# 3rd Party buying into my Student rental business.... Need help!!!



## BrooDogg (May 12, 2015)

Hello, let me get right to it...

Over the last two years my best friend Greg and I have started our own business and purchased 3 houses which we rent out to College students. We figure we have each invested approximately $60,000 in the purchase of the homes, and all major renovations/additions. Today the figures are as follows...

House #1
Value: $170,000
Mortgage: $125,000
Equity: $45,000
Rent: $2175/month OR $26,100/year
Bills/mortgage payments: $1200/month OR $14,400/year
Profit: $975/month OR $11,700/year

House #2
Value: $170,000
Mortgage: $132,000
Equity: $38,000
Rent: $2350/month OR $28,200/year
Bills/mortgage payments: $1200/month OR $14,400/year
Profit: $1150/month or $13,800/year

House #3
Value: $165,000
Mortgage: $125,000
Equity: $40,000
Rent: $2350/month OR $28,200/year
Bills/mortgage payments: $1200/month OR $14,400/year
Profit: $1150/month or $13,800/year

So in total we have $123,000 in equity, and a business that generates a gross income of $82,500 per year and nets $39,300 per year. 

Not a bad start, but we're looking to expand! So we recently had a pow wow with a 3rd party/friend. Now before you tell me the risks of involving a 3rd party into the business, let me just tell you that I've heard just about it all! This particular person is a very good friend. I think the 3 of us would work together very well.

The problem is, we don't know how he buys in, and for how much? And once he buys in, does that money stay in the business or does my partner and I get to split the buy in? Since we have $123,000 equity, does that mean that the buy in would be $61,500? And if he buys in to the company for that much, does Greg and I split that money for ourselves? Or does the money circulate within the business. Neither option is making sense to me yet.

We've spent the last few days talking about it. And we're going to be setting up an appointment with our lawyer soon. But I thought I'd ask the internet first.


----------



## gt_23 (Jan 18, 2014)

The tricky part is deciding the amount of the buy-in, which is based on the valuation you assign to the operation. Normally, a valuation would be based on a multiple of net income (or FFO in the case of real estate investment firms) which makes sense since the rents you generate are somewhat a function of your ability to renovate the assets. On the low end, you could use NAV or BV (=123k) as the basis for valuation at market value for the assets. Just be aware that you're diluting your own cash investment at V <=$120k, not to mentioned that doesn't include the value of your time and effort to date.

Assuming V = your chosen valuation amount, then you could either:

1) Your new partner gives you 1/3 x V, which you split with your existing partner 50-50
2) You new partner injects 1/3 x V cash into the company's accounts

Out of curiousity what city are you buying the rentals?


----------



## Charlie (May 20, 2011)

Since they're buying and renting homes, this is more of a real estate deal than an active business.

So figure the value is the equity in the properties -- $120K (easier math than $123K).

New guy would either give each of the old partners $20K so that they each have $40K still invested (total $120K still in business). (gt's 1/3 x V)

Or...if old partners leave money in...then he has to anti up $60K so that each of the three have $60K invested (total $180K). (need to up to 1/2 x V since new guy gets 1/3 of the added capital).

Then they figure a way to compensate whomever is doing the maintenance and rent-up.


----------



## nobleea (Oct 11, 2013)

Why not have 3 people on title for any new properties with everything split three ways, and keep the original 3 houses between you and Greg? Then you're all on a level playing field.


----------



## hystat (Jun 18, 2010)

nobleea said:


> Why not have 3 people on title for any new properties with everything split three ways, and keep the original 3 houses between you and Greg? Then you're all on a level playing field.


yep. or just forget it. 
This 3rd person can never be an equal partner because he's getting into an idea that wasn't his. The original risk the two of you took is what paid off and laid a foundation.


----------



## rikk (May 28, 2012)

^ Starting a business, making it successful, then selling at a profit is what it's all about. If it were me, I'd determine what me and the partner feel the business is currently worth (to the interested third party ... maybe he's looking to make 5%, 10%, ... per year, who knows), consider the "offer", then each sell 1/3 to the 3rd guy ... if that's the split in mind. As to where the money goes (divvy up and declare the income, put into the business, ... ), an accountant can advise on that and the lawyer takes care of the details ... my opinion.


