How to structure a flipping partnership with a contractor?

Rehabbing & House Flipping
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How to structure a flipping partnership with a contractor?

Jake Moran
Rental Property Investor · Tallahassee, FL · Member since 2017 · 38 posts · 15 votes

I met a contractor who did some work on my personal house, and when found out he does a flip from time to time, we agreed to work together. The roles would be:

  • I would put in some cash and do all the work aside from the rehab
  • He would put in some cash and manage the rehab

I really like this setup because it gives me a contractor who is incentivized to get this thing done quickly and done well. But my big question is, how should the profits be split? He mentioned he usually does 75/25 in his favor, which might make sense since he's doing the heavy lifting in managing the rehab. But it would only makes sense if we had an equivalent amount invested, right? So if I put in $100k cash, and he put in $20k cash plus $80k in materials and labor (excluding any profit margin), then I think I'd be okay with giving him 75% of the net profit. But should I be? What else am I not thinking about here?

My other question is on the legal side: what is the best way to do this? He already has an LLC specifically for flipping, separate from his contracting business. Would it be better to buy the house directly through that LLC? Or buy the house under both my name and his LLC? Or create a new LLC where we are the two owners, and buy the house under that entity?

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Will BarnardPro Member
Moderator
Developer · Santa Clarita, CA · Member since 2008 · 15k+ posts · 10k+ votes
6y

There are 3 main portions to any flip project and they are not all equal.

1. Sourcing / negotiating the deal

2. Managing the deal

3 Funding the deal

You and any potential partner need to agree on which section is worth what %. I would rank 1&3 higher than 2. With that said, the contractor doing #2 is not worth much more than had you simply hired him on a fee basis rather than partnership.

Who finds your next deal? The division of the funding is the easiest part to figure out. If you both believe that the funding is worth say 40% of the total 100% and you each fund equal amounts, then that section would earn each of you a 20% share. Then add up your other two sections and see where you come out. 

I personally believe it is not worth partnering with a GC unless he/she is bringing deals and funding to the table.

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  • Greg Dickerson
    Developer · Charlottesville, VA · Member since 2018 · 4k+ posts · 4k+ votes
    6y
    Originally posted by @Jake Moran:

    I met a contractor who did some work on my personal house, and when found out he does a flip from time to time, we agreed to work together. The roles would be:

    • I would put in some cash and do all the work aside from the rehab
    • He would put in some cash and manage the rehab

    I really like this setup because it gives me a contractor who is incentivized to get this thing done quickly and done well. But my big question is, how should the profits be split? He mentioned he usually does 75/25 in his favor, which might make sense since he's doing the heavy lifting in managing the rehab. But it would only makes sense if we had an equivalent amount invested, right? So if I put in $100k cash, and he put in $20k cash plus $80k in materials and labor (excluding any profit margin), then I think I'd be okay with giving him 75% of the net profit. But should I be? What else am I not thinking about here?

    My other question is on the legal side: what is the best way to do this? He already has an LLC specifically for flipping, separate from his contracting business. Would it be better to buy the house directly through that LLC? Or buy the house under both my name and his LLC? Or create a new LLC where we are the two owners, and buy the house under that entity?

    The best bet would be to hire the contractor to do the work and not partner if you do not need to.

    If you want or need to partner then you need to agree on all the terms like you described above as well as very detailed and specific roles. The most fair structure is to value the cash contributions and the work that is performed by each partner and split the profits accordingly. Once you hammer out the terms and roles You need to run everything by an attorney and have them draft your partnership agreement. My suggestion would be for you to set up an LLC to be your operating entity and member of the newly formed LLC that will hold title to the property. The contractor's LLC can be the other member in the new property LLC.

    2Reply
  • Will BarnardPro Member
    Moderator
    Developer · Santa Clarita, CA · Member since 2008 · 15k+ posts · 10k+ votes
    6y

    There are 3 main portions to any flip project and they are not all equal.

    1. Sourcing / negotiating the deal

    2. Managing the deal

    3 Funding the deal

    You and any potential partner need to agree on which section is worth what %. I would rank 1&3 higher than 2. With that said, the contractor doing #2 is not worth much more than had you simply hired him on a fee basis rather than partnership.

    Who finds your next deal? The division of the funding is the easiest part to figure out. If you both believe that the funding is worth say 40% of the total 100% and you each fund equal amounts, then that section would earn each of you a 20% share. Then add up your other two sections and see where you come out. 

    I personally believe it is not worth partnering with a GC unless he/she is bringing deals and funding to the table.

