Real estate question

[Scout]

I’ve always been interested in diversifying outside of the market with real estate, but never had an interest in managing properties. I’ve always asked my landlord/friend to keep me in mind with opportunities. He’s proposed we purchase a 12 unit property, but I would be the putting down the majority of the down payment ~70% on a 20 year mortgage and I’d be repaid using a ‘15/50/50’ method such that I receive I assume an additional 15% of total monthly income until the difference is accounted for. This is projected to take a little more than 7 years and then after that everything is split 50/50 including profits made on thé sale of the building. Of note, he’ll also be providing property management and we’d split all expenses. I know this only scratches the surface, but from 1000 feet does this sound standard?

((Im still trying to wrap my head around the numbers (vs a typical market return) which I’m happy to provide It seems like the worthiness of an investment like this very much depends on the actual property value in 20 years as the cash flow provided will not come close to returns in an index fund earning 6% over that time frame. Given the nature of this housing market I tend to think the appreciation on this particular property will not match the 4% growth our area has experienced over the last 20 years.))

 

[Starsky]

Quick thoughts. He is paying you back the extra 20% down over time in cash and the property management is the 'interest' for loaning him that money for 7 years. What happens after he pays you off? Who makes the decisions in a 50/50 relationship if you disagree? Will he want to collect a salary for providing that service, or will he do it for free forever?

If you both can get along over the long run, and he's trustworthy, it could be a good deal. Or not. How well do you know this person and would he be a good partner?

Only you know the numbers and can decide whether it's a good investment or not, but you may want to define the relationship further and quantify the value of his services compared to the loan interest he would otherwise pay as a way to make a decision about that arrangement. FWIW, I pay $75 per rental per month plus a months rent for a new tenant for management, and I think my monthly rates will probably go up for the first time ever this year (which is ok with me).

If you are making a true go/no-go analysis, I'm not sure where you'll get a 6% guaranteed return these days on your money - or in the foreseeable future. Also, you really need to look at your personal financial situation and the tax benefits of this project. The depreciation may help you lower your taxable income while adding cash flow at the same time, which is a nice situation that materially affects ROI. How it affects your taxes could greatly depend on how you structure your business - partnership, Corporation, LLC, etc.. FYI, with 12 units, you can qualify for an SBA loan and put 10% down on the total investment if you want.

 

[OldShooter]

I've done a few RE deals and owned quite a few duplexes, fours, and small apartment buildings.

IMO this is a lousy deal for you. You are providing the majority of the down payment, hence taking the majority of the risk (including that the "15" will be paid), yet you share the building appreciation equally.

Will your junior partner manage for free? What happens if he becomes unwilling or unable to do this? Whose names are on the mortgage? Does your state permit deficiency judgments if the deal bubbles and the building gets reposessed? Who is the seller? How will you know that this is an arms-length deal between your junior partner and the seller? Do you expect to live for another 20 years? (Not "hope." "Expect.") Who inherits the building when you die? Are they stuck with it or can they sell to your partner? What happens to you if he dies and his heirs want out? What does the proforma income statement look like vs the past few years' history? Guaranteed there is deferred maintenance from the day the owner decided he would be selling it. How much? What is the regulatory environment? Does the city council consider landlords to be enemies of the people like ours does? Are there restrictions on tenant screening? (Like no asking about past felonies.) Is there talk of rent control?

How big a piece of your net worth would this be? Would your retirement lifestyle be significantly hurt if this turned into a stinky negative cash deal with you writing a check every month for the balance of the 20 years or selling at a loss?

Find a CPA and an attorney who are familiar with local mom & pop landlording and see what they say. Find your state multi-housing association (they are mostly the big guys) and see what you can learn there.

 

[pb4uski]

Can you elaborate on this 15/50/15 method?

Sounds like you'll put up 70% of the down payment and he'll put up 30%? And then you get the first 15% of monthly income (rents or rents net of operating expenses) until you get repaid... but is there any interest on the extra 20% that you are putting up?

