Joint Venture (a bit complicated!) help!

TommyK

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Registered
Hello REIN experts.



First of all, I want to thank REIN for giving me the know-how and courage to begin my real estate investment back in 2008. I was lucky and invested 4 properties in Edmonton between 2008-2009. Since the investment has already been 5-years, I recently sold two properties with a bit of profits (thank you REIN!).



Now that I have some capital, I want to move back to Vancouver. Yes, I know it's the most expensive market in Canada. But I grew up there and I want to be able to live there and be close with family. Anyway, to make the long story short, this is the scenario:





This is what both parties bring to the table:



Couple A (that's me)

- provide 35% down

- qualify mortgage (Couple B have poor credit and little income to proof)

- provide basic sweat equities (ie painting, cleaning, demolition?)



Couple B (my friends)

- provide renovation know-how

- provide discounted rates on trades for licensed electrical and major plumbing issues

- very handy, cabinetry, tiling, flooring, some plumbing and some lighting (not licensed)

- design work

- stronger cash-flow



I want to propose my friends a joint venture deal where I can save on renovation cost (I am not a handy-man), share living expenses (ie: mortgage, utilities etc) while both couples reside in the property, and a chance to greatly improve the premise for future sale. At this point, I am thinking of a 2-3 year window that will give us the time to fix the property while all of us are busy with other projects. This opportunity will help both parties build capital for the future.



This is what my initial thought on the proposal:




Property Closing Costs:

Couple A and B share 50 /50



Fixed Living Expenses:

Couple A 40% / Couple B 60%

- Since Couple B don't have a lump sum down payment to contribute to the joint venture, and we have a weaker monthly income, I think it's fair for my friends to be responsible for more monthly expenses. My friends need a place to rent anyway, so why not put it towards this joint venture instead of making another landlord rich?



Renovation Expenses:

- Share 50 / 50 on materials and hired licensed trades cost

- Couple B is responsible for all design work, provide sweat equalities on renovations (I will have to spell out what exactly they can do)



Sales of Property Cost:


- Share 50 /50 (ie. realtor fee, property transfer tax, lawyers etc, upon selling)



Ownership:


Couple A owns 100%. Couple B is secured by a two-year agreement.



Profit-Sharing:


When there is property appreciation, Couple A gets his down payment back and split profit 50/50 with Couple B.





So based on what I described, is this a fair win-win joint venture for both parties?



Thank you!



Tommy
 

Matt Crowley

0
REIN Member
Hi Tommy,



Congratulations on your success, that's outstanding. On the surface I can definitely see that both parties are bringing complimentary skills to the table.



I have a few questions:



What's the initial value of the house? Who pays for renovation materials?



What if friend gets too busy to perform renovations? What if friend's or subtrades work are not acceptable? How are you going to protect your interest in the property?



What is the profit margin you are looking at? What your friend's track record for 'flips'?



I'm imagining a $600,000 house...at 35% down that's $210,000. You are letting your friend leverage all your money and all of your experience.



What's the real $$$ difference between a "cheap" renovation with your friend and hiring a fixed-bid contractor? Interest rates are pretty low these days and if you have the capital to outlay initially, you could try and get a purchase plus improvements loan and keep a lot more of the profits yourself (you may even be able to hire your friend as a contractor).



My concern is (and I really don't know your friend or his work)...that you are going really all or nothing on this one deal. It's all of your capital and predominately all of your risk. It sucks to pay rent to someone else but are you sure you want to be around your friend 24/7 with the ongoing renovations?



(I don't think I would go this way) but if you want to do a 50/50 profit split, I would suggest your friend's share be performance dependent. It makes no sense to hire him if the final cost is 50% higher than a professional contractor and he still gets 50% of the profits.
 

Thomas Beyer

0
REIN Member
Depends really on reno work required and anticipated profit. Perhaps a better formula is $s/h, say $40/h and a lower %, say 20%.



I'd split living expenses 50/50 (assuming both use the same space roughly), and profit 80/20 plus $s/h worked .. 80 for you as you put up the money AND the mortgage AND the expertise to find the asset to buy AND 50% of the ownership cost.



I would then put a price on the work of couple B, as work, like painting, scrubbing, plumbing etc. has an hourly cost that can easily be hired for $s. As such, if you honestly propose a far too generous 50/50 on profit then couple B HAS TO DO LOT of work for free, equal to 30% of profit. It thus makes sense to quantify this work, i.e. # of hours worked vs. the anticipated profits.



So, as an example, if "sweat equity" is 1500 hours over 3 years and a person could be hired for $40/h+20% of profit i.e. $60,000 and if 30% is equal to $60,000 profit has to be over $200,000 for couple B to make more in a 50/50 vs. a 20/80 scenario. In other words, if profit is under 200,000 50/50 is better for you than paying $40/h plus 20% of profit.