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  • Jake Moran
    OP
    Rental Property Investor · Tallahassee, FL · Member since 2017 · 38 posts · 15 votes
    6y

    Thanks to both of you. This makes sense. I still plan to partner with him, primarily because he is in fact providing funding (both in cash to purchase the deal as well as deferred payment for the rehab work), but also because I still believe that this significantly increases his incentive to do the job fast and well. All I ever hear is how unreliable, slow, expensive, and/or dishonest most contractors are. The extra cost of partnering with him would seem to not outweigh the benefits.

    I've been trying to come up with a good formula that provides him a normal profit margin for the rehab work, plus a fair share of the profits for his investment. Would something like my outline below make sense? Hopefully you can follow what I'm doing but let me know if you need any explanation.

    Also, what is the typical profit margin that contractors tack on -- is there a norm, or is it all over the map?

    Possible structure:

    @Will Barnard I realize this doesn't account for the value of me sourcing and negotiating the deal. I need to think more about how to incorporate that...

    0Reply
  • Jake Moran
    OP
    Rental Property Investor · Tallahassee, FL · Member since 2017 · 38 posts · 15 votes
    6y

    @Greg Dickerson @Will Barnard

    Made some revisions. Anything I'm missing?

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  • Will BarnardPro Member
    Moderator
    Developer · Santa Clarita, CA · Member since 2008 · 15k+ posts · 10k+ votes
    6y

    Typical contractor profit and overhead charges are 20% of total invoices work. There also could be on site project management fees, document fees, and project insurance costs on top of that or included in that. Using 20% in this situation would be fair and possibly 15%-18% since the added profits will come from partnership.

    As far as resale costs, not sure about your area but for a $500k plus value property, the real estate fees should be no more than 5% and the closing costs should be around 1.25-1.5%.

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  • Ben C.
    Metuchen, NJ · Member since 2015 · 374 posts · 27 votes
    5y

    @Will Barnard where do you value the contractor doing the work for his cost in this equation?

    In my area that’s around 30% profit chopped off the rehab. This opens up ALOT more possible deals in northern NJ. On a 300k rehab that saves 90k. Therefore I can make the numbers work more often and makes more potential projects viable vs factoring in GC profit (as is normally done).

    Look forward to your thoughts.

    0Reply
    • Will BarnardPro Member
      Moderator
      Developer · Santa Clarita, CA · Member since 2008 · 15k+ posts · 10k+ votes
      5y
      Originally posted by @Ben C.:

      @Will Barnard where do you value the contractor doing the work for his cost in this equation?

      In my area that’s around 30% profit chopped off the rehab. This opens up ALOT more possible deals in northern NJ. On a 300k rehab that saves 90k. Therefore I can make the numbers work more often and makes more potential projects viable vs factoring in GC profit (as is normally done).

      Look forward to your thoughts.

      Like I mentioned before, the contractor expects to have around a 20% spread so if he actually did the job for you at actual cost of labor and materials, then you are only saving that 20% number and as such, it’s only worth about that p,us the cost of the money. I don’t recommend partnering with a GC unless he/she is brining much more than just the labor/materials to the table at cost. 

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  • Ben C.
    Metuchen, NJ · Member since 2015 · 374 posts · 27 votes
    5y

    @Jake Moran how did the project end up? What were the final investments and % payouts to you and your contractor?

    0Reply
  • Steven Goldman
    Lender · PA · Member since 2019 · 535 posts · 461 votes
    5y

    First, I would create a new LLC with the shares corresponding to the partnership interest. As or the division of the LLC ownership. If you are going to put up the lions share of the money and also be a guarantor than the split is unfair in my opinion. If the contractor is charging a fee for his services such as a typical 20 percent surcharge on the job than the split should be 50/50. He is already getting the benefit of the work and the split should be based on the liabilities not the labor. As his labor is already being paid! The hardest part of the job is finding a property which will make the project worthwhile. Are you doing that? Than you have the biggest chip in the game. Good luck!

    0Reply
  • Bruce WoodruffPro Member
    Contractor/Investor/Consultant · San Diego / Phoenix · Member since 2021 · 12k+ posts · 15k+ votes
    5y
    Originally posted by @Jake Moran:

    All I ever hear is how unreliable, slow, expensive, and/or dishonest most contractors are. 

    Also, what is the typical profit margin that contractors tack on -- is there a norm, or is it all over the map?

    Where did you hear the first statement? True there are bad GCs out there, but in my world they were the exception. The customer is almost ALWAYS responsible for cost and schedule overruns.

