Jays 90/10 Money Partner Plan for Cash-Poor Investors
My 90/10 money partner plan is a shared ownership arrangement, an ideal two-party investment vehicle for the active investor, with the ability to fix up and manage the property, and for the passive investor, who can supply most of the cash that’s needed.
It means that my partner and I will both invest in a property. The partner will contribute 90% of the cash down payment—making him or her the money partner—and I will pay the remaining 10%. For this plan to work, the down payment should be at least 20% to 25% of the purchase price. I prefer not to scrimp on the cash down payment. The reason is that when the mortgage debt exceeds 80% of the purchase price, there is great danger of having negative cash flow while operating the property. The down payment should always be large enough to reduce the principal balance so that the income generated from the property will cover both the mortgage payment and operating costs.
When you locate a property that seems promising, keep in mind that you will need to thoroughly check out the income and expenses. You don’t want any hidden costs of operation to show up after you close the deal. It can be very awkward explaining to your partner that, because you underestimated operating costs, he or she must now come up with additional money every month. It’s also not very good for the track record you’re trying to establish.
How the 90/10 Plan Works
The 90/10 plan works like this. I find a money partner who will put up 90% of the cash down payment after I locate a good solid money-maker property and agree to do the daily management. The money partner is basically a hands-off investor. I will be the field manager and operate the property. I agree to do the renting, cleaning, fixing, advertising, and whatever else is needed to make our joint investment profitable for both of us.
To illustrate how my 90/10 plan works, let’s go through some numbers. Assume we locate a $90,000 rental house that we can purchase for $80,000. That shouldn’t be too difficult to do when we can pay $20,000 cash down. The money partner in this case puts up $18,000 (90%), of the down payment cash and becomes a 90% owner. I contribute $2,000 (10%) and get 10% ownership in the property. Remember, I’m only talking about the down payment here. I continue to contribute my services throughout our ownership period, which is normally set up for a period of 10 years on my agreement.
By the way, don’t make these deals without a co-ownership agreement. Investment partners should always decide up front how long they wish to be partners. I personally like to state a firm termination date, then provide for extending it if we should choose to continue. The agreement doesn’t need to be long and complicated; however, it must cover the important terms, as with any co-investment venture. See the previous chapter for an example of how to use my co-ownership agreement.
For Just 10% Cash, I Receive 50% Profit
Although I’m only a 10% cash investor, I will earn 50% of the profits at the end, plus there’s an excellent chance I’ll make a few dollars from cash flow along the way. At the end (the date is specified in our contract), the profits are split like this. First, the 90% investor and I will both get our down payments back ($18,000 for the 90% investor and $2,000 for me). After that, the balance is split 50-50, after subtracting what we still owe on the mortgage. For example, let’s say the $90,000 property we buy now for $80,000 sells for double that amount 10 years from now—$180,000—and the original $60,000 mortgage debt is paid down to $50,000. Here’s how the numbers would look:
Original purchase price: $80,000
Cash down payment: -20,000
Mortgage balance to start: $60,000
Selling price after 10 years: $180,000
Mortgage balance after 10 years: -50,000
Gross profit: $130,000
Original cash down payment (returned to investors): -20,000
Net profit to split 50-50: $110,000
I realize there will be selling expenses (escrow fees) and, perhaps, real estate commissions to pay. However, as you can see, there’s still a sizable profit.
Depending on how long the contract agreement is and how much the property appreciates in my particular investment area, I expect to earn a substantial return on my 10% portion of the down payment. Naturally, I’ll get my $2,000 back, too.
High Returns and Buying Power Are Keys to Plan
The reason I like the 90/10 plan so well is that I get a maximum for my money. High-percentage returns and leverage are the big wealth builders in real estate.
This plan allows a skilled investor, with a very small amount of up-front cash, to generate the same “horsepower” as a much larger, traditional down payment. A $2,000 down payment would not be enough cash, in most cases, to bargain with sellers about their price. Most would not be willing to sell for such a small down payment.
This is the kind of deal that works very well for folks who don’t have much money to invest, but who are willing to invest their time and professional skills. I always view single ownership (me only) as the best kind. However, lack of cash makes this plan an attractive alternative, until you have more money. Real estate investors need to be creative. This plan creates big opportunities for ambitious folks who are temporarily short of money.
Contributions Are Equal for Both Investors
The 90/10 plan provides for clean accounting of the transaction. The money partner who contributes 90% of the cash down payment also gets 90% of everything else. That includes income, expenses, depreciation, and tax credits. He or she is also responsible for 90% of additional contributions, if needed, for upgrading or repairs. The 10% partner (field manager) is responsible for the remaining 10% of everything, including any shortages during operations of the property. He or she also receives 10% of the cash flow.
