How to Best Structure a Partnership for Investing in Rental Properties

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Disclaimer: I am not a legal or tax professional, and all matters of real estate partnering should go through either legal or tax professionals (or both) before being implemented.

I hear the question quite a bit: How can a partnership be structured for investing in rental properties? I assume I get this question a lot because if you’ve read many of my articles, you know that I have used an investment partner for a lot of my properties. So I figure, why not just tell you exactly how my partner and I are structured so if you are thinking about doing it for yourself you have a little more clarity on how it can work?

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A Starting Point for Structuring Partnerships

Before I tell you how I’ve structured things with my partner, I want to give you a quick backstory as to how I came up with the structure, mostly because if you are pondering partnerships at all, this may help. Basically you are going to get two structuring options for the price of one!

I was in Las Vegas at a self-storage convention (when I thought my life path was going to be owning a self-storage facility rather than being a real estate investor), and I met a guy there who was in town from Miami. This guy owned a couple businesses, and it didn’t take long for me to realize that he could be a wealth of information. I got on the topic of telling him that I knew someone who was interested in going in on a self-storage facility with me, but I had no idea what kind of partnership to offer — what would it even look like? What kind of splits? What kind of investment requirement?

outsource-delegate

Here’s the structure he suggested to me:

Your investor puts down the money required to buy the business, then you give him 30% off the top of the NET each month and then split the remainder 50/50 until he is paid back, at which point the split then goes to 50/50 straight.

I was intrigued! He went on further to say it can be very incentivizing to the investor because that 30% goes a long way, and then it’s free money after that. And it’s of course a good deal for me because I’m making free money the entire time. I had to say — he had a point! I stuck this idea in my back pocket and thought about it often, and then when it came time for me to take on an investment partner, I pulled it out of my back pocket!

Rental Property Partnership Structuring Options

So there’s the first way to structure a partnership: 30% off the top of the NET, then 50/50 split after that. I was so excited about how awesome this sounded that I couldn’t wait to do the math when an investor partnering potential came around. However, I ran into a hiccup.

Being the spreadsheet nerd that I am, I started working all of the math for my first potential rental property purchase and my newfound favorite partnership structure in quite a bit of detail in Excel. I knew the numbers on the property (anticipated cash flow, income vs. expenses, purchase price, etc.), and I tried to apply the 30/50/50 split to it. I ran into a major problem. That 30% off the top then 50/50 split bit led to negative cash flow! I don’t remember how exactly, but basically the numbers didn’t work. I thought, oh no, my magical partnership structure proposal is in the water! I tried every which way to make it work, but it just wasn’t happening.

I continued working on it, trying everything I could pull out of my hat, and I finally came up with a logical solution. So, remember that one method — the 30/50/50 method — because it could be very useful on some partnerships. And now here is one that works for smaller-dollar investments:

On my first little rental property I wanted to buy, a lonely little (adorable) $55,000 single-family house in the suburbs of Atlanta (oh, the days of those prices!) that was going to rent for $975/month, I just couldn’t make that 30/50/50 split work because it led to negative cash flow. Here’s what I did find that would work, though, and it did because my partner and I still operate several rental properties under this exact partnership.

Related: 4 Types of Win-Win Partnerships That Will Help Grow Your Business

The Terms

  • Partner puts in the cash required for the down payment and the closing costs; I take out the mortgage and do the work.
  • We split the NET (profit or loss) 50/50.
  • If we sell the property, we split the NET (profit or loss) 50/50.
  • Equity is always split 50/50, including appreciation and any possible refinancing.
  • I provide my investor with a statement and direct deposit every month.
  • We both report the 50% income (or loss) on our personal taxes.
  • Our partnership is legalized through a legally documented Partnership Agreement (no LLCs, etc.).

business-project

Pretty simple, huh? All I needed to adjust from the 30/50/50 thing was the 30% off the top part. But wait, why would that deal be enticing to an investor? That 30% off the top to pay him back for his initial investment seems kind of important, no? The answer is: Yes, it is important. It’s an important enticement. When you are talking about high-dollar investments, like commercial level, i.e. an investor is going to be putting down a mega chunk of change, that 30% off the top may be critical to offer in order to convince anyone to buy in. But at the residential level, it’s not as critical.