    Most GCs want to make 20% - 10% overhead/10% profit (generally speaking) What most people don't know/understand is that in order to get a 20% margin (ratio of profit) you need to add a 25% markup. So I used to add 25% to a sub or material price. If a customer didn't understand this, I just hid it elsewhere, but I always got it.

    0Reply
  • Ben C.
    Metuchen, NJ · Member since 2015 · 374 posts · 27 votes
    5y

    @Will Barnard what if contractor brought you the labor and material at cost and is throwing in 300k of cash into the deal (on a 700-1M deal)

    0Reply
  • Jason Cacioppo
    Real Estate Agent · Commerce CIty, CO · Member since 2018 · 127 posts · 78 votes
    5y

    I don't think this would end well, he's getting way too much. You're better off slowing learning rehab yourself and contracting out each portion to people who are ready and willing to complete the project.

    0Reply
  • Will BarnardPro Member
    Moderator
    Developer · Santa Clarita, CA · Member since 2008 · 15k+ posts · 10k+ votes
    5y
    Originally posted by @Ben C.:

    @Will Barnard what if contractor brought you the labor and material at cost and is throwing in 300k of cash into the deal (on a 700-1M deal)

     How can you be certain you are getting labor and materials at cost? if you have no experience, it is very easy for any contractor to inflate costs and state it was his cost. Secondly, the $300k capital towards the purchase is certainly something and should be accounted for in your split. To know exactly how much of a % of ownership in equity the contractor should get for that, I/we would need to know what the total capital raise is, i.e. purchase price, closing costs, holding costs, rehab/construction costs, etc.

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  • Ben C.
    Metuchen, NJ · Member since 2015 · 374 posts · 27 votes
    5y

    @Will Barnard I will message you. Thanks!

    0Reply
  • Will BarnardPro Member
    Moderator
    Developer · Santa Clarita, CA · Member since 2008 · 15k+ posts · 10k+ votes
    5y
    Originally posted by @Ben C.:

    @Will Barnard I will message you. Thanks!

     Why not post here for the benefit of all to see the numbers and evaluate? It would likely be better for you and for all.

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  • Ben C.
    Metuchen, NJ · Member since 2015 · 374 posts · 27 votes
    5y

    @Will Barnard a typical deal would be…

    500k purchase price

    300-350k Reno (210-250k if at his cost)

    Holding 75k

    ARV 1.2M

    Wondering if makes sense for him to do at cost plus inject 300k cash into deal. I could get that 300k at around 9-10% plus 1-1.5 points

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  • Will BarnardPro Member
    Moderator
    Developer · Santa Clarita, CA · Member since 2008 · 15k+ posts · 10k+ votes
    5y

    Debt financing is almost always cheaper then giving equity, so that is the overhead reply to you on that. The real question is, what would the contractor accept in equity for his $300k in cash and how do you control the cost situation of the purported labor and materials at cost provided by contractor. This is where I personal would say it is better to pay the contractor the fee (not at cost) and only take the $300k as his equity position. SO if acquisition plus rehab is $850k and he is putting up $300k, how you will need to come to terms on how much equity is fair for both sides. I suggest running an excel spreadsheet to compare potential examples. It really comes down to the numbers here.

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  • Ben C.
    Metuchen, NJ · Member since 2015 · 374 posts · 27 votes
    5y
    Originally posted by @Will Barnard:

    Debt financing is almost always cheaper then giving equity, so that is the overhead reply to you on that. The real question is, what would the contractor accept in equity for his $300k in cash and how do you control the cost situation of the purported labor and materials at cost provided by contractor. This is where I personal would say it is better to pay the contractor the fee (not at cost) and only take the $300k as his equity position. SO if acquisition plus rehab is $850k and he is putting up $300k, how you will need to come to terms on how much equity is fair for both sides. I suggest running an excel spreadsheet to compare potential examples. It really comes down to the numbers here.

    Thanks Will. Seems like to be honest it is simpler to just pay him his regular fee and get the 300k from my lender instead to keep it nice and simple. I imagine it is a real pain the behind come tax time as well if you are giving up equity. 

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  • Will BarnardPro Member
    Moderator
    Developer · Santa Clarita, CA · Member since 2008 · 15k+ posts · 10k+ votes
    5y
    Originally posted by @Ben C.:
    Originally posted by @Will Barnard:

    Debt financing is almost always cheaper then giving equity, so that is the overhead reply to you on that. The real question is, what would the contractor accept in equity for his $300k in cash and how do you control the cost situation of the purported labor and materials at cost provided by contractor. This is where I personal would say it is better to pay the contractor the fee (not at cost) and only take the $300k as his equity position. SO if acquisition plus rehab is $850k and he is putting up $300k, how you will need to come to terms on how much equity is fair for both sides. I suggest running an excel spreadsheet to compare potential examples. It really comes down to the numbers here.

