become investors like us weirdo's on BiggerPockets, but I think they want to try to dip their toes in and see if anything bites their feet off.

Hypothetical scenario, please comment freely.

Someone offers to invest in a BRRRR that I have lined up. They give 5K which is 10% of of the 50K house I buy with cash. So (sorry for the Kindergarten math) they're in for 5K and I'm in for 45K. Investor puts a lien on my title.

We do 15K in reno that I pay for.

We get a tenant, paying 1K a month rent. I'll use round numbers to make the math easier for me.

We can refinance at 6 months, for 75% of the ARV.

ARV is 125,000. Yeah I know fantasy land, keep reading.

Cash out REFI is 93,750

I get my 45K back because I said so.

Dude get's his 5K back.
I get my 15K in reno costs back.

I realize I haven't discussed operating costs while unoccupied, just consider that in the reno costs.

That leaves 28,750 on the table.

Investor get's 10% of that right? So, 2875?

He/she also gets 10% of the monthly profit. So if the rent is 1K, and the note is 650, he/she gets 10% of the 350 profit (I know I forgot vacancy, CAPEX, etc assume that's in the 650) which is 35 a month.

What is the value of this investors interest? Is that the right term?

If I want to buy him out????

Is it 10% of the appraised value to buy out their interest?

On month 1, there's 31,250 in equity fair market, do I just buy out ten percent of that part?

The part that really made me cringe, what if after five years (est) they want to be bought out. Accounting practices say the value of an item is its value at purchase until you are selling. So dude or dudette wants me to buy them out, do I use the purchase price?

Make them pay for a current inspection, and then use that price?

Make them pay for a current inspection, and then offer them less than their share of the current value in an attempt to negotiate the best value for myself?

Clearly the person initiating the buy out is paying for the inspection...IMO.

Educate me oh accounting nerds. :P

Am I way wrong here?

Now that I've written all of that. It's a relative, well an In-Law for me, who wants in...they have nothing...this would be like, be their shot out of minimum wage forever kind of stuff. The catch is that they'd have little to no say at the beginning. The idea is that, my wife can throw her little brother a bone, without....hmmm....putting us at risk.

Discuss...I'm looking for all the differing strategies here, but please understand that there won't be any family favors going...it's business.

Thanks team!

Account Closed

So I'm not very educated/experienced here, which may be a good thing in this case, but why not just ask him to loan you the 5K? 

Offer him 10% interest, you pay him the interest only and then balloon him back his 5K when you refi? 
In that case his $5K is earning him $50/month for 6 months and then he gets his $5K back, he earned $250 or 5% in 6 months on his $5K, that's better than anywhere else he could have put that money. 

If you want to be more generous offer him and even better rate. Just know that during that period you'll have to account for that $ as an extra expense coming out of your cash flow. 

Solid idea @Derek Tellier hadn't thought of that one.

I think the original intent, since I don't really need his 5K is to let him get into this gracefully. But also, my wife and I floated the idea to let our children slowly buy their way in as they grow into teens and young adults.

The IRS says I can only gift my children so much money, and I don't really want to gift them anything. I would however, like for them to get into this so they can see the benefit of real estate and an entrepreneurial thought process. I think if they invested their babysitting and lawn mowing money, and could watch it grow....they'd be more motivated.

It's all theory, just trying to understand the accounting practices is all.... 

KISS Your scenario is way to complicated. Maybe they put money in after all is said and done. If they put 5% ARV, then they get 5% monthly profit. Buying out would be the others partners percentage of the market value at the time.

Account Closed
I'm guessing the 5% in 6 months would make him feel good enough to look bigger for the next one. Don't over complicate such a small investment on his part. 
When he gets his 5K back ask if he wants to go a lot bigger on the next one then you can look deeper into it. 

Really yall can work out whatever you want as his interest, it doesn't have to be equal to his dollars put into the deal. But if he's at 10% interest, and doesn't contribute to the 15k renovation, he should be at 5k/65k or 7.7 aka ~8% interest.