But wait. What’s in it for the investor in this straight 50/50 deal? Good question. The theory of this split is it’s a 50% investment for the person willing to put up the cash and a 50% investment for the person willing to take the risk. My partner’s name is not on the property, so if anything happens to it, he is not liable. So him putting up the cash constitutes a reward of 50% of the NET income, and my accepting all of the liability and also doing all of the work and management for the property (although minimal since we bought turnkeys) constitutes the other 50%.

Further Points to Consider

If you aren’t convinced this is a balanced enough split (money vs. risk split), here are some further points to consider with regard to why this may be an enticing deal for the money partner:

  • What if someone doesn’t qualify for a mortgage but they have cash they want to invest? This is a great deal for them because they can still take advantage of leveraging, even though they can’t get it under their own name. Score!
  • What about the 10 mortgage limit? A big stress for buy-and-hold investors is what to do after they hit the 10 mortgage limit. Well, investing with a partner this way frees up one of those mortgage usages for you! My investor partner also invests in properties by himself, so with our partnership he is able to still do 10 of his own with mortgages and THEN have ownership with me — so he can go way past 10!

Starting to see why this setup may be enticing for the money investor? And then of course for me, the risk investor, my returns are infinite! Since I am no money into the deal, any returns I make are technically infinite returns. That’s hard to beat! And then of course the more obvious reason someone may want to be the risk investor, so to speak, is if they are low on cash but still want to buy into properties.

Now a couple of points worth noting:

This setup can be done with or without the use or mortgages or other loans.

It can easily be done with an all-cash purchase. However, I don’t know the exact balance of the money vs. risk investment — like if you own it outright, you don’t have the mortgage risk or the offering of covering the mortgage side of things (see previous incentives for the cash investor), so I’m not positive how you would convince anyone to do it. But who knows? If you pull it off, let me know how you did it.

under-contract-deals

Don’t partner with just anyone!

My investor partner is a very long-term friend of mine, and we have done a lot of business-related things together. I trust him fully, as he does me (obviously, since his name isn’t on the house), but even that has risks. I don’t anticipate anything going crazy, but you just never know. So know who you are going into business with!

Not just from the standpoint of giving your money to someone, but in how well they will manage the properties once you guys own them together. Bad management will tank an investment, so that isn’t good if you dump money into something and that happens. I recommend a ton of networking and other awesome stuff on BiggerPockets, but I don’t recommend soliciting around to anyone who is willing to invest with you. Come on, now.

Speaking of partners going crazy, make sure you are protected.

It’s important to be smart going into a partnership, and it’s also important to be smart legally with the partnership. Spell it all out so there is no question later. And if you do it like I did, where the cash partner’s name isn’t on the house, make sure it is set up that should something happen to you (death), that person has a way of getting the house. You can do this type of legalese with an LLC or a legal real estate contract, etc. But do something.

Related: Real Estate Partnerships: How to Find a Great Fit & Work Together Towards Success

Make sure your numbers make sense.

This type of split is based on rental properties that generate monthly cash flow, and in order for the split to be worth it, the margins need to be of certain size. It wouldn’t be very enticing to offer a partner $10/month in cash flow split. If you are wondering if a cash flow or margin is high enough to entice anyone, run a calculation on how long it would be until the investor would get his initial investment back. Oftentimes running that number suddenly will make it seem like a pretty good deal!

For example, on the margins, one of our properties nets anywhere from $400-500/month, so that is $200-250/person/month, and his investment was only around $16,000. So that’s actually not too bad of a turnaround time — never mind the equity and tax benefits he gets from it as well.

