Contractor Joint Venture

Here is a conversation that was recently posted on Facebook between a real estate investor and his contractor, a prospective joint venture partner:

Contractor: Can you tell me what you can offer?

Me:  Well I buy a lot of houses at good prices and need a few trustworthy contractors with some capital to partner up to fix them and sell them for a profit.  I will be responsible for finding the deal, buying it using hard money loans, making monthly payments, and then reselling it.  The contractor will be responsible for managing the project and providing the capital to renovate the house within a reasonable budget and time frame.  Once the house is sold we would split the profit 50/50.

Contractor:  So you don’t use your money to buy the house?  You have to use hard money loans?  What are the terms?

Me:  I buy too many houses and simply do not have all the capital to buy them outright.  I’m using hard money loans with 5% down, 2 points in fees, and 12% APR

Conctractor:  How much money do these projects usually require in order to fix up?

Me:  Most require at least $50,000.  Some can run as high as $100,000.  But the ones that require more capitals tend to have higher profit margins so we will end up making more.  I usually start out a new business relationship such as this with smaller, easier deals to test out the contractors' skills and capabilities.  As time goes by and things are tested and proven, we could do even bigger deals where fixing costs could be beyond $150,000…

Contractor:  Hmmm…  So you won’t help me with some of the capital for fixing the house?  Will you even help me with fixing the house?

Me:  At this point you would have to provide your own capital.  I can provide you with some sub-contractors that you can use but typically you’d have to find your own employees or subcontractors and manage these projects yourself.  Keep in mind that whatever deal I bring to you, it’s up to you to determine if you wish to be involved or not.  I would not force you into working with me on any deal.  The choice is always yours.

Contractor:  Hmmmm…  This still doesn’t seem fair as I will be spending more money and time on these projects than you.  You just buy a house, put only 5% down and make some payments.  I would have to take care of everything else

Me:  Well, let me ask you this…  How many houses have you bought and sold for yourself the past 12 months?  How much did you spend and how much did you make on each deal?

Contractor:  Well, I was able to buy 3 houses.  I also got hard money loans for all of them but I put 20% down on each loan.  I spent about $40,000 on fixing costs on each house.  In the end I made about $19,000 on the first house, $25,000 on the 2nd house, and $14,000 on the 3rd house.  The 3rd house I could have made more but the buyer ended up asking for a bunch of extra things and I didn’t want to hold it for too long…

Me:  Did you have to spend time doing actual work on these houses?

Contractor:  I did some light work and the rest I hired other people to do

Me:  Under my system, you are only expected to manage the employees and sub-contractors.  You would have to identify finish products to be used on the house but you are not expected to do any physical labor.  Furthermore, you seem to be spending a lot of money for such little profit.  I buy houses very cheaply so the profit margins are a lot higher.  Net profit per house is anywhere from $40,000 to $80,000 and sometimes even higher…  The value I bring is my ability to find these good deals routinely.  If you are capable, we can do a lot more than the 3 that you got for yourself last year.  Plus even if you get only 50% profit, if you do the math, you’ll ended up investing less money per deal and make more per deal as well.

Contractor:  But I would still have to put more time and money into each deal than you.  I can manage the projects but I don’t think it is fair that I may have to put in a lot more money than you.  It would be fair if we put equal amount of capital into each deal.

Me:  So you don’t care for that facts that you’ll make more money and get more deals working with me?  You don’t care that you’ll ended up spending less money and have less risks working with me?  All you are focusing on is the fact that you spend more money per deal than me?  What about the marketing costs I have to spend to get these good deals?  What about the numerous hours I have to spend talking to sellers, agents, wholesalers, or other investors in order to get some of these deals?  What about the money that I spend to subscribe to web sites for leads generation?  What about the hours I spend analyzing numerous leads just to get 1 or 2 workable deals?  Those money and time I spend don’t count for anything?

Contractor: …. ….

Me:  I’m sorry but the fact of the matter is I have a system that enables me to buy 50 to 60 houses a year.  Your system doesn’t get you anywhere close to that.  Furthermore, your way of doing business and viewing “fairness” haven’t gotten you that far in this flipping business.  However, if you are happy with the ways things are working for you, then I have no say in such matter.  But if you are not completely satisfied with your business, perhaps you should go home and reconsider my proposal before determining if it is fair for you.  Don’t worry about what I get.  Look more into what you could get working with me.  Here is a list of houses I bought and sold just within the past 12 months.  You could check with title companies and agent friends to find out what I bought and sold them for…

Me: In addition, if you do 1 deal with me and you don’t like how things work out, then you could always stop working with me.  I’m not going to twist your arms or put a gun against your head.  You can do whatever you think is best for you.  I would never force you to do anything against your will.  Have a nice day and I wish you the best of luck.

