Partner wants me to pay him future (potential) profits

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Partner wants me to pay him future (potential) profits

Austin Smith
Rental Property Investor · Mason, MI · Member since 2018 · 11 posts · 1 vote

Hello. My partner and I are both starting out and bought a SFR to buy-and-hold. We made the mistake of getting absolutely nothing in writing. He was unable to qualify for the loan, so I took on the mortgage. Two months post-closing, I need to buy him out as I'd rather not attempt to quit claim to an LLC and put the time into documenting a structured partnership with an attorney.

These are his three demands:

1) his DP amount, plus the other expenses he has covered

2) Two years worth of would-be income

3) A share of the appreciation that has accrued since closing (two months)

I don’t have any problem with #1 above. But I want to know what you think of #2 and #3.

Purchased two months ago at $140,000 but it’s probably worth $170,000 now.

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Russell BrazilBusiness Member
Moderator
Real Estate Agent · Washington, D.C. · Member since 2012 · 17k+ posts · 30k+ votes
6y
Originally posted by @Austin Smith:

@Russell Brazil roof, gutters, flooring, cosmetics.

Next door neighbor is a decent comp and just appraised last month at $178,000.

Youll need to apply a discount rate to whatever appreciation you value, because if you were to simply sell the property, there are costs involved.

So Id figure some calculation like

Current Value $170,000

-potential closing costs of 8% ($13,600)

- rehab costs (Im making up a number here, but Ill say $10k)

- Purchase closing costs ($4200)

-purchase price ($140,000_)

= Current extra created equity. That leaves in my opinion $2200 in created equity (if the rehab was $10k).

So Id give him back his down payment, his share of rehab costs and $1100.

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  • Wayne Brooks
    Real Estate Professional · West Palm Beach, FL · Member since 2012 · 23k+ posts · 13k+ votes
    6y

    1&3 are straight up legit....#2, not so much.  But, you are the one wanting to change the game, so.....

    1Reply
  • Russell BrazilBusiness Member
    Moderator
    Real Estate Agent · Washington, D.C. · Member since 2012 · 17k+ posts · 30k+ votes
    6y

    How did it appreciate 21% in 60 days?

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  • Austin Smith
    OP
    Rental Property Investor · Mason, MI · Member since 2018 · 11 posts · 1 vote
    6y

    @Wayne Brooks say I wanted to pay him his share of the appreciation. How could that value be quantified?

    Since I’m not selling; just buying him out.

    0Reply
  • Austin Smith
    OP
    Rental Property Investor · Mason, MI · Member since 2018 · 11 posts · 1 vote
    6y

    @Russell Brazil roof, gutters, flooring, cosmetics.

    Next door neighbor is a decent comp and just appraised last month at $178,000.

    0Reply
  • Theresa HarrisPro Member
    Member since 2019 · 15k+ posts · 11k+ votes
    6y

    I'd do the first, not the second and for the third-why did it increase so much?  If it went up because you did major renos, take that money out of the equation.  So if you bought it for $140K, put in $20K and it is worth $170K now, after you put $20K in, it is worth another $10K-split 50:50, that is $5K for him.

    2Reply
  • Russell BrazilBusiness Member
    Moderator
    Real Estate Agent · Washington, D.C. · Member since 2012 · 17k+ posts · 30k+ votes
    6y
    Originally posted by @Austin Smith:

    @Russell Brazil roof, gutters, flooring, cosmetics.

    Next door neighbor is a decent comp and just appraised last month at $178,000.

    Youll need to apply a discount rate to whatever appreciation you value, because if you were to simply sell the property, there are costs involved.

    So Id figure some calculation like

    Current Value $170,000

    -potential closing costs of 8% ($13,600)

    - rehab costs (Im making up a number here, but Ill say $10k)

    - Purchase closing costs ($4200)

    -purchase price ($140,000_)

    = Current extra created equity. That leaves in my opinion $2200 in created equity (if the rehab was $10k).

    So Id give him back his down payment, his share of rehab costs and $1100.

    [email protected]301-893-4635Podcast Guest on Show #192
    District Invest Group545 Reviews
    WebsiteView Page
    14Reply
  • Austin Smith
    OP
    Rental Property Investor · Mason, MI · Member since 2018 · 11 posts · 1 vote
    6y

    @Russell Brazil so we’re essentially evaluating what a hypothetical sale would be today? That makes a lot of sense. I hold all the cards and leverage, but I want to be as fair and equitable as possible. You have helped me accomplish that, which I appreciate. Thank you.