I woud reframe the deal slightly. You and your friend form an LLC that has 100 shares and you each put in 6 of the total cost in exchange for 50 shares each. Additionally, you loan 8 of the total cost in exchange for a secured note that accrues interest at x% and 15% of the cash flow goes to paying off the loan. Then the LLC buys the property for 100, with 80 of mortgage financing and 20 down payment (6+6+8).

Unlike my good friend Old Shooter, I don't necessarily see it as a lousy deal for you... it is just different for you vs your partner. Neither you or your friend can put up the 20 needed for the down payment so this is the only way to do the deal.

 

[Mr. Tightwad]

I always invest with me as the sole owner.

The only ship that doesn't sail is a partnership.

 

[Bruceski44]

...using a ‘15/50/50’ method such that I receive I assume an additional 15% of total monthly income until the difference is accounted for.

Does this snippet mean you'll get 65% of the monthly income initially? i.e.: a 50/50 split, then your "additional 15%?" You said "additional..."

 

[Retired Expat]

How you get paid back is one issue, how the deal will do is another? I look for my rental properties to offer a net 6 % return on the rental and usually 2-3% annual in value appreciation at a minimum. Lately that is more like 2% a month!

 

[Letj]

How you get paid back is one issue, how the deal will do is another? I look for my rental properties to offer a net 6 % return on the rental and usually 2-3% annual in value appreciation at a minimum. Lately that is more like 2% a month!

Are you looking for a 6% return on the rental unit or a 6% cash on cash return?

 

[WhatsIRR]

The other option if you can find one you like/trust is syndicates. We’ve invested in 4 properties through syndications. We receive quarterly returns and then will get the principle and appreciation returned when the property sales. You are 100% hands off but have to be ok with someone else controlling your investment.

 

[Retired Expat]

Are you looking for a 6% return on the rental unit or a 6% cash on cash return?

I look at cash on cash return, mostly

 

[CRLLS]

Why not set it as you get 70% and he gets 30% of net profits, as per the down payment ratio, until you get paid (with interest on the 40% difference). That interest rate would be at least as high as similar market returns IMO.

Then there is how the ownership is legally done. i.e. as an LLC, as a simple partnership, . And what is the agreement on how to dispose of the property if one, or the other are to decide they don't want to play that game anymore or files bankruptcy, or.... What happens to the co-ownership if one of you pass? These are just as big a deal as the payback calculations IMO.

 

[Scuba]

I know it’s hard to even think about this in the current real estate market, but what happens if the economy crashes and the rental is not performing, and depreciates in value? You are taking most of the risk by funding most of the up front investment, and in my opinion you are not being compensated adequately for that.

My best friend got totally burned on an arrangement not too dissimilar in 2007. She put up all the cash, her “partner” and she had joint ownership, and he contributed his “expertise.” They did several deals together and the properties all crashed in 2008-2009. He walked away completely free and she had a bunch of foreclosures on her credit. Not to mention she lost a beachfront condo that she took equity out of to fund these investments.

 

[rodi]

I hate to say it - but the same logic I apply to variable annuities I apply here... If it's too complex and you don't understand the details, it's probably good for the other party, not for you.

Same as with annuities you need to ask:
- Can I get my money out? Are there surrender charges?

The devil is in the details.

Personally - I would not do it.

 

[chassis]

You want to diversify out of the market. You want real estate. You mentioned a 20 year horizon. Is this correct?

The deal proposed sounds like it's too much downside and too little upside in my view. You don't appear to have previous RE experience; not a criticism just the situation as it is. If your friend doesn't have RE experience, it's a big red flag. If your friend has lots of experience, it's still a red flag because you as the majority investor would be relying almost totally on your friend's knowledge and abilities.

Have you considered vacant land that will, or is likely to be, developed within your 20 year horizon? For example a parcel on the corner of intersecting roads, near a freeway ramp, future residential subdivision farm acreage, etc.? The downside in this scenario is potentially a long time with no income while paying property taxes, but the upside could be significant on the resale. If purchased well, the book value would not decrease, or would decrease very little, during the holding period.

