Advice on joint venture profit sharing...

[Dustin Racine]

Hello,
I am considering starting a joint venture with a partner. I would be responsible for the on sight construction and management of the project, as I own a general contracting and plumbing company. The other party would finance the project and be responsible for the business aspect of things: finding properties, crunching the numbers, dealing with financing, etc. This is the first time I have ever considered a joint venture and want to make sure the deal is fair for both parties involved and that I am protected. Any advice regarding profit sharing, contracts or any other useful information would be appreciated. The proposed profit sharing plan is below.
other party Myself
Capital 50%
Mortgage 10% 10%
Asset Management 5% 5%
Real Estate Expertise 10%
Construction Expertise 10%
total 75% 25%

 

[TrevorW]

Yeah, that seems about right... Depending on the construction aspects and whether or not you are saving the project any fees related to management, you might consider bumping up your construction expertise component to 15%. I suppose your partner could make a similar claim to the RE expertise portion though. Really should depend where the big risk factors are within your deals.

 

[Matt Crowley]

Hello,
Construction Expertise 10%

The breakout looks okay, just make sure the construction cost of wages and materials is repaid by the capital investor in the initial stages. The construction expertise as a 10% equity position should be used to capture your "lost profit" down the road.

 

[Thomas Beyer]

The proposed profit sharing plan is below.
other party Myself
Capital 50%
Mortgage 10% 10%
Asset Management 5% 5%
Real Estate Expertise 10%
Construction Expertise 10%
total 75% 25%

Looks a bit better in the "reply" option due to formatting, although I assume you take the 10% for real estate expertise ?

Your 25% is slightly better than what a GC would get, namely 15-18% of construction cost, but also some risk for the mortgage. So I'd say your 25% is about right.

Is the intent to sell the asset once constructed ?

 

[Dustin Racine]

Looks a bit better in the "reply" option due to formatting, although I assume you take the 10% for real estate expertise ?

Your 25% is slightly better than what a GC would get, namely 15-18% of construction cost, but also some risk for the mortgage. So I'd say your 25% is about right.

Is the intent to sell the asset once constructed ?

Depends on the numbers. He seems more inclined to flip. I would prefer to hold long term given the current market conditions. The potential partner is a realtor/investor so he would be the real estate expert. Given that he would be financing the whole deal, he would have final say on weather to hold or sell.

 

[Matt Crowley]

Flip vs. long term hold are drastically different strategies.

Flip strategy: buy a dog with risk most buyers are unwilling to purchase. Address major structural issues and finish with high-value cosmetics (bathroom / kitchen). Unless you are in a crazy appreciation market, the "lipstick on a pig" strategy is a total bust. Buy a resale home and sell to a retail customer. Usually, don't bother suiting it or putting in second kitchens, ect. Process is faster and easier preparing for a primary resale market buyer. I would not buy a home and suite it in hopes of making money on development. Better and easier money in selling to the broader consumer. Retail value: look at cultured stone, SS appliances, granite countertops, glass tile, ect. All the finishings to complete with the show home market, but for a consumer desiring a better location. Strategy is quick in quick out. Renovations are likely equity financed.

Long term hold: don't bother on the high-cost finishings: granite countertops, glass tile. You will probably not see your money out of it and the cost of replacement is high. Invest and develop sturdy. Fix all grading issues, eavestroughs, and potential window well issues. Properly vent downstairs suite. Install interconnected detectors throughout suite. Accept a low initial yield - money is made over the long term hold. Tiny initial yield (3 - 6%) and this will eventually grow. The goal on a long term hold is to drive down your repair and maintenance costs as low as possible. This is your most variable cost and is really the marker between a professional developer-manager and an amateur owner. If you don't have a legal suite and you invest in a city that cracks down on illegal suites, you are not a long-term investor. You own a liability and a short term cash flow stream.

The flip strategy does not easily convert to a long term hold. Most small time investors do not see the value in developing a suite properly for long term hold and you will not get your money out on a flip of a properly legally suited home (at least initially).

You really need to commit to the strategy you are taking. These development strategies are very different.