The huge risk in this project is that couple B slacks off, you end up with most of the work, hiring and paying sub-trades and still owe them 50%. The risk is on you, not couple B ! As such, ensure there is some teeth in the contract to allow you to "fire" couple B if necessary.
 

TommyK

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Registered
Hi Matt,



Thank you for raising your questions.

Yes, I have and will consider the consequences when their "expertise" do not meet the expectation.



I am entertaining that reno material cost to be 50/50 split. I don't want to pay it all by myself then there's no real "push" on my friends to finish the job on a timely and cheaper cost. I wouldn't suggest 100% material cost to be paid by then as I know they are short with running capital (they run their own reno company), and I am afraid of them delaying the home reno project just because they are out of funds.



This is why I suggest the profit to be split so the real incentive is to do the job right and within our schedule. If they don't complete the project, then none of us will get paid, and they don't own any % of the property.
 

TommyK

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Registered
Hi Thomas,



I knew I could count on you to give me some wisdom!!!



My target purchase price is $750K. It will be my "max" limit (as I am putting down 35% of that amount!).



I would love to expect the profit to be around 120-150K range and the hours required to fix up the property will be less than 1500 hr. I will also be putting in many sweat equity like painting and doing small things.



There are a few selfish reasons for this potential proposal:



- Once I put all my savings in this deal, I will be short with cash flow. I am moving back to Vancouver and I am temporarily working with Couple B in their renovation projects until I find my own career. This is why I want to propose a 60/40 living expense split with them paying more. This is how I want to reduce my daily expense.



- I also want the opportunity to learn a few things from working with them. So in the future, I have a few tricks in my own pocket. So there is this "learning opportunity" that I am looking forward to.



I think if they pay more on daily expenses, then they won't want to prolong the reno and their stay in the property--and I can reduce my fixed cost.



I think the key points are:

- list as many things as they will do and put it on the agreement

- have "violation" clauses that can terminate this joint venture relationship. For example, if they are late for the mortgage payment and the utilities, then there is one warning.. and then second late payment will automatically terminate the joint venture relationship to project my capital.



So would you still think 60/40 split on daily expenses being "unfair"? Obviously they will be paying down more principal than I do, but I have all my savings invested + qualifying the mortgage which they can never do.
 

Thomas Beyer

0
REIN Member
Ideally you have a lease with them stating the payments. A lease is easier to terminate than a JV agreement.



Then you have a JV agreement with them re renovation, $s and profit sharing. Much can go wrong, such as expenses over budget, disagreement over who does what, a flat market, rising interest rates, disagreements on when to sell and for how much, personal conflict, divorces .. a high risk venture. High risk if couple B has little invested. Be prepared that they walk out the door one day. What about if you want to quit the project, but they do not ? How to handle that contractually ?



Renovation projects in Vancouver are a good idea in general, and if you are fast and have an understanding spouse you can do one a year where you live in, plus 2-3 in parallel, then move every year while making 100,000 tax free on the house you live in and another 100-200 for the other 2-3.



What can you buy these days for 750,000 in Vancouver besides a vacant lot in East-Van ? I hear houses are $1M+ anywhere. Better in Coquitlam, PoCo, Surrey, Delta, Northvan (even there $1M is often the minimum now) or east i.e. Langley, Maple Ridge .. how far does your "Vancouver" go east or north or south ?
 

TommyK

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Registered
Thank you Thomas! I love how you ask these "tough" questions. They really make me think about where I should be investing and how to protect my own investment and also create a win-win situation with my joint venture partners.



I have one joint venture newbie question. Say if I am going to propose to my Couple B friends, is the joint venture contract going to be registered as a lien against the title to secure their interest? I understand you said a lease is easier to evict my friends if they don't perform what they are supposed to. I am confused by how they protect their interest (and mine) if either party doesn't fulfill their duties.



My friends talk about East Vancouver, but after my initial search, we won't be able to find a detached home under $900K that is worth considering to flip. I am from Richmond, so we may consider Richmond, Delta, New Westminster and Burnaby (and east to include Coquitlam). It's not what we "envision", but we need to build our capital before we can venture the Vancouver market.



Yes, my partner and I, and my Couple B friends, are all adults who move a lot... LOL I have lived in 7 places from Richmond to Edmonton, then from Toronto to Monction, New Brunswick in the last 6 years.. so go figure! None of us have young kids so we don't need to worry about schools and stuff. ;) This is a "plus" side in our joint venture nature since both couples enjoy moving and "move on" to the next project.
 

