Posted by John B. Corey Jr. on July 01, 2005 at 12:20:11:
One answer is to offer then the minimum that they will accept. They might choose badly as they are not that used to such investments. Hence ill will could developer later if you given them what they want.
If they were to supply the funds as a loan then they have some extra security. Hence they would expect (or should expect) a lower return then if they were putting in cash as equity.
Things to consider.
Appreciation. As this sounds like a commercial property the appreciation is more the result of the management then it is of the general market. Hence passive appreciation (market forces) is a bit different then active appreciation (good management, improving the property, changes that fundamentally shift the NOI).
There are tax benefits that can be carved out to some extent. The tax benefits might have different value to each investors. Write offs now and possible capital gains treatment later. Hence the deal can be structured to bias the tax benefits to some investors and not others.
The investment is illiquid and has higher risk. If the cash stays in a bank account the investor can pull it out any day and they are very well protected compared to investing in a specific piece of RE. Hence there should be some benefit for taking on the added risk and lack of liquidity.
The opposite is also true. If you set up the deal so that they can get out at a specific point in the future or so that they are less at risk then some other investor in the deal then it will make sense that they earn a lower return in comparison.
- NOI - You made no mention of what the property should produce in spare cash flow. Remember that the person managing the property should be compensated for their time and effort. Hence more of the NOI can go to the active manager. You can leave the ‘surplus’ NOI in a account for the benefit of the project. A reserve that builds up to deal with major improvements, etc. If there is more cash then is needed and it sits there the excess can be distributed to the investors as an interim payment or at the end of the project’s life.
You can use the NOI to buy out the partners who put up the cash assuming that is something agreed to initially.
Luis - Golden rule for such deals. Assume that you will get real good at finding deals. Figure that this deal is nothing. Hence take real good care of the investors so that later then want to do more with you and they brag to others how well they did. That way you will have people chasing you with cash. Take care of them this time and you will have a gold mine to draw on for future deals.
Simple math - If they are expecting X in total return pay them 110% of X. Exceed their expectations.