 

[Dustin Racine]

Thanks for the feedback. To make a short story long...he proposed 85, 15. I said no way as politely as I could and countered with 75,25. He declined. So its a no go. As some say...sometimes the best deals are the ones u don't make. Would not have been worth my time and would have taken me away from my plumbing company. Also, as mentioned, we had different strategies and goals. His to flip, mine to hold long-term. Going to keep persevering and try to find a joint venture partner, kind of sitting in limbo till our home sells, but I believe my experience in suite development and general contracting is still a valuable asset for the right person. Meeting with another individual in the new year, hopefully we will be on the same page and the numbers will be more favourable. Hardest part is getting your foot in the door. It's a lot easier if you can present a portfolio of cash flowing properties, not so easy when you're first starting out. I will post the proposal I emailed to the next potential partner. if you could let me know what you think: are my values accurate, is there anything flawed about my plan ? Focusing on the win-win and as Sherri-lynn has said, better to own half of something then all of nothing. Thanks for your time!

 

[Dustin Racine]

Just so you know, if we were to partner up, I think it would be highly beneficial to both of us. Once we have possession I can start the construction process and you have nothing to worry about. I have done legal secondary basement suites, so my trades and I know what we're doing. I think it would be great if we could grab a coffee some time and chat, I can work around your schedule. Just let me know your availability.

The great thing is: you are already in the investing market and can enlighten me on the property management side of things. I would love to learn that aspect of the industry. And as you had said, up n down suites are great for positive cash flow.

On the other hand, I have a general contracting and construction background and can be of benefit when developing the suites. I can save us a lot of money use trades directly without a markup on general contracting. Also, I get very good rates from suppliers and trades, as I have a good relationship with them.

To spite my current lack of capital, I think I may have found a practical way to have a win-win situation for each of us. We would obviously want to talk to a banker, realtor and probably an account first to make sure it would work and we wouldn't get screwed at tax time, here are my thoughts using a 300,000$ purchase price as an example.


purchase 300,000 (downpayment@20%=60k. We each pay 30k.)
left owing on home 240,000
reno/holding costs 50,000 (paid separately if possible with cash by you or a private lender if needed)

approx. appraised value upon completion 430,000 we can borrow 80% >344,000-240,000 still owing = 104,000 / 2 = 52,000 each.

Of my 52,000 I would pay back 50% of my half of the reno and holding costs to you (25,000). The other 27,000 I would hold for the next property. Out of the deal I own half the home and enjoy the positive cash flow

You on the other hand would get 52,000k + the 25k I owe you. You own 50% of the property, enjoy positive cash flow and have some money in your pocket.

In the end u spent 3 k and now own half the property. (30k down payment + 25k renos =55k - 52,000 accessible equity.)
I spent 3k and a lot of time general contracting and own half the property. Also received a interest free loan in the process.



Now if u did the same scenario on your own it would look like this.
purchase price 300,000 (downpayment@20% 60k.)
left owing on home 240,000
reno/holding costs
(hiring general contractor) 75,000

approx. appraised value upon completion 430,000 @ 80% = 344,000 - 240,000 still owing = 104,000 in equity - 75k in renos & 60k down payment means -31,000

 

[Matt Crowley]

^ Don't get discouraged! Why work for less than you are worth? There is nothing sacred or better about the money earned from a RE investment than your business. It is very clear that you are not under the illusion of "passive income" and you are willing to work your tail off to get it.

If you can achieve those margins, go get some private money! There are lenders who will lend at 10 - 15%. Go to family or close friends. If you can achieve a margin like that the only thing really holding you back is finding the deal that will offer that kind of margin.

It looks like you have a very good handle on how the financials work for the deal. Go and find that $300k home on the market and show the actual comparables to defend the value at $430k. This is an incredible margin from a $300k purchase so you will have your work cut out for you to defend that margin.

Keep in mind that a $344k mortgage has a ~$1,500 monthly payment (2.2% rate, 25 year amortization and rates likely to increase this week). +300 / month property tax + $100 insurance + $100 R&M + $200 PM (min) + $60 bookkeeping acct + $10 marketing +$350 utilities = $2,520 monthly expenses. I do better than this for my revenue line for my legal suites in Edmonton but most PM's will not. (Most PMs will rent bsmt for ~$1050 and upstairs ~$1400 including utilities). If you apply that kind of leverage you will force yourself into a negative cash flow property and one that will require cash calls. A huge red flag no-no when using JV money. Real estate investing is somewhere you put your capital to preserve it once you have a large lump sum saved up.

If I could achieve your numbers I would be thinking flip! Get a couple flips under your belt and sell them to investors and build up that fund. Even if you have to pay a Realtor $18k to sell a home you made $105 gross margin on - well that is an incredible gain. You may not need to promise an equity interest in it at all. Just a high interest 15% interest rate on $50k for 6 months? That is like $3,750. Man, if you can get those margins sky is the limit.