Thomas Beyer

0
REIN Member
Yes an agreement can be registered as a caveat on title . Best to sit down and discuss scenarios / options with them. Consider ALL possibilities such as death, divorce, illness, rising interest rates, construction deficiencies, kids , disagreement over price or quality, cash, cash payments, missed payments, living together in a house under renovation, who does what when for how much , mutual expectations etc .. Before you discuss at how to split the upside. A four way partnership takes a lot of mutual respect and give and take.



Happy JVing !



Let us know how it turned out and send postcard from Hawaii or wherever you will celebrate the first 100,000 !!
 

TommyK

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Registered
Yeah we should talk about what could possibly go wrong before we get excited for the potential gain.



Since Couple B is not bringing any down payment to the table, technically they don't own the property. So they wouldn't be on "title" except a joint venture agreement as a caveat to protect their interest.



I have sent out a couple emails to seek realtor in New Westminster and Coquitlam area. Couple B have agreed that with our current limited capital, Vancouver is not douable at this point. Hopefully we can build up additional 100K capital in 2 years time.



And thank you so much for your expert advice Thomas!



Tommy
 

TommyK

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Registered
Thomas,



I am writing my propose to my Couple B friend. I think the toughest scenario will be when the market value doesn't result in a net positive position for both parties after our 18-month committment to the Joint Venture contract.



Since Couple B is responsible for half of the material cost on reno and any outsourced trades, I thin it's fair for them to receive a portion of their investment back if they decide to terminate the JV relationship at the end of the contract.



Here if what I plan to propose (Party A is me and Part B is my friend):



----------------------------------

Scenario: What happens if the market value of the property is lower than the purchase price after 18 months?



If
the market value of the property (after Party A's initial investment
and cost of selling) doesn't result in a net positive revenue position
for Party B, then Party B have two options:

1) extend the Joint Venture
contract for an additional year at a time until both parties decide to sell

2) dissolve the Joint Venture
relationship by releasing the caveat on title.



Party B is entitled to be reimbursed on material cost and outsourced trade cost according to the schedule below:

After the first 18 months: 100% reimbursement

After 1 year extension: 80% reimbursement

After 2 year extension: 60% reimbursement

After 3 year extension: 40% reimbursement

*Party B receives no reimbursement after the 3rd extension and the Joint Venture relationship shall be terminated at the end of the 54th month (which is after the 3rd year extension).



*Party B's labour
cost and design expertise do not constitute as renovation material
cost.



----------------------------



I think if they decide to extend another year to wait out the market, the material cost rebate should be discounted to reflect amortization. They will be putting in their own labour in this project, so that's the risk they have to take. And since they will share 50% of the reno material cost and outsourced trades, I think it's fair they receive some back if they decide to walk away. The JV relationship will automatically end at the end of the 54 month. I don't think it's fair they have this caveat on the title and wait forever for the market to return to a net positive position, especially if they decide to move out and not become roommates.



So is this a fair proposal?



Thanks!
 

therenoguy

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Registered
Oh my goodness, I haven't heard anything in a long time that is such a recipe for disaster! You are talking about four individuals who will be living together, and deciding how best to renovate a space you're sharing. Stressors include: cabin fever, money stresses(as you'll be pretty much maxing yourself out), the ideas and egos of four people(there could be a major war over the colour of the bathroom light switch), the fact that you'll be working with the guy which means you and he will never be able to escape each other, the dust and dirt of renovating in your living space, him getting injured, either at work or while working on this project, one of the four of you not getting along with any other one of the four of you, two women living in the same house with no kitchen after their periods have synced up,

that moment when you say,"but I'm paying for it and I can't afford that granite," and he says, "but you put me in charge of design and construction."



If you do decide to go ahead with it, make sure you call Fox first. You may as well get the revenue from the hit reality series they will create, starring you and couple B.



Honestly, even if the actual Reno and flip is a success, If wager you will never talk to them again.



My two bits,

Keith.
 

TommyK

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Registered
It does sound very scary!



The reality is we can't afford to live on our own without roommates. And I need help with the reno if we want to build equity from property improvement. This is the reason why I propose to split the reno cost so that if one party wants to go crazy with materials, then at least they are paying half of it! lol



One good thing is.. there will only be one woman in the household.. three guys... so no period will be synched! The woman is over 50 so I think she has her menopause.... LOL
 

therenoguy

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Registered
It still smells Titanic-esque to me.



I'd suggest one of two tacks:



1-you buy, you pay for all materials, you rent the basement to him, and then hire him to do the work. That way you're not married to him if it doesn't work out. You take your chances that you can make the flip work. If not, you continue to live in the house, and rent out your basement(to him, or anyone). When you sell, you take the profits.



2-admit you can't afford Vancouver right now and save/make enough cash until you can. Pinning your future financial success to a deal which could get submarined by a multitude of potential problems, most of which no one can even imagine or predict now, is very, very dangerous.



all the above advice and 1.50 is worth exactly 1 medium coffee...

Keith
 
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