AMA - How Much To Offer Partners?

The Real Estate Espresso Podcast

AMA – How Much To Offer Partners?

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AMA – How Much To Offer Partners?

Welcome to the Real Estate Espresso Podcast, your morning shot at what’s new in the world of real estate investing. I’m your host, Victor Menasce. Today is another AMA episode, that is, Ask Me Anything. I love to answer your questions and if you have a question that you think could be of broad interest, send it in. I’ll answer it live on the air. Send your questions to victor.victorjam.com.

Today’s question comes from Eddie in New Mexico, and he asks, “out of a 50-50 split, how much should be allocated to bringing in investors, bringing in the property, bringing the deal know-how?” Well, Eddie, this is a great question. There is no one-size-fits-all answer to this question, but I can give you some principles that we adhere to when it comes to deciding how to structure a project.

The first question is how much debt to bring into the project vs equity. We always want to make sure if the project is being financed, particularly with construction financing, there’s enough buffer to comfortably transition into permanent financing without a capital call. In today’s environment, lenders are going to specify their permanent financing as either a maximal loan-to-value ratio or as a minimum debt coverage ratio; in our experience, it is usually the debt coverage ratio that is the limiting factor.

The decision as to how much to offer the investors is based on the financial model of the project. I’m assuming in all of this, the project generates enough economic value that it will spin off a respectable rate of return to investors. Now, we always back into that number.

For instance, let’s say our target annual IRR might be 20%. Of course, the project has to deliver more than that, and we’ll dial the ownership accordingly to achieve that number. This doesn’t mean that the project would be a perfect fit for all investors. You need to decide what type of investors you want to attract and then structure the deal appropriately to match the appetite for those investors.

For example, if you’re aimed at cash flow, then you’ll want to structure the offering to deliver cash flow. Conversely, for investors who are mostly using retirement funds and don’t necessarily need the cash flow right now, perhaps an offering that favors appreciation would be a better fit. In fact, you might even have more than one offering for a single project. You could have a quasi-debt offering that favors cash flow and a growth offering that favors appreciation within the same project.

In terms of partner equity splits, numbers can vary widely. For example, you might bring in a partner purely to add some balance sheet strength for lending. Though that partner might not put any cash in, they’re simply offering their signature to fortify the loan application. This could lead to favorable loan terms such as a lower interest rate or a higher loan-to-value ratio. I’ve seen this kind of contribution be recognized with a few percentage points of the deal.

Please remember, though, that it is illegal under SEC rules, and probably other jurisdictions as well, to link compensation to the amount of capital raised from investors. The only exception to this rule is if the individual is a FINRA-licensed broker-dealer. Any compensation you offer to partners should be linked to the work they carry out on the project, not capital raising. Again, I strongly encourage you to consult your securities lawyer for guidance on these points.

In conclusion, there are various ways to engage people in your project. You can bring them on board as partners, employees, contractors, or advisors. Remember, offering equity in a project that might not be as liquid as other forms of compensation can become a problem, especially if that partner is not going to be actively involved throughout the course of the project.

Thank you, Eddie, for your question. And to the listeners at home, have an incredible rest of your day. Go out there and make some great things happen. We’ll talk again tomorrow.