He does the work, I fund it, then the refinance shows up. How does that split?

Question

A friend who does renovation work wants to do a version of this together, and most of my money sits in passive deals. He'd run the buy and the rehab, I'd fund the acquisition and the construction budget, call it 180k total on a property he thinks appraises around 250k after.

Where I'm stuck is the refinance. If the new loan is in his name, he's the borrower and I'm what, a lender? An equity partner who gets paid out of the proceeds? If the loan is in a jointly-owned entity, does the lender care that I have no operating role? And if the refi only returns 160k of my 180k, who eats the 20k, and does he get any equity for the labor before I'm whole?

I'd rather sort out the ugly version now than discover it at the closing table.

Rena Expert · Accepted Answer

The three structures people actually use here are different animals and they fail differently.

You lend. You hold a note secured by the property, he owns it, he refinances and pays you off. Your upside is capped at the interest rate, your downside is that a shortfall at refi is his problem to solve, not yours, and you have foreclosure as the remedy if he can't. Cleanest documentation, least upside.

You co-own through an entity. Both names on the operating agreement, the entity borrows, and most lenders on a small commercial or DSCR-style loan will want personal guarantees from anyone over a certain ownership percentage, commonly 20% or 25%. That means your passive intent doesn't keep you off the guarantee. Ask any prospective lender for their guarantee threshold in writing before you paper the entity, because restructuring ownership after the fact to dodge a guarantee is the kind of thing that gets a loan pulled.

You fund as preferred equity. You get paid back first out of refi proceeds, he gets his sweat equity position only after your 180k is returned, and the operating agreement says exactly that in the distribution waterfall.

On the 20k shortfall, that's a drafting decision, not a market fact. The agreement can say it stays as your outstanding capital balance accruing a preferred return until a later refi or sale clears it, or it can say he contributes cash to make you whole, or it can say you both take the haircut pro rata. Decide which before you fund. A lawyer in your state should draft it, and if you're taking money from anyone beyond this one friend there are securities questions that need a licensed opinion.

The thing that breaks these deals more often than the shortfall is scope creep on the rehab. Your 180k number needs a change-order clause saying who approves overruns and whose capital funds them.

Rena Guide · Answer

Adding one layer for anyone reading this who hasn't met these words yet.

Sweat equity means an ownership share given to someone for their work rather than their money. In a BRRRR partnership the operator often argues that finding the deal and running the renovation is worth a percentage, and the funder argues that the cash took the actual risk. Both positions are normal, and the number lands somewhere between 20% and 50% of profit depending on how much of the work is genuinely his and how scarce your money is.

A distribution waterfall is just the order in which money leaves the deal. First the loan gets paid, then the funder gets capital back, then a preferred return if there is one, then profit splits. Writing it as an ordered list in the agreement is what stops the argument later.

One thing that catches new partners: the refinance doesn't end the partnership. After the refi you still jointly own a rental with a mortgage on it for years. Who handles a vacancy, who approves a 6k roof, who decides to sell, and what happens if one of you wants out in year three all need answers in the same document. The refi feels like the finish line when you're planning it and it turns out to be about a third of the way in.

dpatel_re · Answer

The guarantee threshold point is the one I'd chase first, arbor. I've seen the 20% number and I've seen 25%, and one lender wanted a guarantee from every member regardless of percentage. It's entirely a credit box question.

monica_tran3 · Answer

We've had a partner in this business for five years, and the clause I wish we'd written first was the exit one. Not the shortfall, not the split. What happens when one person's life changes. Buy-sell terms, valuation method, timeline. arbor, put that in before you argue about the 20k.

chriswalton8 · Answer

If you go the lending route the interest you charge might be capped by your state's usury limit, and those limits vary a lot and sometimes have carve-outs for business-purpose loans. Worth having someone check for your state before you pick a rate.

tonyv88 · Answer

Post-refi management is where I see these partnerships actually rot. He's a renovation guy. Renovation guys are frequently terrible landlords, no offense to any of them, because the work is the opposite skill. Decide now whether you're hiring third party management out of the rent at 8 to 10% or whether he's doing it and getting paid for it.

raj_mehta14 · Answer

The difference finally clicked for me here, after weeks of reading about notes. If arbor holds a note he's a lender with a lien. If he's an equity member he's an owner with a claim on whatever's left. Those are completely different positions when something goes wrong and I'd been treating them as roughly the same thing.

He does the work, I fund it, then the refinance shows up. How does that split?

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