I assume you are familiar with a REIT investment as another alternative.

 

[Scout]

Thanks for all of the responses. I’m trying to respond to each question (some with a question), but I’m having difficulty copying/pasting only small sections from each post. Is there a way to do that on an iPhone or do I need my PC which I don’t have with me this weekend? My general feeling is that this is not a good deal for me at all Bc I’m not earning interest on this loan. The suggestion of getting a SBA loan at 10% down was good and I’m looking in to it as it would bring the down payment into a range my friend could
Put in 50% which still makes me hesitant bc I don’t have good answer to many of the other questions posed such as what happens if housing market crashed, he died and heirs wanted out and new property manager price made it non profitable. The question regarding my time horizon…I’m 46 so I do expect to still be alive in 20 years. As far as percentage of my net worth/retirement…Thé whole unit represents ~20% of net worth and I could somewhat easily fund the mortgage if needed although that would be painful. Im still learning to ‘Blow that dough’, but that’s another post:-/
If you know how to copy and paste snippets from an iPhone let me know if not I’ll respond more thoroughly next week.
Have a great weekend

 

[chassis]

Thanks for all of the responses. I’m trying to respond to each question (some with a question), but I’m having difficulty copying/pasting only small sections from each post. Is there a way to do that on an iPhone or do I need my PC which I don’t have with me this weekend? My general feeling is that this is not a good deal for me at all Bc I’m not earning interest on this loan. The suggestion of getting a SBA loan at 10% down was good and I’m looking in to it as it would bring the down payment into a range my friend could
Put in 50% which still makes me hesitant bc I don’t have good answer to many of the other questions posed such as what happens if housing market crashed, he died and heirs wanted out and new property manager price made it non profitable. The question regarding my time horizon…I’m 46 so I do expect to still be alive in 20 years. As far as percentage of my net worth/retirement…Thé whole unit represents ~20% of net worth and I could somewhat easily fund the mortgage if needed although that would be painful. Im still learning to ‘Blow that dough’, but that’s another post:-/
If you know how to copy and paste snippets from an iPhone let me know if not I’ll respond more thoroughly next week.
Have a great weekend

@Scout multi quote on the phone might be hard. You can tap the "quote" button on the phone and quote+reply to individual posts. More effort but maybe clearer for all.

20% of your net worth in RE, and you don't have experience in it, and you are considering getting into a potentially risky deal in an unfavorable position?

For me the answer would be: no way.

 

[OldShooter]

... I don’t have good answer to many of the other questions posed such as what happens if ... he died and heirs wanted out and new property manager price made it non profitable.

@Scout, my point in asking those questions was to get you to see how complex your proposed relationship is. These and many more are addressed by the lawyers (yours and his, separate) as part of a partnership agreement. Such agreement will also include a buy-sell agreement with buyouts possibly funded by life insurance. Your attorney will guide you through this swamp.

... The question regarding my time horizon…I’m 46 so I do expect to still be alive in 20 years. As far as percentage of my net worth/retirement…Thé whole unit represents ~20% of net worth and I could somewhat easily fund the mortgage if needed although that would be painful. ...

Unlike @chassis, with this information I don't think you're in a bad spot to take a little risk on a real estate investment. You probably have a long working life to recover if the RE is a disaster and anything immediate won't hurt you too badly. And, hey, it might be a great investment!

I still don't like this deal, though. I suggest that you consult your network, particularly CPAs and attorneys, letting them know that you're interested in hearing about good private real estate deals as they come along. In Olden Times we were limited partners (aka silent partners) and there was an experienced general partner doing the deal and running it thereafter. I'm not sure what they call the general now that everyone is using LLCs, but it is the experience and strength of the general that you want to look to to evaluate the deal. In particular, the general should get most of his profits when the property is sold, not from fees paid from the cash flow (aka paid by the limiteds). Your CPA can help you analyze the deal. Also, these will effectively be non-recourse where your risk is limited to the money you put in.

Here is a useful general rule: Never fall in love with a deal. There is always another one coming.

