Good Deal? Partnership Question - Posted by Sean

Posted by Sean on July 29, 2003 at 08:12:31:

Dear Sir:

Thank you very much for your thoughts.

A provision for “prior to 5 years period” was not something I came up. By making it unilateral agreement (ensuring that they will not exit at least for 5 years, I can buy back their shares within 7 years at no extra, and I can ‘kick’ them out by paying for 5 years of interest), it is actually favors my goal.

I intend to enjoy its capital gain thus would like to hold more than 5-7 years. My object is to get 100% ownership within 7 years.

As for the cash reserve, I will build into the Agreemtn. However, what is the general rule of such cash reserve when it comes to apartment buildings? I am only interested in less than 20 years old building. I also have relatives who owns architectural firm and general construction business. Therefore, I can easily make all expenses extremely low.

What I encounter is that the investors want both CF and preferred return on investment, not interested in CG at all. It sounds just like a “growth fund” to me.



Good Deal? Partnership Question - Posted by Sean

Posted by Sean on July 27, 2003 at 04:01:36:

I am in negotiation with cash investor to purchase an apartment. A cash investor means, they will not do anything besides putting some cash (equity) into the property when purchasing.

Initially, they offered me as below:

Myself: Investor:
Cash Flow: 30% 70%
Net Income: 30% 70%
Profit on Sale: 100% 0%
Cash Input: 0% 100%
Preferred Return: 5%

Credit Requirement: Myself
Loan: Myself
Cash Requirement: Investor
Purchase: Myself
Property Management: Myself
Any Other Taks: Myself

  1. 5% interest will be paid on whatever they invested into the property.
  2. They will not exit for 5 years. Thereafter, I will hold a right to buy back their share wihtin 7th year.

Basically this means that they want both Cash Flow and interest on the cash they invested by giving up any capital gain. When they exit, I will simply hand out their initial cash input.

Since they will take care of all cash requirements when I purchase, it is a true No-DP deal to me. However, I feel that my CF is too slim…since I am the one whose getting the loan, I feel that I can get a little more.

What is your opinion. Is this a good or bad deal? Both opinions are welcome. I also would like to know how to correct (restructure) the deal as well.

Thanks for your valuable time.



Re: Good Deal? Partnership Question - Posted by RobH_WA

Posted by RobH_WA on July 27, 2003 at 20:45:08:

Some questions, in no particular order:

1 Who has title?
2 Who decides when a sale is to be made? ie, can you trigger a sale before 5 years if the Cap Gain is there, and can you hold beyond 7 if it isnt?
3 How is the depreciation recapture calculated on sale?
4 Is the preferred return before calculating the 30:70 split of any residue or is it the minimum return the 70% share would receive before you would receive your 30%?
5 Is the preferred return cumulative? (eg what happens in later years if cash flow is negative one year - do they get their 5% for any past year before distributions are made for the current year)
6 What are the distribution periods (annual?)
7 Given that you get the CG and they get majority of the CF how do you decide upon maintenance and capital expenditure costs (assuming these in general lower CF but boost eventual CG?)
8 Does CF/NI calculation allow for a payment to you for management?


Re: Good Deal? Partnership Question - Posted by Sean

Posted by Sean on July 28, 2003 at 24:56:34:

Thanks for your input!

Below is additional info:

1 We (myself & cash investor) intend to form a new LLC. The new LLC will hold the title. However, I will make financing arrangements with lender/s.
2 There is no exit for first 5 years. After that period, I can trigger a sale with 60-day notice. I intend to hold the property after 5 years therefore, I will give back the original cash investment (cash investors does not want any CG). I will have to have them exit before 7 years. In other words, I can trigger a sale between 5-7 years.
3 If the property was depreciated using the straight-line method, there is no depreciation recapture. Could you please clarify this question more?
4 Cash investors will take 5% on the cash first, then 30:70 split.
5 If our cash flow portion does not meet 5% return, then a remainder will happen in next month. No interest or late fees on those unpaid 5% return.
6 Distribution will be made monthly.
7 After mortgage and all the monthly expenses, it is up to me how I want to spend on the property to boost its value.
8 Cash investors say it is OK to take 5% Property Management fee.

I wonder what is a general equity partnership share (split) out there… This deal seems to me it is unfair to me. Or, am I trying to get more than I should get?

I look forward to hearing from you soon,


Re: Good Deal? Partnership Question - Posted by RobH_WA

Posted by RobH_WA on July 28, 2003 at 13:18:20:

Some thoughts:

  1. Why not build in a provision for investors to be paid x if you decide to sell before 5 years? For example, they could get their annualized 5% for the remainder of the 5 years left prorated from date of sale, and the fact that they get this paid early compensates them for not getting any additional CF. Point is if market moves quickly why restrict yourself to not selling within 5, it may still be worthwhile to pay them off and it would be a one-way option in your favor. In simplified form, say the DP was 20% and sale made after 2 years for a 25% gain. They would get 23% of the original cost (20% returned plus 5% of that for 3 remaining years)whereas you would get 125% less the 23% less 80% (loan outstanding might be less) = 22%.

  2. That’s not my understanding, but I am not an accountant.

  3. If it is to be so frequent then you will definitely need an agreed cash reserve, especially in view of 7. CF could fluctuate wildly on a month to month basis, even with a steady rental, depending on when major costs are incurred.

  4. There is the potential for major disputes here. You could effectively ensure that there is no residual cash over the 5% (or never even make the 5% depending on how thin the CF is to begin with) by spending on maintenance and capital expenditures, or by the terms of your financing. As it stands it would appear to be in your favor, but if I was the money I would want some control over how my 70 cents on the dollar was being spent.

Overall it would seem to be simpler to give a higher preferred return and no participation in excess. That way the issue of spending control is removed as it would come from CF and affect your CG. That is of course very close to the money holding a note as 2nd, and that approach (or even the one that you currently have) may raise issues with a lender since you will have no money in the deal, but that would need to be checked out.