Sweat/Capital partnership - how to structure a deal?

Question

Hey everyone!

I'm a rental property investor where we've used a standard 50/50 ownership and profit split with a capital partner on our last 3 properties. All rehabs. We are all the work, the investor is the capital. We put in 10% capital and the investor puts in 90%. This has worked out wonderfully for us.

I've had a few friends who have seen what we've done and want to start doing deals with us, but i'm unsure how to best structure it. They all want to do 50/50 capital split but I'm not sure if that's the best way given we may be doing a lot of the work? Here's the two scenarios we're in:

Scenario one:

3 people split all costs down the middle on a property. For the work... I'm going to be analyzing markets, finding the deal, setting up insurance, LLC, loan, realtor, handling title, ongoing maintenance management. The other party handling the rehab and furnishing. The third party... her work responsibilities TBD.

Scenario two:

2 people split all costs down the middle on a property out of state. She finds the property, I do "the work".

Looking for some advice on how some experts out there might recommend a deal structure and why, so it feels great for everyone!

Daniel Dietz · Answer

We do ours a little differently, as most of our purchases dont need much rehab... maybe carpet and paint and a days work tuning things up.

With that said, now that we are out of our own capital once we hit 25 units we are starting to partner with Private Money Partners (PMP). The PMP brings ALL of the down payment capital and reserves needed (about 23-25%). We do ALL of the finding (usually by cold calling/mailing), negotiations, securing financing, setting up LLC etc.... AND we do ALL of the ongoing PM and business management. We both sign on the loan also. A side note - if we are ever NOT able to perform PM, that fee would come out of OUR half of the profits, as that is OUR responsibility.

We split cash flow and long term equity gains 50-50. We form an LCC where we are 50-50 partners. This gives us EACH about a 9-15% return on the amount of capital originally invested. We make money from nothing but our expertise and a bit of time, and the PMP gets a GREAT return considering the level of risk with absolutely NO work on their part - no checking stock prices, rebalancing the portfolio etc....

We also have others that want to do this with us 'standing in line'. Now the problem is finding deals that fit our criteria.

Dan Dietz

Maggie D. · Answer

What's up Aaron, thanks for your response! I've actually found the exact opposite. Not rare at all. That 50/50 deal structure (sweat/capital) is pretty common and can be a more advantageous deal to the capital investor. They put zero energy in, and after the rehab they get their capital back in full and then get 50% equity and 50% profits on the property. Way better than the stock market or parking your dough in the bank.

I totally hear you though, for someone like you who is knowledgeable in real estate, knowing how to hire the right people to do the work etc, and has the time, I can see where that wouldn't make sense.

Laurent Palmatier · Answer

The 50/50 split with 90/10 capital sounds clean but the math underneath usually isn't.
Pin down what the sweat is actually worth per deal. 200 hours of GC + project management at $75/hr is $15k of sweat on a $200k deal.

A couple things to nail down before signing:

If the rehab takes 400 hours instead of 200, does the sweat partner earn more equity, or did they price the risk wrong upfront?

What's the deliverable that turns sweat into equity? Or even better, are you tracking each co-owners percent ownership, and converting sweat into equity at regular intervals?

My brother did a house hack a few years back. This lead to significant sweat from both of us, held it about a year, sold for $80k profit. We both walked away thinking the time and effort weren't worth it. Time is currency. Price the work right at the start, or resentment builds fast.

Maggie D. · Answer

@Daniel Dietz

Dan thank you for such a thoughtful response! I love hearing how other people are finding success for everyone involved implementing this strategy! We do EXACTLY what you do (minus the rehab part). The rehabbing portion of this equation has been lucrative for us since once we do a cash out refi, we get all our initial capital back, plus some, keep 20% in and then use the extra money for another property. Good luck with your new project!

Aaron K. · Answer

@Maggie Davis you've been incredibly lucky with finding someone to do a 90/ 10 capital partnership with a 50/50 profit split, that is incredibly rare. The reason is that it is almost never worth it for the person with the capital, it is almost always cheaper to hire the work done. Now that you appear to be more in that position of having capital where you are putting up at least 50% of the capital I'd be very skeptical about giving equity away without a capital contribution.

If I were to structure something like this I'd hire out most things and then split profits from there. For things that can't be hired out like actually analyzing properties etc. come up with some sort of hourly rate for each of you and split that way, it won't work if you don't trust each other, but if that were the case you shouldn't be in that partnership anyway.

Sweat/Capital partnership - how to structure a deal?

Sweat/Capital partnership - how to structure a deal?

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