Money Partner Deal Feedback

16 Replies

Ok so a co-worker and long time family friend of mine is also a successful commercial real estate investor in my area. When he learned about my plans to begin investing in real estate he wanted to get involved. I am 1.5 years out of college so I have about enough saved for a 3% down payment on an FHA Loan on an ok multifamily... i.e. not a lot of capital. We sat down after work yesterday to try to come up with a deal that works for both of us. What we came up with and what I am looking for feedback on is whether this sounds like a good deal and anything I need to consider that I may not have.

He wants to start an LLC with me 50/50 ownership. Problem is I don't have the capital to put the down payment down. So our solution is to have him put 100% of the down payment down into the LLC. 50% would be his down payment and 50% would be a loan (no interest) for my down payment. I would act as the live-in manager for the property for a gross rent fee of 10% - market rate paid by the LLC. That money (as well as surplus from my W2 job as an engineer) would be used to pay him back personally until I cover my half of the down payment. After that It would be as if I had the money today.

Budget is a bit all over the place. He stated he only cares about long term ROI on the property - mainly focusing on sustainable cash flow with the reasonable possibility of appreciation. So far we have looked at 150k-500k buildings and he said he would be willing to go up to $1M if it had a good ROI.

Location is Louisville, KY. 

This seems like an awesome deal for me considering I get a massive amount more leverage with him and this could be a jumping off point as well as being on the better end of the current value of money deal. I am planning on getting a contract agreement drafted by a lawyer before we purchase a property.

All constructive feedback is greatly appreciated.

@William Morgan interesting structure and props to both of you for coming up with it. Help me understand a little better, what type of properties are you looking at buying? The financing part of this and personal guarantees might need to be taken into account too. 

I would take this deal all day long.

Hey William,

This sounds like it could have the makings of a great partnership.  I like that you have known this person for years and that he has experience in real estate investing that he is bringing to the table along with the capital.  

In my opinion it is important to keep in mind that you are forming a partnership with the proposed LLC. Buy and hold real estate investing is a long term game and partnerships have a very very high failure rate. I would say most fail because they are never given the proper attention before formation. Putting a plan together "after work one day" and then moving quickly to purchasing real estate is a recipe for disaster. I see you are planning to put together a contract agreement with a lawyer, which is good, but that agreement needs to be preceded with some significant discussions between you and your potential partner.

My wife and I recently looked at partnering with another couple on some real estate investments and other business opportunities.  We found an extensive list of questions to go through together which was designed to help us all understand each other better.  Over three separate four hour meetings we finally discovered that there were some significant barriers to moving forward together.  This came out in the third meeting, which means we had over eight hours of focused discussions which were all leading to a green light for the partnership before we unearthed the deal breaker.  

As a starting point I would run through all kinds of "What if" scenarios. What if the property is vacant and the LLC needs to make the mortgage payment? What if one of you does something that causes a financial loss for the LLC...how is that handled. What if each partner has a very different idea of how to move forward in an area of the business? What happens if your 0% interest loan is not paid back on time? What if one partner is not meeting their obligation to perform designated tasks?

I would want to make sure I share the same values with any business partner.  Make sure you both have the same definition of integrity.  Clearly define responsibilities of each member in writing.  

I have several partners on various properties and think partnerships have the potential to make a bigger and better whole than the sum of the individual parts.  You just need to make sure you treat the formation of a partnership with the respect and attention it deserves.  

@William Morgan - welcome to BP and congrats on finding somebody to partner with right off the bat.  As @Joe Fairless pointed out, the financing may be a little tricky but if your prospective partner is already into commercial real estate then he should have some connections and be able to walk you through that end of the process. It will definitely have to be a commercial loan and you'll likely be looking at 80% LTV, 20 year amortization (5 year term) and 4.5-5.0% interest rate so keep that in mind when running numbers.