----------



## rsyl (Aug 15, 2014)

I would consider doing the following (keep in mind this is my 2 second thought, so obviously take it with a grain of salt and do more research as you are already)

1) Consider the cost to buy you and Greg out completely. If you were to sell the whole operation how much could the two of you pull out of the company? This should be your starting point.

Say this number was $123,000 (assuming your valuations are correct) plus a % of the earnings being generated (depending where you are operating), what I mean by this is the annual revenue is less important than the difficulty in reproducing it. If there are properties everywhere in town you can make similar revenue than it's less valuable. If there are no properties that can make that kind of ROI than it is more valuable.

So on paper you would sell your company in its entirety splitting the proceeds, say $150,000 (this would not be the actual number) you would each extract $75,000 from the company. then each of you would have to re-invest $50,000 including the new third party.

Once you come up with that number, you have the friend pay you that amount, not a penny less. (in this case $50,000 which you would split 25,000 each) or of course you could have him add his 50,000 towards a 4th property

The amount of work you put into renovations is irrelevant, that went into increasing the value of the house and/or annual rent which is already calculated above.

Caveat, don't forget about the tax man, if you do sell 1/3rd of the company I presume you will have to pay tax on that money this year, I don't know...

2) You may consider having this friend purchase a property in the $225,000 range (paying 25% with his own money), this would give him a valuation of 1/3 the total and put him on equal footing with you (easier said than done).


----------



## MoreMiles (Apr 20, 2011)

nobleea said:


> Why not have 3 people on title for any new properties with everything split three ways, and keep the original 3 houses between you and Greg? Then you're all on a level playing field.


+1 

There is no reason why a new person can buy in at 'IPO price'. You and your partner took all the risk so it should not be sold without any appreciation. There were mortgage rate risk, tenant recruitment, insurance arrangement, etc. All those are worth something. They are called goodwill and can be sold as asset in business. It's like trying to buy Apple for $2 per share... The old price with founders is no longer available to new comers. 

Just open a new corporation and buy future buildings into this corporation. He can be a partner for new acquisition with this new corporation. 

If your argument is that you don't want to be tough in business with friends, then that's also why you should not do it. It will never be fair... just look at Dragons or Sharks. It's a dog eat dog world there. If you are nice, you will get eaten so don't give out your asset for free.


----------



## gt_23 (Jan 18, 2014)

hystat said:


> yep. or just forget it.
> This 3rd person can never be an equal partner because he's getting into an idea that wasn't his. The original risk the two of you took is what paid off and laid a foundation.


That's why the new investor pays a premium over book. Why would entrepreneurs take on investor for an idea that wasn't his? If everyone thought like you, the billionaire founders of Facebook, LinkedIn, Uber, Google, +100s more, would not be billionaires!

There is risk in continuing to operate and grow a business, not just in it's launch phase.


----------



## gt_23 (Jan 18, 2014)

MoreMiles said:


> +1
> 
> There is no reason why a new person can buy in at 'IPO price'. You and your partner took all the risk so it should not be sold without any appreciation. There were mortgage rate risk, tenant recruitment, insurance arrangement, etc. All those are worth something. They are called goodwill and can be sold as asset in business. It's like trying to buy Apple for $2 per share... The old price with founders is no longer available to new comers.
> 
> ...


You don't understand valuation at all.

There is no necessity to keep Greg out of the existing properties to protect the value previously accumulated in the operation - just make him buy-in at a value that reflects the risk, capital, and time investment to date.

Funny that you use the Dragons and Sharks to support your dubious claim. The greatest lesson from those shows is that greedy entrepreuners usually fail because of their own greed and shortsightedness. When their company is worth $100k, they focus on giving away too much equity because they think it's going to $100MM and that equity will be valuable. The reality is, that's the type of decision-making that prevents them from ever getting to $100MM! Frugality only becomes important in business when it reaches a mature, slow-growth phase and has saturated the market.

As long as Greg has something to offer (capital, time, connections), figure out an appropriate price that reflects all your work to date and go for it. When you're all at 100 doors, it probably won't matter the extra 10-20% you could've gotten from him at this stage!


----------



## Numbersman61 (Jan 26, 2015)

I'm confused about basic facts in this case. Where can you buy a house in Canada for under $175,000? I live in Calgary and average home price is around $500,000. How are you able to collect such high rents in such low priced properties? If you are renting to students, how can you collect rents for a full 12 months each year? This real estate investment just sounds too good to be true.