How does this deal stack up in terms of equality? What are the values of each contributing partner? Obviously $18,000 and $2,000 are not equal cash contributions. To determine the noncash values, let’s make several assumptions. First, we’ll say the property we decide to purchase will rent for $800 per month, or $9,600 annually, to start out. We’ll also say our co-ownership agreement specifies a term of 10 years and that the working partner will be allowed a 10% management fee.
The 10 years of management fees will be calculated at 120 months times 10% of the $800 for a total of $9,600. Also, rents are estimated to increase at least 3% each year during the 10-year term, which amounts to roughly $400 in additional management fees. After 10 full years, my contribution will be the $2,000 cash down payment, plus $10,000 worth of management fees, for a total of $12,000.
OK, that’s much closer to the money partner’s contribution, but still less. However, the money partner gets some tax benefits. Assume the $80,000 property will have $60,000 worth of depreciation. For this purpose, let’s consider only the 27.5-year depreciation schedule ($60,000 divided by 27.5 years equals approximately $2,200 annually). The value of a 90% share of depreciation to a 28% tax payer, who qualifies for the deduction under current tax rules, is $554 annually, or $5,540 for 10 years. Now, you see how the contributions of both partners are starting to balance out. The money partner’s net contribution after taxes is $18,000 less $5,540 for a total of $12,460. The 10% remaining depreciation is worth about $600 to the working partner if he has adequate income to use it. Also to be considered is the distribution of cash flow, particularly in the later years of ownership. The cash investor will be entitled to 90% of all rental income, over and above expenses. This rent money will reduce his net cash invested even more before the partnership ends. Basically, the contributions end up about equal for both investors.
Never Forget the Golden Rule of Investing
When you’re first getting started, a money partner will always be the most important member of your investment team. I call my 90% money partner the “golden partner,” and with all golden partners, the Golden Rule applies—He who has the gold, rules! Look at the situation this way—no matter how important you value your personal skills or how much money you think you might earn for the partnership, it isn’t worth a hill of beans unless you can first acquire the property to apply those skills. If you don’t have the money to purchase property, nothing else matters much. I hope this point is clear. That’s why a money partner is truly a “golden partner.”
The Main Street Apartments: An Ideal 90/10 Partnership
First Main Street was a 92-unit studio apartment built in 1927. After many years of neglect and of being rented to the wrong kind of occupants, the three-story building was badly in need of some TLC—or tender loving care. Structurally, the building was very solid, but many pipes were leaking, the paint was peeling, and the carpets smelled like a thousand cats were locked inside. The seller had great ideas when he purchased the property, but renting it out was his downfall. He had no screening requirements for tenants, other than that they had to pay the first month’s rent. To get a key required no applications and no interviews and there obviously were no rules for living in the building. It was a perfect plan for disaster and, of course, that’s exactly what happened. After four years, he ended up in bankruptcy and was forced to sell the property.
I negotiated with the seller for almost a year, making offers that would have been very beneficial to me—if he had accepted them. However, since he didn’t accept any of them, I was forced to make my offers a bit more realistic. The seller was broke, but he wasn’t stupid. The building had a lot of potential—we both knew it—even though it would take a lot of money to get the apartments fixed up and rented out to decent tenants. I estimated the studio apartments, once fixed up, would rent for at least $250 a month. That’s potentially $23,000 per month—more than a quarter of a million dollars annually.
In Search of Investor Cash
The big problem for me was finding the immediate cash I needed to fix a building of that size. I had never attempted to fix up so many apartments at one time and I knew I would need some financial help to get the job done. I decided to schedule an appointment with a local physician who had purchased several properties from me over the past several years. When I told him about the potential income and the very generous depreciation allowance for partially furnished units, he was ready to write me a check. We agreed to set the deal up using my 90/10 investment plan.
Here’s how it worked. The doctor would put up 90% of the required cash, which would include the down payment and all the fix-up costs. Naturally, the fix-up money would not be required all at one time, since the bills would be paid as we went along. I estimated the job would take about three years from start to finish. It was my plan to improve the cash flow and use the extra rent money to help pay for some of the fix-up work. I also knew that many of the tenants we inherited would most likely not survive too long under our much stricter renting policy.
The building had only 53 tenants on the day escrow closed and I expected to lose some of those as fix-up progressed and I began systematically weeding out undesirable renters. By fixing up vacant apartments first, we could bring in new tenants at a higher rental rate. Selecting the Right Partner Is Critical
I cannot overemphasize the importance of a good investor match-up if this plan is to help you create wealth. In my view, the only time partnership investing makes good sense is when each investor needs what the other possesses or can immediately provide. It will work only if both are made stronger by joining together. Quite often you will see investors of equal means attempting to work as partners; however, they are seldom successful because they are no stronger together than as individuals.