You'll definitely want to make sure the terms of this arrangement are clearly laid out and that there is a contingency plan in case something doesn't turn out as planned.  The piece that really stands out to me is how you plan to live in the building and collect 10% for management.  The only way this would make sense is if you're paying market rent for your apartment.

A couple things you will want to plan for and outline in the operating agreement are:

What if you move out of the property?
What if the property requires an outside PM (i.e. you can no longer manage or are not meeting expectations of the partner)?
When can the property be sold and who determines for how much?

This really sounds like a great opportunity for you, but it is worth it to lay a proper foundation up front so there are no disconnects between you and your partner/family friend.  It would be terrible to get 3 years into the deal and you decide you're ready for a house in the burbs only to find out his expectation is that you'll be an onsite manager for the next 20 years.

@Craig Jones - what was the revelation on day 3 of discussions that led you to figure out the partnership arrangement wouldn't work?

Thanks for the replies. To answer some of your questions:

@Joe Fairless

We are looking for small multifamily properties but not necessarily limited to 4 unit as he has done several commercial deals and is willing to guarantee it if it comes to that. 

@Craig Jones :  

I really appreciate your feedback and this is exactly what I came here looking for. I will admit that I oversimplified the process a bit. The conversation about a deal began on a buisness trip back in February and we have since discussed several scenarios of the partnership. To your point though: to date the discussions have revolved mainly around  how to structure the deal and what it is that we are looking for. I am fully on board with going through various"what-if" scenarios. An issue here is that being new to the industry, my imagination for possible scenarios leaves something to be desired (and hopefully something I can improve on in this forum). I have read several articles about this and probably the best one so far has been this one:  http://www.realestateinvestorlaw.com/Articles/arti...

Thank you for your listed "what if" scenarios, I will discuss these with him. If you wouldn't mind sending me or posting the list of questions you found that helped you find out that your partnership wouldn't work I would greatly appreciate it. Also like Michael I am curious as to what your deal breaker was. If you could elaborate a bit I feel that could be a big benefit for me.

@Michael Seeker

I would pay market rent for the apartment. If I move out I would still be the PM. If I don't want to be the PM or I am not doing a good job, we could hire a local firm. I would then still be responsible for paying the loan with my W2 income. The property can be sold if either of us wants out of the deal. If at that time the loan is not paid back, I would be responsible for the rest of the loan. We don't have terms drafted yet for who determines how much.

@Craig Jones

  2 married couples going in as partners is a very very tough thing to do...

As we know women and men see things completely different.. so now you have 4 separate opinions.... and man if your wife or your other partners wife decides they don't like something or what have you its a recipe for disaster. Not only is your business life rocked but you then get to come home and hear about it on the personal side.

My personal banker over here in Portland we have been doing business for going on our 23rd year.. and so that has led to some interesting conversations over the years.. and his number one issue with a problem loan is usually a partnership break up that is compounded by business where the spouse is also a principal.

Originally posted by @Jay Hinrichs :

@Craig Jones

  2 married couples going in as partners is a very very tough thing to do...

Yea I am not married but I have already had the conversation with my SO that we need to keep our investments separate... I have seen some of the bad results that can come from that.

Originally posted by @Jay Hinrichs :

@Craig Jones

  2 married couples going in as partners is a very very tough thing to do...

As we know women and men see things completely different.. so now you have 4 separate opinions.... and man if your wife or your other partners wife decides they don't like something or what have you its a recipe for disaster. Not only is your business life rocked but you then get to come home and hear about it on the personal side.

My personal banker over here in Portland we have been doing business for going on our 23rd year.. and so that has led to some interesting conversations over the years.. and his number one issue with a problem loan is usually a partnership break up that is compounded by business where the spouse is also a principal.

 Not only is it tough it is down right stupid!

@Michael Siekerka - The revelation on day 3 was that we found out the other couple was undergoing marriage counseling.  That was an immediate deal breaker for us.  It was actually quite shocking it didn't come up earlier.  