----------



## Berubeland (Sep 6, 2009)

I can tell you how the process will usually work. The problem with real estate businesses is two fold. The first problem is that your cash is mostly used to pay down the mortgage and that equity is stuck until sale or refinancing. This makes it hard to expand the business. No one actually makes money from rent anymore, certainly now from 3 units. Basically, it sounds like you and your partner are making $39,000 per year or roughly $13,000 per house per year. Nothing you can quit your job over and in student rentals you have to work for your money and you'll be going over there daily to keep an eye on things. 

Now you want to split your already meager profits with a third party. 

What you need to do is use his capital to buy more houses, and increase your and your partner's income stream and his income stream. You and your partner keep the properties and the income you worked for. 

Then you'll run out of capital again. If no one takes a paycheck you might be able to buy one rental every 18 months. 

Financing will be a problem but not impossible. Skyline REIT started their company this way.


----------



## MrMatt (Dec 21, 2011)

I'd have the new partnership distinct from the first.
Keeps it nice and clean.

After a while, if you want to roll it all together do so, but I wouldn't start out like that.


----------



## BrooDogg (May 12, 2015)

Numbersman61 said:


> I'm confused about basic facts in this case. Where can you buy a house in Canada for under $175,000? I live in Calgary and average home price is around $500,000. How are you able to collect such high rents in such low priced properties? If you are renting to students, how can you collect rents for a full 12 months each year? This real estate investment just sounds too good to be true.


Where can you buy a house in Canada for under $175,000? Canada is a big place, with some pristine Colleges and Universities in small cities. Once you get away from the big cities it's quite easy to find homes under $175,000. Look at Windsor, you can pick up a detached house there for $40,000. As for your second and third question... Students rent rooms and rent-prices are usually standard. Convert the house into as many legal rooms as you can, and you'll profit big. Students rent all year round. It's not uncommon to find students who sign 12 year leases, or 4 month summer leases.

I'd like to add, that I appreciate the help everyone has given. It's easy to put a price on the equity split. But it's a little harder to put a price on the risk/time/effort that Greg and I put into it. And then you got to throw in the fact that he's buying into a business that generates monthly income. How do you find a proper buy-in that takes all this into account, fairly for both parties?


----------



## Cal (Jun 17, 2009)

I prefer not to own properties with anyone, why split the profits, when potentially you could be on the hook for everything.....I would rather just take all the risk alone and not split the profits.


----------



## Just a Guy (Mar 27, 2012)

Remember, you'll also need to work on a buy out clause which deals with how you split the assets if one partner wants out. Real estate isn't very liquid, buying out a partner can be difficult.

People often worry about getting into business when, in reality, getting out is often much more complicated.


----------



## gt_23 (Jan 18, 2014)

Cal said:


> I prefer not to own properties with anyone, why split the profits, when potentially you could be on the hook for everything.....I would rather just take all the risk alone and not split the profits.


There's two big reasons why it's good to have a partner in any business (not just real estate):

1) Growth - assuming you actually want to grow, it's easier with more cash and ability to source deals, qualify for mortgages, etc..
2) Operations - there's a lot less stress dealing with the day-to-day if you have a partner to back you up. It's also a bonus if they complement your skills in some way.


----------



## gt_23 (Jan 18, 2014)

Berubeland said:


> I can tell you how the process will usually work. The problem with real estate businesses is two fold. The first problem is that your cash is mostly used to pay down the mortgage and that equity is stuck until sale or refinancing. This makes it hard to expand the business. No one actually makes money from rent anymore, certainly now from 3 units. Basically, it sounds like you and your partner are making $39,000 per year or roughly $13,000 per house per year. Nothing you can quit your job over and in student rentals you have to work for your money and you'll be going over there daily to keep an eye on things.
> 
> Now you want to split your already meager profits with a third party.
> 
> ...


No one makes money from rent anymore? Meager profits? Did you even read the original post? You seem to have a chip on your shoulder...

If you criticize these investments, you should probably get out of the business because it doesn't get much better than this. The guy has CFBT of $39k on his investment of $60k (65% cash return). He'll also likely profit further from his mortgage principal payments (assuming the property values don't drop) and even capital gains (if the property values increase).

The biggest issue will be trying to scale it up with the same economics...