First Main Street required my fix-up expertise and the doctor’s money in about the same proportion. To put it another way, without a lot of money, all my fix-up skills could not earn me one thin dime and the doctor could do absolutely nothing to take advantage of a high-profit opportunity without my fix-up skills and ability to manage the building and the tenants. This is what I mean when I say that both investors are stronger together.
Separation of Duties Is Essential for Success
Although it is clearly spelled out in a 90/10 plan agreement who is responsible for what, it’s extremely important that each co-investor be allowed to perform his or her specified task with the least interference from the other. Obviously, a fairly high level of trust is necessary to get the job done. For example, the doctor didn’t try to give me fix-up advice, unless I asked his opinion, nor did I have to beg him for money when the big invoices started rolling in for payment. This kind of understanding is absolutely necessary before any joint project is started.
Co-Investors Are Tenants in Common
My basic agreement for First Main Street was quite simple, as agreements should be. Both investors will take title as tenants in common. (I have, generally, found it best to conduct business as co-investors or tenants in common, rather than create a separate tax reporting partnership.) The 90% investor (money partner) will receive 90% of the total benefits, including rents, credits, and depreciation, during the period of fixing up the property. The 10% investor (operator)—that’s me—will receive 10% of the benefits, plus a management fee equal to 5% of the gross monthly rents until the property is sold or traded.
The co-investor agreement should specify a future date when a sale is planned. Naturally, there should be enough flexibility in the written agreement to allow for selling whenever you can take best advantage of a good seller’s market. When the property is sold, each investor will be fully reimbursed for his or her total cash contribution first.
The net sale proceeds will then be split on a 50/50 basis.
By the way, co-investing doesn’t mean you should be sloppy about written rules or agreements, merely because it’s not a formal partnership. In fact, let me once again emphasize that you should never invest with anyone without first preparing and executing a written agreement detailing exactly who does what and when. Refer to the example of my co-ownership agreement in the previous chapter. You can rearrange the terms of the agreement to suit your particular transaction.
Fix the Building, Then Up the Income
We acquired the building for approximately $450,000, which was an excellent price, even though it was a mess. It would require several years of fix-up work and enough time to rid the place of its flophouse reputation. As I had planned, the monthly cash flow paid for much of the fix-up work. I initiated tenant cycling and raised the rents almost immediately and new tenants moving into the upgraded apartments had no objections to our $60 per month rent increases. Painting and cleaning made a tremendous improvement to the looks. Most tenants had nothing but praise for our fix-up efforts.
Dividing Up the Money at the End
After three years of fix-up and tenant cycling, the First Main Street Studio Apartments were like new again. They were easy to rent, even though the larger units were renting for $125 more than when we acquired the building. Speaking for the operator/manager side, I was quite proud of what we had accomplished—and, because we were able to attract 35 more renters along the way, our cash contributions for fix-up were much less than we had anticipated at the start.
When we were ready to sell the First Main Street apartments, my total cash contribution added up to $16,000 and the doctor had invested $145,000 as 90% co-investor. However, an opportunity to sell didn’t come up for another year and a half. Finally, we sold the apartments for $300,000, over and above the total amount of money we had invested.
When escrow closed, the doctor’s check was $295,000, more than double what he had invested. He had also enjoyed substantial tax write-offs in the first three years of ownership. That benefit sheltered lots of doctoring income.
I chose to carry back a promissory note for $150,000, secured by the First Main Street property. The terms provided monthly payments of $1,500 (12% interest only), with the principal all due in 10 years. My total compensation for the use of my fix-up skills and property management was very pleasing to me, as the following numbers show.
52 months of management fees: $40,820
120 months at 12% interest payments: 180,000
Principle amount from note receivable (end of 10 years): 150,000
Total earnings: $370,820
Leverage is about investing a very small amount of your own money in order to earn a very large amount from someone else. First Main Street is a perfect example of how maximum leverage can help your bank account.
I’ve estimated that I spent somewhere near 2,500 hours on the job while I owned the apartment. Some days, the work required 10 or 12 hours, but many days it was only a few minutes. According to my calculations, that gave me hourly earnings of almost $150 for this project. You can easily see that personal skills are worth a great deal more than having a regular job down at the sawmill, as we discussed back in Chapter 1.
Give More of Yourself Than You Expect in Return
I have had many experiences working with well-heeled partners. Their buying power and ability to obtain quick credit has allowed me to build personal wealth much faster than I could have ever done alone.
Again, I will repeat my personal philosophy about working with others, because it has much to do with being successful. It also has everything to do with repeat business—investors who will keep reinvesting with you because you make money for them. Always give more than you expect to receive (Jay’s 60/40 rule). If you set up a 50-50 partnership arrangement or a 90/10 investor plan, don’t be content merely to contribute your portion. Instead, do a little more. When the word gets out, you’ll find more cash investors than you can find deals to include them in. Just a small 10% extra will buy you lots of super deals and much faster wealth, believe me.
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