Consider your conscience.

There is one factor I didn’t think to consider before I jumped into properties with my partner. This was my conscience. We had a couple properties that did pretty badly for about a year, and essentially I had no profit to give him. I was SO stressed about it! I would’ve been fine with it all had he not been in the picture because the margins on these properties were so high, I’d be able to make up for it pretty quickly once they were cash-flowing again, and I knew the big picture about how good of investment properties these things were, but nonetheless, I felt horrible. I was so stressed out having to report nothing good to him. It was not something I had taken into consideration going into it. So don’t forget to weigh the “what if things go wrong” scenario.

There you have it! Now you know how I am structured with my investor partner on my rental properties.

Any other creative partnership structures you guys have tried and liked? Have you been involved in any partnering? If so, pros and cons?

Leave your comments below!

About Author

Ali Boone

Ali Boone(G+) left her corporate job as an Aeronautical Engineer to work full-time in Real Estate Investing. She began as an investor in 2011 and managed to buy 5 properties in her first 18 months using only creative financing methods. Her focus is on rental properties, specifically turnkey rental properties, and has also invested out of the country in Nicaragua.

39 Comments

  1. Curt Smith

    If the deal is large enough to warrent the fuss to settup a deal specific LLC, both the lender and the investor are equal members, then the K-1 can divide the tax benefits too, which is an additional benefit to attract an investor. A CPA needs to step in to confirm that an LLC as a pass through, and partnership tax return for the LLC/partnership and K-1 is how tax benefit sharing is accomplished. I believe so.

  2. Michael Seeker

    I don’t think a 30/50/50 split could be negative if you’re applying it to net income as you suggested. If net income is $100/month, then $30 goes to the investor to pay down their principle and the remaining $70 is split with $35 going to each party. The only way this could go negative is if the investment it’s being applied to generates a negative cashflow.

    The primary difference between the 30/50/50 split and a 50/50 split is that the money partner does not recoup any of their initial investment each month. Instead it is maintained as an equity position which would be paid out of any sale before splitting up profits (losses). The 30/50/50 split is a bit more advantageous for the money partner (quicker return of capital) but on smaller deals it’s probably not worth the hassle to set up. There may also be a different tax treatment on the 30% since it would be considered return of capital and not income.

    I’d say stick with the 50/50 method where the money partner is rewarded with sizable low hassle returns and the non-money partner is rewarded with payment and equity for their sizable efforts.

    • I’m very interested in creative ways to structure partnerships and I enjoyed your article. However, if a money partner willing to put in 100% of the down payment and closing costs, why not hire a property manager? It seems like you’re just acting as a property manager and taking 50% of the profits. Am I understanding that right?

      • Blake Elder

        Property managers don’t help put deals together and make sure that the deal is a good investment before purchase. This type of investor wants someone active to find the deal, put it together, then take care of all the details to make it work after closing. If you know of a property manager that does all of that, let us know who they are!

      • Ali Boone

        Good question Cory. Not totally. We have a property manager on the properties. The “work” I do on the property is just the over-seeing, decision-making, statement distributing, loan/refi work, etc. So all oversight work, not management of the actual property.

        But more of the profit split is based off the risk taken by me (since I’m the only one named), more than the “work”. If that makes sense.

  3. David Roberts

    Heres one:

    Cash investor puts up the purchase plus rehab. The partner manages the rehab and puts property manager in place. Partner dies cash out refi and returns money to investor with 25% net cash flow going forward. Partner gets 75% (all the risk). Cash guy is made whole making 100% return, partner takes the risk, making 100% return.

    To make it hands off, put property manager in place so nobody does much work after the rental is set.

    If not all the money can be cashed out, then you give that cash investor 50% until it all gets paid back. Then goes to a 25/75 split.