----------



## gt_23 (Jan 18, 2014)

Just a Guy said:


> Remember, you'll also need to work on a buy out clause which deals with how you split the assets if one partner wants out. Real estate isn't very liquid, buying out a partner can be difficult.
> 
> People often worry about getting into business when, in reality, getting out is often much more complicated.


Shotgun clause will be key, esp with 3 partners.


----------



## Getafix (Dec 29, 2014)

BrooDogg said:


> Where can you buy a house in Canada for under $175,000? Canada is a big place, with some pristine Colleges and Universities in small cities. Once you get away from the big cities it's quite easy to find homes under $175,000. Look at Windsor, you can pick up a detached house there for $40,000. As for your second and third question... Students rent rooms and rent-prices are usually standard. Convert the house into as many legal rooms as you can, and you'll profit big. Students rent all year round. It's not uncommon to find students who sign 12 year leases, or 4 month summer leases.
> 
> I'd like to add, that I appreciate the help everyone has given. It's easy to put a price on the equity split. But it's a little harder to put a price on the risk/time/effort that Greg and I put into it. And then you got to throw in the fact that he's buying into a business that generates monthly income. How do you find a proper buy-in that takes all this into account, fairly for both parties?


Wow, i had no clue houses were so cheap in Windsor! Would be definitely be a good place to invest in income properties.


----------



## Just a Guy (Mar 27, 2012)

Don't be in to much of a hurry, rents are also low, unemployment is high, and ontario's tenant laws are a nightmare to landlords.


----------



## Getafix (Dec 29, 2014)

LOL yeah, i just read up a little bit more & now the prices make sense. There goes my dream of moving to a warm, cheap place in Ontario!


----------



## Berubeland (Sep 6, 2009)

gt_23 said:


> No one makes money from rent anymore? Meager profits? Did you even read the original post? You seem to have a chip on your shoulder...
> 
> If you criticize these investments, you should probably get out of the business because it doesn't get much better than this. The guy has CFBT of $39k on his investment of $60k (65% cash return). He'll also likely profit further from his mortgage principal payments (assuming the property values don't drop) and even capital gains (if the property values increase).
> 
> The biggest issue will be trying to scale it up with the same economics...


The question is..how does he buy more? If he and his partner *DON'T TAKE A PAYCHECK* they can buy more, but how much fun is that? 

The game is capital appreciation. Not rent payments because that money is trapped. How can you get it out to get more properties? You can't unless you refinance or sell the house which is obviously a problem when you are trying to get more properties. 

I'm not criticizing his investment at all, I'm pointing out the difficulties in getting more properties. To make a living and quit his job, he has to get many more properties unless he really does want to live on 13K per year. 

Also I'm old enough to remember 12% cap rate properties on the market in Toronto, real cap rates with real expenses, that were not student rentals... when we made money from rent.


----------



## Feruk (Aug 15, 2012)

Does the business have any cash on the books? Two years in, total investment of $120K ($60k/partner), and the only asset you have is $123K? I assume you're paying yourself? Aka business net income is $0. I don't see why you'd need this third guy's money if you're pocketing $40K and not already looking to reinvest that... 

You say you wanna grow this, so taking his $60K and paying yourself, rather than your business, makes no sense. You'd want to invest it into the business. However, since you're not already reinvesting your $40K in profit, I question if you wanna do this either...


----------



## Getafix (Dec 29, 2014)

Sorry if this is slightly off-topic but i thought i would ask here since you have experience with this. Could this be a potential income property:

2 beds, 1.5 baths, finished basement with a separate entrance (bathroom without shower), that could be turned into a third bedroom. Located near a local college. Condo fee's are $368, including water. Asking price is $176'800. 

I could pay up to 20-30% down if needed. I'm new to Canada so don't have experience with real-estate. I'm just wondering if there will be additional property taxes on top of the condo fees?

I'm guessing each bedroom could easily go for $400-500, so potential rental income of $1200-1500.


----------



## tygrus (Mar 13, 2012)

I think I would rather tend a herd of buffalo than chase after student tenants, but hey thats just me.


----------



## Just a Guy (Mar 27, 2012)

I'm sure you could jerry rig the numbers and convince yourself that it's a cash machine, but it's probably 50% too expensive to be something I'd look at if that helps.