    1Reply
  • Brian G.
    Rental Property Investor · Los Angeles, CA · Member since 2013 · 1k+ posts · 1k+ votes
    6y

    @Austin Smith I agree with @Wayne Brooks and why is your partner making demands? This is likely a sign that this partnership has something faulty in the foundation besides not having things in writing.

    0Reply
  • Account Closed
    Specialist · OverTheRainbow · Member since 2020 · 607 posts · 909 votes
    6y
    Originally posted by @Austin Smith:

    Hello. My partner and I are both starting out and bought a SFR to buy-and-hold. We made the mistake of getting absolutely nothing in writing. He was unable to qualify for the loan, so I took on the mortgage. Two months post-closing, I need to buy him out as I'd rather not attempt to quit claim to an LLC and put the time into documenting a structured partnership with an attorney.

    These are his three demands:

    1) his DP amount, plus the other expenses he has covered

    2) Two years worth of would-be income

    3) A share of the appreciation that has accrued since closing (two months)

    I don’t have any problem with #1 above. But I want to know what you think of #2 and #3.

    Purchased two months ago at $140,000 but it’s probably worth $170,000 now.

    In some jurisdictions, verbal agreements are legally binding. I think I'd have coffee (or a beer) and together write down what you agreed to in the beginning. Then, make adjustments. Otherwise a lot of detail gets lost in all of the "where to's and what for's" and serious misunderstandings make attorneys rich. It would be better to sell the property and split the profits than lose a partner and friend. And next time, write out a well written agreement that both of you have a copy of and have the appropriate contingencies. Lawsuits and hard feelings last for years and you will long regret making a boneheaded mistake. Nothing personal, mind you.

    2Reply
  • Danny Webber
    Real Estate Broker · Austin, TX · Member since 2016 · 834 posts · 449 votes
    6y

    Get an appraisal, potential future value should be valued on present terms. it is always discounted.

    i would think of appreciation minus cost of sale/closing/inspection/repairs not in absolute terms

    1Reply
  • Anthony Dadlani
    Investor · New York City, NY · Member since 2013 · 1k+ posts · 269 votes
    6y

    @Austin Smith

    a suggestion : maybe negotiate to meet somewhere in the middle. That way you both can move on. 

    Best of luck in all your endeavors.  

    1Reply
  • Dennis Cosgrave
    Rental Property Investor · Member since 2019 · 304 posts · 462 votes
    6y

    There is an old saying; An agreement is not worth the paper it is NOT written on. Hopefully, you learned a valuable lesson from this experience and it is good it happened when you are just starting out. Always get everything in writing, even if you partner is your life-long best friend. People have short memories and will often forget things. A written agreement provides a written record of what was actually agreed to and the signatures verify that written record. $100 spent on an attorney today saves you thousands down the road. 

    1Reply
  • Joe SplitrockPro Member
    Moderator
    Rental Property Investor · Sioux Falls, SD · Member since 2015 · 9k+ posts · 18k+ votes
    6y

    Give him three options. You may choose to change these options a little bit, but the point is you are giving him choice. Most likely offer 1 will look best, which is the intent:

    1. Offer him the buy out price and show him the math as @Russell Brazil calculated it. Benefit to him is he can take his cash and reinvest.

    2. Offer to sell it on the open market, after selling expenses and sales concessions, you are both going to get less money. This may not be your preferred option, but it is better than overpaying to buy him out.

    3. Offer to hold the property and keep him as a silent partner. Ultimately the property is in your name as is the financing. At this point he is just a cash investor, not a lien holder or title holder. You have no legal requirement to deed anything to him. At best he could cloud the title for the amount he has invested.

    2Reply
  • Dominique Pradel-Lewis
    Investor · Pittsburgh PA · Member since 2018 · 102 posts · 76 votes
    6y

    I hope there are no bad feelings in the end because it sounds like you used him to get the property and now that you have what you wanted you are ready to dump him.  Discuss and agree to some terms that are fair to both of you and make better choices next time.

    2Reply
  • Joe Cassandra
    Rental Property Investor · Woodstock, GA · Member since 2017 · 517 posts · 772 votes
    6y

    I like @Joe Splitrock #2 idea. 

    If this is getting messy, just sell it, split the proceeds and start over. 

    I agree with the others that #2 (2 years of future income) is BS. 

    When I sell a dividend stock, the company doesn't give me 2 years of future dividends. No one does this. 