  4. Brandon Gentile

    Ali, thanks for the post. Gives me some great ideas. I have a partner of mine that is going to start doing small apartment complexes with me and we have been trying to think of ways to partner on the deal and split up equity/cash flow. Definitely got the creative juices flowing!

  5. Your bio reads that you have used creative financing methods. Can you provide a few examples? Great article and solicits many questions that need to be answered prior to the deal (literally and rhetorically). Thank you.

  6. Peter Sejna

    Thank you Ali for a great article.
    just one question to clarify something for me:

    you say that you take out the mortgage and do the work. where does the money for repairs/remodel come from? do you take out mortgage that includes the repair/remodel costs or do you cover the these costs from your own pocket.
    I assume mortgage covers repair costs since in many cases repair costs could be as much if not more than down payment.

    how would you structure your partnership if you cannot get mortgage that includes repair costs?

    thank you

    • Ali Boone

      Hi Peter, thanks for asking! Not sure I know exactly what you mean by a mortgage covering repair costs? Those are usually separate and I’m not positive how they can work together. Of the income we receive, I pay the mortgage as well as any repair costs off the top, and then split the remained after those are paid.

  7. Wesley Pittman

    Hi Ali,

    Thanks for sharing! One quick question to clarify for my understanding- when you say “net income” are you talking about “net operating income” or “net cash flow.” As Michael indicated, in his comment on December 3rd, I don’t see how the 30% cut could make a property cash flow negatively unless it was taken out before operating expense. I ask because 30% of cash flow is likely a pretty small concession- 30% of NOI is HUGE and would basically eradicate the margins on all of the residential properties I’m familiar with in my area (I’m west coast).

    I like your simple 50/50 split model and I’ll be approaching folks in my area with that going forward.

    Thanks!

    • Ali Boone

      Awesome Wesley, keep us posted on how it goes! As far as your question… I would honestly have to look back at my old spreadsheets and see what numbers I came up with and how. I admit I didn’t look at those before I wrote the article to know if I was speaking exactly right. I remember the 30% putting an unacceptable dent in the numbers, but I’d need to double-check on why.

  8. Michael Faulk

    Ali-

    Thank you so much for describing how you created a mutually beneficial partnership. I am in the process of structuring a partnership for a rental property very similar to what you outlined. I actually took some of the points from your article and included them in our partnership agreement.

    One question for you: When you constructed your partnership agreement did you consult with an attorney or did you draft the agreement yourself? This will be my first partnership and I want to make sure I am doing the right thing to protect the both of us.

    Thank you for answering my question and writing this post! It was awesome how you described everything and it kinda gave me chills because I am going through this exact type of “creative finance”

    Thanks again-
    Michael

    • Ali Boone

      Hey Michael! Yay, glad the article helped and that’s awesome you are getting some partnerships worked out! Keep me posted on how they go. I do recommend speaking with a real estate attorney (one who deals with investments a lot, not just someone claiming they can cover real estate agreements). When it comes to legality, I don’t typically recommend shorting out too much. But, creating your own agreement could be equally as fine, as long as you are somehow able to confirm the language and that there are no outs in it and everything is covered, etc. But for the most part with any real estate related (taxes, laws, etc.) I do recommend consulting a professional.

  9. Troy M.

    I don’t think you can approach partnership agreements as “one size fits all”. Each deal is different. Would a 50/50 split be equitable when the $on$ return is 10% vs another deal where it is 30%? Also, what is the exit strategy for a particular property? That too, must be taken into consideration. Finally, the investment objectives of each partner must be taken into consideration. Is the partner who’s putting up all of the cash more interested in monthly cash flow or capital appreciation? Same with the other partner, are they interested in cash flow or capital appreciation. At the end of the day lots of variables must be considered in each deal to create a “win/win” proposition.

    • Ali Boone

      I couldn’t agree more Troy. My intent with this article was just to get the juices flowing and open up the door to possibilities for how a partnership can be structured. I do recommend everyone take into consideration each point you mention, so thanks for sharing those!