I don't think $5k rates ownership interest. I'd give them a percentage return on their investment so they can see a favorable ROO and move on. This is your brother-in-law's first investment so definitely agree with keeping it simple. Separately, I highly recommend reading Tax Strategies for the Savvy Real Estate Investor. It'll help you get your kids involved now and save you money. 

You can make this way simpler by just making it a loan. If you’re doing single family homes don’t give an investor equity. Make it a loan.

The easiest way to do this is for the rehab or a loan for a certain part of ARV. I get something for 50k and the ARV is 125k. The rehab is 15k. Most private lenders will lend to 65 or 70 percent ARV. So if it’s 70 percent Thad 87.5k meaning my entire acquisition and rehab is covered. Now obviously this is unlikely in today’s market but that’s how it would work.

As the private lender I’d charge 2-3 points and 10 percent interest, amortize over say 20 years and balloon payment at 1 year.

Put the mortgage on record and away you go

It seems this is not an acounting question. It is a negotiating question. You have to decide what works for you given the risk. Once you decide what works for you in terms of what you can offer, then an acountant may be able to tell you a better way to structure it.

I agree with @Ned Carey . This isn't an accounting question, this is a general business valuation question. To determine the "value" of the family members interest you will need to look at the perpetual monthly income as much as the price of the property as a whole. There may also be non-monetary factors to consider, such as the family members expected rate of appreciation for the property and tax considerations. 

Originally posted by Account Closed:

I mean the nerd term affectionately. I say it with pure humor and respect for math way over my head. Help with the below...

The idea of someone investing in my property investing came up. Although in this case it is a relative, let's not focus there because it will be a business relationship. They don't want to become investors like us weirdo's on BiggerPockets, but I think they want to try to dip their toes in and see if anything bites their feet off.

Hypothetical scenario, please comment freely.

Someone offers to invest in a BRRRR that I have lined up. They give 5K which is 10% of of the 50K house I buy with cash. So (sorry for the Kindergarten math) they're in for 5K and I'm in for 45K. Investor puts a lien on my title.

We do 15K in reno that I pay for.

We get a tenant, paying 1K a month rent. I'll use round numbers to make the math easier for me.

We can refinance at 6 months, for 75% of the ARV.

ARV is 125,000. Yeah I know fantasy land, keep reading.

Cash out REFI is 93,750

I get my 45K back because I said so.

Dude get's his 5K back.
I get my 15K in reno costs back.

I realize I haven't discussed operating costs while unoccupied, just consider that in the reno costs.

That leaves 28,750 on the table.

Investor get's 10% of that right? So, 2875?

He/she also gets 10% of the monthly profit. So if the rent is 1K, and the note is 650, he/she gets 10% of the 350 profit (I know I forgot vacancy, CAPEX, etc assume that's in the 650) which is 35 a month.

What is the value of this investors interest? Is that the right term?

If I want to buy him out????

Is it 10% of the appraised value to buy out their interest?

On month 1, there's 31,250 in equity fair market, do I just buy out ten percent of that part?

The part that really made me cringe, what if after five years (est) they want to be bought out. Accounting practices say the value of an item is its value at purchase until you are selling. So dude or dudette wants me to buy them out, do I use the purchase price?

Make them pay for a current inspection, and then use that price?

Make them pay for a current inspection, and then offer them less than their share of the current value in an attempt to negotiate the best value for myself?

Clearly the person initiating the buy out is paying for the inspection...IMO.

Educate me oh accounting nerds. :P

Am I way wrong here?

Now that I've written all of that. It's a relative, well an In-Law for me, who wants in...they have nothing...this would be like, be their shot out of minimum wage forever kind of stuff. The catch is that they'd have little to no say at the beginning. The idea is that, my wife can throw her little brother a bone, without....hmmm....putting us at risk.

Discuss...I'm looking for all the differing strategies here, but please understand that there won't be any family favors going...it's business.

Thanks team!

 Just on principle, I have an issue with a 5k lien.  Next, you have to be compensated for the renovation cost, all holding and closing expenses.  After you knock that off then the 10% distribution would be more than fair.

All very good answers, thank you all.

Tax Strategies for the Savvy Real Estate Investor....my wife's a CPA she can read that. JK, I'll pick it up.