 

[Scout]

Thanks chassis
To be clear the total exposure I’d have would be 20% amount invested would represent ~2.8 percent of net worth. But still….
Thanks for info on multi quote

 

[street]

I wish you well in your decision. I have bought land and sold land almost all my life. I have not bought any real-estate that was a house or apartment etc. I have bought land, bare land and have done well and will always have real-estate as part of my portfolio.

 

[mboley]

Thanks chassis
To be clear the total exposure I’d have would be 20% amount invested would represent ~2.8 percent of net worth. But still….
Thanks for info on multi quote

Sounds like you can afford to do a deal by yourself. You dont need a partner to manage the property, just hire a property manager if you dont want to do it.
You never said where the property is located.

 

[SJ1_]

I would run - partner with a bank. U can lose everything if ur parnters becomes an addict alcoholic etc Believe me this does happen
ur financially responsible for his life and decisions

 

[Letj]

The other option if you can find one you like/trust is syndicates. We’ve invested in 4 properties through syndications. We receive quarterly returns and then will get the principle and appreciation returned when the property sales. You are 100% hands off but have to be ok with someone else controlling your investment.

What do you mean by syndications? Do you mean DSTs? I am considering them now but worry about principal preservation and consistency of returns. Do you mind sharing your experience with these type of hands off real estate investments where you don’t have any control? How do you plan on getting out of them.

 

[WhatsIRR]

What do you mean by syndications? Do you mean DSTs? I am considering them now but worry about principal preservation and consistency of returns. Do you mind sharing your experience with these type of hands off real estate investments where you don’t have any control? How do you plan on getting out of them.

This describes it better than I could:

https://www.google.com/amp/s/www.mi...nvesting-basics/what-real-estate-syndication/

Each of our properties is set up as an LLC not a DST and are not easily available for a 1031 but since we are owners we do get to claim depreciation on the properties.

I have been happy with our experience so far. I do not have the expertise or the time to hunt real estate so the hands off approach is preferable. I ran some rough numbers against SFH rentals and feel like I was giving up a couple percentage points of return by outsourcing. The benefit is the company we are working with often gets off the market deals brought to them that as an individual investor I’d probably never see. They are also investing in large apartments and hotels so the risk is spread across multiple tenants instead of a SFH, again I would not be able to accomplish this alone.

On the apartments the returns have been as presented in the Pro Forma, Covid was a small hiccup early but ended up not being a big deal. The hotels were hit hard from Covid and are still recovering.

One big concern for some is the money is tied up and not liquid. The investment package has an exit strategy of usually 5-6 years but until then the money is not available. I would not go all in with my cash but am using it as an augmentation to our taxable brokerage account.

We are working with a company that started as invitation only and have never used one of the website crowd funding sites. I honestly don’t believe I would use those. I have met the people running our company and have had multiple email exchanges on the fine details and questions on proposals so I have never felt like there is communication problem.

I plan to continue to invest into opportunities that I like the looks of as I have the funds and feel comfortable locking them up for the next 5 years.

 

[wolf]

OP:

Lot's of useful information. Based on your comments, and your original post.

" I’ve always been interested in diversifying outside of the market with real estate, but never had an interest in managing properties."

"Never had an interest in managing properties. " IMHO, Rule #1. To be a landlord, you must have an interest in managing properties. Requires a certain mindset.
So....this might not be your cup of tea!

However, if you really want to try. I suggest. Start small. Baby steps.

Buy a House, and rent it out. You will learn, location, cash flow, depreciation, repairs,
tax law, people skills (good/bad tenants). When you do all this, managing.

It will be much easier to progress to a larger more complex rental unit. You will have learned, how the "game" is played. IMHO, there are no short cuts! Requires work.

Good luck.

 

[Scout]

Thanks again for all of the very helpful comments. You’ve essentially helped talk me off the cliff. The initial investment would represent a very small portion of my portfolio, but with the entire unit representing 20% and I really have no idea how to navigate (nor that much interest in learning) it would likely be a foolish thing to jump into. This is why I love this forum!