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Law Educator, Esq.
Law Educator, Esq., Lawyer
Category: Real Estate Law
Satisfied Customers: 118148
Experience:  Licensed attorney practicing landlord-tenant, land use and other real estate law and litigation.
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In structuring a real estate deal that involves building an

Customer Question

In structuring a real estate deal that involves building an apartment building from construction through to the building being stabilized (85% occupancy), which should take no more than a total of 30 months. I am giving an investor who is investing 7 million 12% interest. (the other 13 million to build will be supplied by a bank). The 12% interest that the investor gets is a fixed rate of return (no compounding), paid out monthly. After the complex is built and has 85%+ occupancy it will be worth approx 29 million. In addition, I am writing into the contract and LLC agreement that the investor receives the return of his capital, plus another 30% of the 7 million he gave at the 30 month mark via a refinance. If for some reason the refinance cannot be done right at the 30 month mark, their return increases 1% per month each month. If it goes beyond 42 months and their capital plus return has not been given to them, then this "convertible debt" converts over to them owning 51% of the property.
We estimate that there will be approximately 7 million in equity created by getting the building built and stabilized.
When asked why I am giving the investor 30% of initial capital they gave as their "bonus" or as their "refinance buyout" instead of just giving him a percentage of the ownership of the project right off the bat, here is my response:
The co-developer I am partnered with would like to own this (and other) properties we develop. However, the agreements we make with them afford them much latitude over the execution of the sale. While it is extremely likely that they will be purchasing the properties, the exact timing of when they purchase will be flexible, and the final cap rate valuation will have many performance hurdles and metrics that don’t align with the normal simple truth of what the market will bear (which is what would be fair to the investor). If the properties were selling on the open market it would be simple, but in this situation there will be many properties involved, with the timing and pricing variability, added to the fact that there will be a number of different investors who will each have their own market opinions. As such, the potential is high for disagreements on pricing and opinions about timing. To allow a smooth ownership transition and no arguments over the final decisions about timing on sale, while simultaneously providing certainty to investors on returns, we have opted for fixed percentage of capital refinance buyout structure.
Does that logic make sense? What red flags do you see for the investor and specifically with my logic about giving the 30% instead of giving them 30% ownership right off the bat.
Submitted: 1 year ago.
Category: Real Estate Law
Expert:  Law Educator, Esq. replied 1 year ago.

Thank you for your question. I look forward to working with you to provide you the information you are seeking for educational purposes only.

Your reasoning is completely logical, since you are correct that with multiple partners and multiple possible opinions conflicts can cause delays. In these types of agreements, the parties are free to contract as they see fit, as long as it is not illegal, and this is not illegal. It is actually reasonable that there may be some delays here and that the investor should be compensated for those delays if they occur.