Exit Strategies with JV Partner

[matthewrlee]

Hello,



I'm putting together various potential exit strategy options for a potential JV partner.



1) Hold as is

2) Sell

2) Refinance

3) Partner Buyout

4) 3rd party buys JV partner share



I'm trying to understand #3, 4, and 5 better.
Looking for information to help me create the JV agreement.



Sample Scenario

Purchase: $250,000

Initial 80% LTV mortgage: $200,000

Downpayment from JV partner: $50,000

New value (5yrs): $300,000

Value of mortgage in 5yrs: $175,000

Equity in property: $125,000

"Profit": $75,000

"Profit" split 50/50: $37,500

New 80% LTV mortgage: $240,000

Refinance Equity takeout: $65,000



If we go #3 Refinance...

What typically happens to the $65,000 equity takeout from the refinance? Is the JV partner's initial $50,000 investment to be paid back first, before we split the profits 50/50? Or is the the $65,000 considered the profit, and thus split 50/50? The reason I ask is because REIN's JV model typically says "The investor partner is paid back his initial investment before the profits are split".



If we go #4 Partner Buyout...

If my partner wants out and I want to stay in... If we refinance, it raises $65,000. I pay the JV partner $50,000 of that to cover his initial investment (then there is $15,000 left). He is still owed $37,500 for the "profits", which is a shortfall of $22,500. What is typical in this situation? Would I cover the $22,500 out of pocket in order to stay in the property? What if I don't have the money to do so (or if I'm buying a much bigger asset that is actually 10x the cost, and I don't have $225,000 to stay in)? Are there any other options?



If we go #5 3rd party buys JV share...

Would 3rd party need to come up with $50,000 (JV partner's original investment) + $37,500 (JV partner's profits) to buy in?



Or would the asset be refinanced first, with the new 3rd party qualifying for the mortgage? 3rd party downpayment is $60,000 (20% of new value), mortgage is $240,000 (80% LTV). Existing mortgage is discharged, leaving $65,000 leftover. JV Partner is owed $87,500 ($50,000 investment + $37,500 profits), so 3rd party comes up with the $22,500 shortfall, for a total investment of $82,500 (instead of $87,500)?





What is the most "typical" scenario for most seasoned REIN members? I know holding and refinancing is the most ideal option, but in speaking with potential JV partners, it appears that they want to start getting some profits in their pockets after 5 years. Thanks in advance.

 

[Matt Crowley]

[quote user=matthewrlee]If we go #3 Refinance...

What typically happens to the $65,000 equity takeout from the refinance? Is the JV partner's initial $50,000 investment to be paid back first, before we split the profits 50/50? Or is the the $65,000 considered the profit, and thus split 50/50? The reason I ask is because REIN's JV model typically says "The investor partner is paid back his initial investment before the profits are split".




"Profit" depends on the profit centres you agree to split...PPD, cash flow, and appreciation are typically included. So they are entitled to half the cash flow. Remaining profit is then simply = (value) - (mortgage) - (initial capital invested), or $75,000. ($300,000 - $175,000 - $50,000). Assuming zero cash flow for simplicity, that is $37,500 profit to split, exactly as you indicated.



The total investor's share at the end of 5 years is equal to (profit) + (initial capital invested), or $87,500. Most JV contracts contain a "shotgun clause" which allows for the agreement to be bought out by either party. One party offers a price for the other's share. The second party can then buy or sell their share to the offering party at that price. In practice, you would consider liquidation costs (Realtor fees, staging costs, deferred maintenance items necessary to ready the property for sale, legal fees). Consequently, the money partner's profit would be less than $37,500 after these are considered.



The joint venture continues until the parties agree to settle their interests in it for an agreed price. Consequently, refinancing to repay capital or profits must be settled in view of the agreed value of the property. Payouts in excess of proportional profit is a return of the investor's capital. They will continue to hold an interest in the property at a reduced rate which is based on the new agreed-upon value of the property.



The amount you choose to refinance has no bearing on the total amount the investor is owed. The investor is due $87,500. Imagine getting all your $50,000 returned along with $15,000 profit and getting an I.O.U. for profit of $22,500 with all your rights to the property extinguished. Anything is possible, but more likely they will want their profit and hold a part of the equity remaining in the property.