@William Morgan -  I'll track down the questions we used and send them to you.  They came from a mentor I work with so I don't know that he would want me posting his material on line, but I'm sure he would be fine with me sharing it individually.  

I'm happy to provide a copy to anyone else who would like them...just pm me and ask for a copy.  

@William Morgan I love the structure! I just offered on a 88 unit in Louisville, lost it to an all cash offer. I am tracking the deal because I think it might fall apart, would you guys have any interest in it?

Great feedback here from everyone! 

@William Morgan - I think a partnership can be an awesome opportunity for both sides. If you approach your partnership agreement and your subsequent interactions from the perspective of making money AND taking care of the relationship, I think that gives you the best chance of succeeding as a business and ensuring that everyone remains friends.

A few other scenarios to think through: make sure you decide up front what happens if you decide to split up the LLC, but you both want to keep the building. Who would get to buy it from the other person, and at what terms? Better to nail it down now than fight about it later. Also, let's say everything looks good when it's inspected, but there is an unexpected expense up front (like, say, a water pipe freezes this winter and you have to shell out a bunch of money to repair broken water pipe plus add more insulation etc). Who pays for that, your partner? In that case, is that money a capital contribution, or is it a loan? If a loan, in what order is that money paid back (as in, you pay him back the loan first, and then resume payments on your half of the down payment)? Finally, if for some reason something happens and you are forced to sell, in what order is the money paid out? What if there is not enough money to cover the mortgage AND the complete down payment from your partner and whatever you have paid in - who takes the loss? Again, I'm not saying this is likely but these are the kinds of things it is important to think about up front.

And, in addition to working through possible failure scenarios (very important), it's also key to make sure that you plan for success! For example, what if your partnership goes really well, and you decide you want to invest in another property? Would you use the terms in the operating agreement from your existing LLC, or would you plan to structure another one? Not saying you have to figure out the complete framework of another structure up front (that would be premature) - but would be good to think about whether or not this LLC is designed to cover one building, period, and anything else would be a separate conversation, or whether it's designed to expand.

Good luck and keep us posted!

"The revelation on day 3 was that we found out the other couple was undergoing marriage counseling. That was an immediate deal breaker for us. It was actually quite shocking it didn't come up earlier."

So that is a deal breaker??

I guess if they were having marital problems and had separated it would be one thing. You would just run through a what happens if they divorce scenario.

I looked at property owned by a lady the other day that was awarded property through the divorce decree she was selling.

I know lot's of people that go to counseling once a month and have done it for years. It has actually bettered their relationships immensely. They take the arguments and table it until the monthly session. This gives them time to have fun all month rather than having an issue hang around with no end in site and the frustration keeps building. They go talk to a neutral third party for an objective opinion. If someone has unresolved issues all the time then they have a constant problem relationship.

People tend to talk to family members about their troubles and that is usually the wrong solution. Those people are not objective and generally do not have the skills to offer solutions to the issues.

Some people should have never gotten married in the first place. There are lot's of people that have horrible relationships and just sweep things under the rug and put on a façade. So going to counseling for me wouldn't be a determining huge factor.

I guess my point is you could partner with someone business wise who seems perfect and then they get a divorce a week from now and you have no control over that and didn't see it coming.    

@Diane Bartley

Thanks so much for the feedback. These are definitely great suggestions. 

I see on your profile that you invest with a partner in my area. If you don't mind me asking how is that going?

@William Morgan - great question regarding our partnership - at this point we're 18 months in and going strong. We have several multi-family properties in Louisville that are doing well and generating positive cash flow, and are getting ready to acquire another one. 

In my experience a partnership can be an excellent way to combine complementary strengths in order to realize a shared vision. We've dealt with our share of unexpected issues, of course, but that hasn't slowed us down much, and I always enjoy jumping on the phone with my partner and talking through our plans. 

Property management is no joke. Perfect this art. It will make or break your side of the deal. So much to learn.  Come to the next Meetup organized by Brett or KRIEA meeting and I will give you some takeaways to consider.

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