    Thanks Will. Seems like to be honest it is simpler to just pay him his regular fee and get the 300k from my lender instead to keep it nice and simple. I imagine it is a real pain the behind come tax time as well if you are giving up equity. 

    Nail on head!

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  • Ben C.
    Metuchen, NJ · Member since 2015 · 374 posts · 27 votes
    5y

    @Will Barnard my last question I know a lot of development deals have 2/3 partners curious what the most generic way these are structured. Any insight? Assuming they maybe just deal with the tax pain.

    Thanks a ton for all your knowledge you share and best of luck.

    0Reply
  • Will BarnardPro Member
    Moderator
    Developer · Santa Clarita, CA · Member since 2008 · 15k+ posts · 10k+ votes
    5y
    Originally posted by @Ben C.:

    @Will Barnard my last question I know a lot of development deals have 2/3 partners curious what the most generic way these are structured. Any insight? Assuming they maybe just deal with the tax pain.

    Thanks a ton for all your knowledge you share and best of luck.

    I cant speak to all partnership structures as there are many options, however, many can be set up easily using an LLC with managing partners and limited partners. The managing partners making the daily operational decisions and the limited partners typically having no say so, only funding the deal.

    If the 2 or 3 partners are equal (or at minimum, all have operational input status, then a simple LLC with an operating agreement (herein after "OA") outlining each party's duties and responsibilities, as well as the OA stating the precise amount of each partner's financial contribution and associated shares of the entity. It is always recommended to have an attorney draft this OA to ensure all bases are covered and the OA should also include all the what if's like if investor A dies, what happens, if investor B needs out, what happens and what is the process. The OA is very, very important to get right. After that, it is a consult with your tax advisor to ensure you form the proper entity for your purposes.

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  • Debra Webb
    Member since 2022 · 8 posts · 3 votes
    3y
    Quote from @Will Barnard:

    There are 3 main portions to any flip project and they are not all equal.

    1. Sourcing / negotiating the deal

    2. Managing the deal

    3 Funding the deal

    You and any potential partner need to agree on which section is worth what %. I would rank 1&3 higher than 2. With that said, the contractor doing #2 is not worth much more than had you simply hired him on a fee basis rather than partnership.

    Who finds your next deal? The division of the funding is the easiest part to figure out. If you both believe that the funding is worth say 40% of the total 100% and you each fund equal amounts, then that section would earn each of you a 20% share. Then add up your other two sections and see where you come out. 

    I personally believe it is not worth partnering with a GC unless he/she is bringing deals and funding to the table.


    0Reply
  • Debra Webb
    Member since 2022 · 8 posts · 3 votes
    3y

    This is very interesting to me. I'm actually considering partnering up with a contractor that did work on a buddy of mine fix and flip. My situation is I have no capital, so I'm looking for someone to invest the downpayment, closing cost, holding cost, taxes, materials and insurance (did I miss anything?) It will go under my llc, I will be using a HML, so what I'm thinking is give him 10% return on his money once the home is sold. He is already going to get paid for the work that he does as a contractor. Does this make sense?

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  • Will BarnardPro Member
    Moderator
    Developer · Santa Clarita, CA · Member since 2008 · 15k+ posts · 10k+ votes
    3y
    Quote from @Debra Webb:

    This is very interesting to me. I'm actually considering partnering up with a contractor that did work on a buddy of mine fix and flip. My situation is I have no capital, so I'm looking for someone to invest the downpayment, closing cost, holding cost, taxes, materials and insurance (did I miss anything?) It will go under my llc, I will be using a HML, so what I'm thinking is give him 10% return on his money once the home is sold. He is already going to get paid for the work that he does as a contractor. Does this make sense?


    In your scenario, I would structure that as debt and not a partnership. If you intend to pay 10% of money the contractor invests in your project, then simply do a 2nd trust deed (behind the purchase loan) at 10% for the term you both agree to with a balloon payment rider (this is for no payments during loan but one lump sum balloon payment at sale or end of term, whichever comes first). You should also consult your CPA/Tax advisor to ensure that your flip is best suited in an LLC or another entity. Generally speaking, flips work best using an S-corp for a number of reasons. This is not legal or tax advice, just general experience/knowledge. Consult your CPA.

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