    • Brad Ratushny

      Ali, great article as always.

      Has anyone ever come across a book, article, etc. that goes deeper into partnership structure?

      I’ve been searching for a resource that gives insight into different splits, exit strategy, operating accounts (reserves), etc.

      Thanks again!

  10. Paula R.

    Great discussion! Very pertinent to my situation evolving right this minute

    Now that I am pulling in an investor rather than coming up with the down payment and repair costs myself (as in the past), I am looking at working deals differently. I am in the process of working two deals, one with a NV resident and the other with a CA resident.

    In one scenario a house has a loan from investor for purchase price plus repairs, using the house as collateral, with a rate slightly higher than I could have gotten had I put the down payment and paid for repairs myself. So this obviously is a return to investor higher than he could have gotten by having funds in a savings/cd etc. Then I am paid the 10% management fee (long-term rental) and profits are net profits are split after ALL expenses. Depreciation is split, too. Ownership is held 50/50 in our respective Living Trusts to avoid probate.

    In another scenario, a NM LLC (no annual state filing or fees) is formed with me as Managing Member which doesn’t trigger the $800 annual fee for the CA member, but this way the Operating Agreement can give the other member all the depreciation (they are in a higher tax bracket than I am).

    Any comments on which one might be better? I’d like the protection of an LLC but the NV investor has had a bad experience with a NV LLC and wants to look at other options.

    Thanks for all your valuable input!

    • Ali Boone

      Hey Paula! I would definitely defer to either a tax or entity expert on this one as giving wrong advice could be bad! And I’m unfortunately not an expert.

      If the deal with the NM LLC is with the CA resident, how do you plan on avoiding the $800 annual fee for CA? They don’t care where the LLC is formed, they only care if anyone in it has residence in CA.

  11. michelle williams

    Great read! I’m so glad I looked at this post, being a new investor I have been worried about how to start with very little money and wanting to purchase turn key properties. Looking at your profile I would like to invest similar to your strategy, I live in Los Angeles so the thought of trying to purchase a cash flowing property seems a bit limited. I will definitely look into your other articles and connect with you soon!

    Also just starting out how should I legally protect myself with an investment partner?

  12. Jeff P.

    Hello all!

    My apologies in advance about the long post…Any thoughts on my situation would greatly be appreciated!

    I have the money for a down payment + repairs + acquision costs. I need a partner for the financing part. The property I’m looking at is a SFH. I would put down $40K in total and my partner would need to finance $120K.

    I already have a seasoned property manager as a tenant in my property across the street. He’ll manage this new property for free based on a reduced rent he’s paying and he’s excellent (I have 7 years working with him). Therefore, I would also take care of the managing of the property. If my tenant moved away for some reason, the property management fee would be my responsibility in the partnership.

    Any ideas on deal structuring in this case?

    One thought of mine was having my father pull the loan, but he’s 75 years old so my questions are:

    1. Would a bank give a 75 year old man a 30 year loan?
    2. If they do, there a good chance he won;t be around to pay if off so can I take over the loan without the bank calling it in full? My research says I can IF I live in the property: however I’m not sure on an investment property…

    Thanks in advance for your thoughts and input!

  13. I found this article very interesting since I’m trying to bring on an equity partner who would become a percentage partner in my rental properties. I’d like to sell a 22% interest in my two rental properties for $60,000. In return, the partner would receive 22% of the net rental income every month until I sell the properties. I ran some numbers using a 3% increase per year for each property. I also used the present amortization schedule for each mortgage. If the properties were to appreciate at 3% a year, I could sell the properties at a nice profit and my partner would receive 22% of the net selling price. The partner’s 22% would equal $69,000. After figuring in the five years of cash flow, the partner’s Internal Rate of Return is a few basis points shy of 12%.

    Does a partnership like the one I describe sound feasible?

    I’d like to hear comments.

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