----------



## Numbersman61 (Jan 26, 2015)

Getafix said:


> Sorry if this is slightly off-topic but i thought i would ask here since you have experience with this. Could this be a potential income property:
> 
> 2 beds, 1.5 baths, finished basement with a separate entrance (bathroom without shower), that could be turned into a third bedroom. Located near a local college. Condo fee's are $368, including water. Asking price is $176'800.
> 
> ...


In most instances, the condo owner would also have property taxes. Since you're new to Canada, be very careful before making an investment like this. Since this is a condo, research the condo by-laws carefully, they usually contain rules as to who can rent to and the terms of any lease. In most cases, you cannot rent to multiple parties like you plan on doing and they may prohibit short-term rentals. Approvals from the Condo Board may be required. If your tenants break the rules, you may be stuck with fines levied by the Board.


----------



## BrooDogg (May 12, 2015)

Berubeland said:


> The question is..how does he buy more? If he and his partner *DON'T TAKE A PAYCHECK* they can buy more, but how much fun is that?
> 
> The game is capital appreciation. Not rent payments because that money is trapped. How can you get it out to get more properties? You can't unless you refinance or sell the house which is obviously a problem when you are trying to get more properties.
> 
> ...


Sorry haven't check this post in a while.... The original numbers were approximate. We actually have $145k equity as appose to the $123k stated. As I'm reading through some of these it boggles my mind how people can think that these aren't good investments. Both Greg and I work and clear $60k a year, so we don't have to be taking Paychecks from the business Mr. Berube. 

The money stays in an account and grows each month. Once there is enough money in the account for another down payment for a property we buy a house, renovate it, and rent it out. This increases the monthly income/profit, and reduces the duration between present and buying yet another property. Every time you buy a house, it increases profits and reduces the wait time to buy more houses. Eventually it snowballs.

At this time, we probably don't need a 3rd partner. The money however, will help propel us further, and quicker. We believe now would be the best time to let him buy in, because he simply won't be able to afford it a year or two from now once it starts "snowballing". And when that time comes we will need the man power, and as I stated previously he's a hell of a good friend to us, family in fact. 

I know 3 investment rental properties isn't much. But considering we're profiting roughly $15k/year off each house, and with the new recruited buying power we've crunched the numbers and hope we can get to 10 houses over the next two years. Do the math and that's $150k profit a year give or take. 

If that happens all 3 of us can easily quit our day jobs and pursue this full time. Take pay checks and use home equity to buy more homes, leverage ourselves and perhaps try out different business opportunities...

Thanks for all the kind advice. This was my first post on this site and I've read tons of useful information. I think I'll keep checking in.


----------



## thotho (May 7, 2013)

I don't think 150k between 3 guys is enough to quit your full time job and do this full time. I'm sure it was your day jobs that allowed you to qualify for the loans on the first three houses in the first place. With the income from the three houses and keeping your day jobs, you would be able to expand a lot more quickly. Once the place is rented, I don't hear from a tenant for a whole year and anything that needs to be fixed usually takes me 3 phone calls. The complaint, contractor and then the thank you call for getting it done so fast. 

It is just my opinion but why don't you continue your full time job and save. Take all the profit from the business and save that as well. Whenever you have enough for a down payment you buy another house. It won't be cost effective to use only equity in the houses as down payment because if you are on a 2 year fixed, you can't get another house until the two years are up unless you want to break your mortgage and pay the penalties to refinance. Just my opinion


----------



## getliquid (Mar 2, 2014)

Are these town houses and your just renting out 3 bdrms + basement types? Seems really good no matter the location if your buying it for $170,000 and gross renting for $2100


----------



## Melicoy (Nov 15, 2015)

Hi ya,

I suggest you start fresh with this guy and dont bring him in on the first 3 houses. Make like they dont exist.

With any partner I suggest he is a like minded individual and ALWAYS add a shotgun clause to the jv deal making it fair for all.

You have a proven success with your first partner dont add another to something that is already successful (first 3 hours i mean). You can't put a measure on your hard work. It's easy to add - hard to remove.

So like I said before... Start off new as a group of 3 and buy your first property!

Maybe your new partner is a micro manager and always calling asking tell requesting take up time.

Easy to shotgun clause him out of new deal but hard to remove from successful first 3 house deal. ALL GONE ! 

What happened to the goose that laid the golden egg? 

If it is not broken dont fix it!


----------