    You're the one having to deal with the tenants for 24 months...not them...

    1Reply
  • Steve Morris
    Real Estate Broker · Portland, OR · Member since 2019 · 4k+ posts · 2k+ votes
    6y

    Think item 2) is BS.  What if you don't make a profit or have a fire and/or vacancies?

    Item 3) you'll probably need a 3rd party appraisal, maybe a BOV is you both can find a broker you think is neutral.

    You learned the lesson - Contracts involving money MUST be written.  I've explained 100 times (well, almost), it's not because you don't trust the other parties, it's because everyone hears the same terms differently.

    2Reply
  • Connor Bell
    Real Estate Investor · Washington, DC · Member since 2014 · 37 posts · 10 votes
    6y

    @Austin Smith - Here are the options I would consider:

    1) Don't buy him out. Why do you need to buy him out? Assuming this is a close friend, I would come up with a written agreement (nothing fancy) based on the deal the two of you thought you were getting into. However, if you do that, you do need to structure a promote or something for you for guaranteeing/originating the debt. You two got a deal done together, I would try to keep the relationship intact. 

    2) Sell the property and distribute the profits based on each others pro-rata share of invested capital. Obviously the cleanest way but probably not much of an ROI on time/capital involved.

    3) Offer a return of capital plus his share of what the profits would be today if you sold the deal (after selling costs) and maybe the net present value (at a fair discount rate) of projected cash flow/appreciation for the first year or two. Not a common practice in my experience but he deserves more than the profits today if he took the risk with you and you're the one that wants him out. If he wants out, that's a different story. 

    Hope this helps!

    1Reply
  • Michael Barnhart
    Rental Property Investor · Cambridge, UK · Member since 2020 · 203 posts · 95 votes
    6y

    #1 I could accept

    #2 perhaps get some legal advice

    #3 is there a current appraisal showing the appreciation? If not, have him pay for the appraisal and then agree to a fraction of what you think he deserves.

    0Reply
  • Jordan MoorheadBusiness Member
    Real Estate Agent · Austin, TX · Member since 2015 · 5k+ posts · 3k+ votes
    6y

    No. #1 is fair. You don't have anything in writing which is a huge mistake. Give him a $1000 extra to be nice.

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    0Reply
  • Justin V.
    Rental Property Investor · Minneapolis, MN · Member since 2016 · 214 posts · 132 votes
    6y

    @Austin Smith

    How much sweat equity time and effort do you each have in? Value of each of your time should be accounted for. as an example, In my experience, a kitchen Reno is cheap to diy but takes many hours, expensive to hire done but takes less effort, can really increase demanded rent, but doesn’t come close to raising value enough to hire out.

    You do sound like you might be the bad guy in this... you didn’t use him to renovate a rental property and are now trying to cut him out, are you? If something like this were happening to me, I’d want more money for my time than the increase in appraised value especially when Renovations go over budget or time, but will be ok in the long term due to cashflow.

    Why can’t you keep it in your name and keep the partnership?

    The proper time to cut, would have been before you bought once discovered he wasn’t lendable.

    Once you both sell, you’ll both lose the same amount or gain the same amount. this likely won’t fix the friendship, and it sucks... been there. If you manage to save the friendship, please tell me what it took.

    2Reply
  • Zac Boelkow
    Port Richey, FL · Member since 2016 · 129 posts · 48 votes
    6y

    @Austin Smith if he is your partner and you are going to stay partners then this scenario does not make sense. Together you and your partner need to come to a solution. I would go back to your partner and talk/negotiate your way through this.

    1Reply
  • Max T.
    Investor · Philadelphia, PA · Member since 2015 · 3k+ posts · 3k+ votes
    6y

    @Austin Smith

    (Appraised value - (purchase price+closing costs)) / 2

    0Reply
  • Brian Hamel
    Nashua, NH · Member since 2017 · 66 posts · 58 votes
    6y

    @Austin Smith

    Sell, split and buy alone.

    1Reply
  • Robert Beardsley
    Member since 2020 · 117 posts · 84 votes
    6y

    this sounds very sketchy on your part once you read the content. title makes it seem like he is in the wrong. Like others have said looks like you used him for the downpayment then got lazy and didnt want to do the process to put it in the LLC. bad business if you ask me.

    1Reply
  • Nic S.Pro Member
    Danville. CA · Member since 2017 · 313 posts · 221 votes
    6y

    @Austin Smith why do you need to buy him out? This will help me with advice for you...

    0Reply
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