Hope that helps

 

[matthewrlee]

Thanks Sweetzone. Appreciate the reply. I understand everything you wrote. However, I'm not sure that it answered my question directly (or maybe it did, and I'm just misunderstanding it).



For the #3 Refinance scenario, it assumes that the JV partner will want to remain a 50/50 equity owner. But after 5 years, he wants some payout... which as part of a standard JV agreement, states that we will discuss and evaluate our options at the 5yr mark. My question is: after refinancing, we will be left with $65,000. How is that $65,000 to be allocated? Does he get his $50,000 investment back first? Or is the $65,000 to be split between me and the JV partner as "profit"?



The problem I have with paying out the JV partner his investment first from the refi funds is that he is then "into the property for nothing". So (I would imagine) that can't be the ideal scenario for the RE expert partner.

 

[Thomas Beyer]

[quote user=matthewrlee]If we go #3 Refinance...

What typically happens to the $65,000 equity takeout from the refinance? Is the JV partner's initial $50,000 investment to be paid back first, before we split the profits 50/50? Or is the the $65,000 considered the profit, and thus split 50/50? The reason I ask is because REIN's JV model typically says "The investor partner is paid back his initial investment before the profits are split".
yes that is common: first investment is paid back, then profit (if any) is split.



[quote user=matthewrlee]If we go #4 Partner Buyout...

If my partner wants out and I want to stay in... If we refinance, it raises $65,000. I pay the JV partner $50,000 of that to cover his initial investment (then there is $15,000 left). He is still owed $37,500 for the "profits", which is a shortfall of $22,500. What is typical in this situation? Would I cover the $22,500 out of pocket in order to stay in the property? What if I don't have the money to do so (or if I'm buying a much bigger asset that is actually 10x the cost, and I don't have $225,000 to stay in)? Are there any other options?


Yes you'd buy him out for 15,000+22,500. However, you ought to also include a (theoretical) realtor commission as if sold, so if you use 6+3% that maybe $12,500 .. so you owe him only 15,000+10,000



[quote user=matthewrlee]

If we go #5 3rd party buys JV share...

Would 3rd party need to come up with $50,000 (JV partner's original investment) + $37,500 (JV partner's profits) to buy in?




Presumably much more. You'd treat it as a brand new JV, wheer you sell a 300,000 asset to a new party, some $s for you and some equity for the investor.

 

[matthewrlee]

Thanks for your response Thomas!



[quote user=ThomasBeyer]yes that is common: first investment is paid back, then profit (if any) is split.




In this case, the JV partner is now "into the property for nothing", since he now has no original $'s invested in the property. And I (after 5 years of work as the "RE Expert") would get a very minimal return as "cash in hand".



Is that just how it goes for the "RE Expert" in the refi & hold scenario? Most of my return is still stuck in the property as equity, with very minimal cash payout at the 5yr mark?



If that's the case, as the "RE Expert" partner, I'm almost more inclined to want to sell and cash out, and find new JV partners for new ventures.



Can I consider the funds from the refi as "profit", and are thus shared between the JV partner and RE expert (and the JV partner's original investment $ stay in the property)?





[quote user=ThomasBeyer]Yes you'd buy him out for 15,000+22,500. However, you ought to also include a (theoretical) realtor commission as if sold, so if you use 6+3% that maybe $12,500 .. so you owe him only 15,000+10,000




Forgive my ignorance, but what is 6+3%? Normally, commissions are 5%, aren't they? Thank you for this suggestion... it's a good one.





[quote user=ThomasBeyer]Presumably much more. You'd treat it as a brand new JV, wheer you sell a 300,000 asset to a new party, some $s for you and some equity for the investor


Makes sense! Thanks Thomas.

 

[Thomas Beyer]

Some investors change the equity split after investor $s have been returned.



Some also charge a management fee, an acquisition fee and/or a re-finance fee.



If you get little after refi then persuade the investor to do another JV with you with the recycled cash.



6+3 is common as opposed to 5% for realtors, i.e. 6% on the first $100,000, then 3% on the balance.

 

[Cory Sperle]

[quote user=ThomasBeyer]If you get little after refi then persuade the investor to do another JV with you with the recycled cash.








Exactly. Truly win/win