One partner with money, the other with credit...fairest split?

Question

Two partners are working on a deal for a small multifamily (under 5 units) and getting a standard mortgage.

One partner provides a bit more experience and about 3/4 of the capital.

The other partner is securing the loan with their credit.

The structure being contemplated:

-- The cash they each put in gets paid back with interest/return. (Big/key question is what the % should be)

-- After that cash is paid back, they own the property equally 50-50.

What would be a fair return for the cash provided up front? 8% like a preferred return? 12% like a hard money loan? Something else?

Other structure suggestions welcome too, but an answer to the interest rate / return question would be really valuable.

Curt Davis · Answer

Structure it like you stated but once he partner who gets the loan closes on the property, you then quit claim the property into an LLC that is  owned by both partners 50/50.

One thing, the experienced partner can not contribute any down payment funds to the partner who is getting the financing. That money from experienced partner would have to be put into other partners account to be seasoned for 2 statement periods in order for the lender to use it for the financing.

Good luck !!

Steve Sell · Answer

Hi @Jefferson Smith!  On the conventional side I've found the 2 months waiting period to be rather stringent.  If the loan partner has any other capital available they could pull that into their bank account for the loan and the funding partner could reimburse them right after the loan goes through.  For my first rental purchase I didn't know about the seasoning requirement and right when we were about to close they told me I was short on seasoned funds... the only way I could rectify that in time to close was to use the rollover provision for my Roth IRA.  I sold some equities; withdrew IRA funds to my bank account to clear the seasoned funds requirement, closed on the property, and then put the money back into my IRA.

I think an installment loan or HELOC would register as qualified funds as well, but you'd need to make sure opening debt won't skew DTI below requirements.  Heard a funny story once where some first-time buyer was at the tail end of a several month FHA purchase and had a surprise divorce... supposedly the realtor ended up "purchasing" his swing-set for $3,500 to get him over the bar for required funds, and had to supply the bank with a notarized letter of purchase so they wouldn't write the deposit off as an un-seasoned gift.  Something tells me that wouldn't fly these days though.

Another option is to find a commercial lender willing to fund the deal; the underwriting for those is a little more flexible in some areas.  Regarding interest rates, all of the options you've listed are very reasonable depending on the circumstance.  There isn't one right answer to that question--it will be a negotiation and is dependent on context and the relationship involved.  If the buyer has access to other sources of cheap capital, lender will probably have to be happy with the lower end of your range.  If the buyer really wants to close this particular deal and lender's funds are the only way that's going to happen; ask him for 12% and a point or two and see what he says.  If lender's experience is a rather integral part of the transaction and it's on-going operation it would make sense to have a premium over just a passive capital rate.  Hope those thoughts help some.

Jefferson Smith · Answer

Thanks so much,  @Curt Davis. Quick followups:

1) As far as percentage interest return for capital (as above), would you think 8%, 10% or 12% --or something else--would be fairest?

2) As far as getting downpayment funds to the partner getting the loan, is there any solution beyond waiting two statement periods (two months?) ?

Jefferson Smith · Answer

Really helpful, Steve, thanks.