All in all, some pretty good ideas about how an investor might structure a working relationship with his contractor.

Happy Investing!

Joint Ventures

There are many reasons to bring in a partner when it is not possible to cash out a Seller. It is another way to negotiate with a Seller to do a real estate deal. In fact, your Seller may be interested in a joint venture, where they front the property and you the investor does the work.

A joint venture is two or more people in a deal.  They have a single purpose - to develop or improve the property - but separate identities.

Don't do an LLC or partnership, as that requires the investor to take on the partner's liability.  Several real estate gurus recommend to buy the property in a land trust, where each joint partner has a percent interest.  Name of the land trust and trustee are in the public record.  The trustee does not have to disclose ownership or beneficial interest, except by judge order.  The written trust agreement shows the beneficial interest and ownership.  This is private document.  

There are at least three ways to structure a joint venture, according to real estate investor Chris McClatchy:

1. The Seller pays the mortgage, if there is one - with no interest, no payment by the Buyer (joint venture partner).  The mortgage is paid when the property is sold or refinanced.  At that time the original contribution by each is reimbursed, and then profits are split at 50/50.  The Seller's contribution is not a loan, but an equity investment by each joint venture partner.  Any additional cash flow can also be split 50/50.
2. A joint venture partner may pay for the property with a seller-financed mortgage-no interest, but with installments spread over 10 years of payments.  Additional cash flow may be split and profits shared upon sale 50/50.
3. Buy-in method, where Buyer and Seller contribute equally or investor pays a low cash price.  All cash flow is divided.  Profit is divided.

These are a few ideas about joint ventures to get you started, and give you one more tool in your tool belt of negotiation options.

Happy New Year!

Happy Investing!

Why doesn't this buyer get a mortgage?

In today's lending environment, there may be many reasons why an investor could not or chooses not to qualify for a mortgage without a credit partner (or co-borrower). It may be because they are not a W2 wage earner, cannot document earnings (which may be invested in their company as opposed to being paid out as wages), or simply because of the difficulty in today's lending environment of receiving a stated income loan. There are new limits on the number of mortgage loans that an investor may have in their name, or requirements for debt to income coverage on their investment properties that limit their access to conventional financing.

However, with access to today's historically low mortgage interest rates, a savvy investor can generate enough rents and income to create cash flow on properties that may be expected to appreciate in value as the real estate market recovers. A solid investor partner should have no trouble covering costs of obtaining a mortgage for their credit partner, as it is much less expensive than obtaining hard money or other short-term financing.

In the next blog, we'll talk about the risks that a credit partner faces in working with an investor.

Equity Partner on Lease Option Deal

So how would I approach an investor to partner on the lease-option deal described in the previous blog?

In my previous blog, I talked about how I would structure a lease-option purchase for a waterfront property listed for $325,000. In this blog, we will look at how this agreement would appeal to an investor and equity partner.

A conventional mortgage of $250,000 would be needed to replace a hard money loan currently in place on the property. So an investor/equity partner would be someone who was able to qualify for a $250,000 mortgage. As owner of the property, I would be listed on the loan with my equity partner.

The loan would be a conventional, non-owner occupied, interest-only loan, as we expect our lease-option buyer to be able to purchase the property from us in 2-3 years. We could also take out a fully amortized 30-year loan, if we had doubts about the ability of our buyer to exercise their option to purchase, or if we wanted to build in flexibility for future exit strategies. A fully amortized loan would cost us more, but interest only, with taxes of $308 and insurance of $50, would cost us $1800 per month.

If our buyer is paying us $2500 per month (see previous blog), then my investor and I are splitting $700 per month for three years ($25,200 total over three years).
I will cover all the costs of the loan out of the down payment provided by the buyer, so there is no cost to the investor to take out the mortgage—and they are making $8400 per year. In addition, as my equity partner, they get to deduct mortgage interest from their taxes and depreciation on our investment property. Since we are paying interest only, approximately $1440 per month of interest is tax deductible. In addition, they get to depreciate the value of the house (but not the land) over 27.5 years, further reducing taxable income.

As added incentive, I agree to split the net profit on the house over and above my basis of $325,000. So if the house sells for $337,000 ($357,500 less $12,500 as option fee and $18,000 in rent credits), we split another $8000.

So my investor/partner earns a total of around $29,000 over three years for their ability to take out a mortgage, an infinite return on their initial investment of $0. Not bad, eh?