An operator wants $850k of JV equity, and I've only ever held land

Stack the fees before you compare the two versions, because they don't change between them and they're bigger than the 1.5 points you're haggling over.

2% of 1.9M is 38k at closing, out of your 820k. Construction management at 5% of a 450k budget is 22.5k, and unless the draft says otherwise he earns it on the revised budget too, so an overrun pays him more. Asset management at 1.5% of collections on maybe 260k of stabilized revenue is 3.9k a year, small. Property management 5% to his affiliate is another 13k a year.

So roughly 60k of your money leaves in year one before a single unit rents. Your 9% pref on 820k is 73.8k a year. He's collecting close to a year of your pref in fees for doing the work he's already promoted on.

I'm not saying the fees are wrong. Somebody has to get paid to run a 14 month reno. I'm saying find out whether the promote is calculated before or after those fees, and whether it crystallizes on a refinance. A refi promote with no sale is where JV money gets surprised.

The 50k co-invest is the number I'd push on. That's 5.7% of equity and probably less than his acquisition fee, so he's cash positive at closing no matter what happens after. Alignment on paper isn't alignment in cash.

Separately, underwrite the exit, not the story. Ask for his stabilized rent assumption per unit and go pull four comparable properties yourself. Then ask what exit cap he used and whether it's above or below the cap he's buying at. If he's buying at, say, a 6 and exiting at a 5.5, most of the return you're being offered is coming from cap compression rather than from the work.

And get actuals on his last four deals, not the pro formas. Projected versus realized, side by side, including the one that went badly. If there isn't one that went badly he hasn't done enough deals for you to be his 94% partner.

Your own timeline breaks the pref math and I don't think you've noticed yet.

9% on 820k is 73.8k a year. You said no real cash before month 10 and stabilization at 14 months. So call it 18 months before there's distributable cash, and by then you've accrued roughly 110k of unpaid pref. Where does that come from? Either a refinance that has to be large enough to cover it, or the sale. If the refi comes in short (and at current spreads it might), that accrual just sits there compounding, and the operator's promote can't start until it's cleared, which is fine for you and terrible for his motivation.

Also ask whether the pref compounds annually or simple. On a 4 year hold at 820k the difference between simple and compounding at 9% is real money, tens of thousands.

Then the actual question you asked. Version two pays you 1.5 points, call it 12k a year, plus 5 points of split. That's cheap for total loss of control on 820k. @fathom is right that the fee structure is the bigger leak.

Can someone spell out the difference between what @orchard is being offered and just being an LP in a syndication? It looks like the same waterfall to me. Is it only that he's the whole equity check instead of one of thirty people?

@sable the practical difference is that nobody negotiates a syndication's operating agreement with the sponsor. It arrives finished. Orchard can strike clauses.

Orchard, one more piece worth checking is the lender. At 94% of equity you may show up as a controlling member in the loan documents, and lenders often require the party with control to sign a guaranty or at least meet net worth and liquidity covenants. Some will also require lender consent before your interest transfers, which is part of why this is illiquid. Ask the operator to send you the lender's term sheet, not his summary of it, and confirm in writing who's on the guaranty and what the recourse carve-outs cover. If the answer is "you are," version two (no consent rights, full guaranty) is a bad trade at any pref.

Operator diligence is the whole deal and it takes longer than reading the agreement.

What I do, and it's tedious: get names of the lenders on his last three loans and call them. Lenders will tell you whether draws came in clean and whether he ever asked for a forbearance. Get the general contractor from his last reno. Ask about change orders. Then ask him directly for one investor who lost money with him and call that person. If he says there isn't one, ask for the investor from his oldest deal instead, because the ones who've been in longest have seen more.

Also search the county court records where he operates for the entity names. Cheap, public in most places, and mechanic's liens tell you things a reference call won't. What's recorded and searchable varies by state, so you may get more or less than you want.

Dumb question maybe, but if the reno goes 80k over and he only ever put in 50k, who actually writes that check? It sounds like it's Orchard either way, which makes the two versions less different than they look.

@plumb that's not a dumb question, it's the question.

Orchard, my concern is different from everyone else's. 820k into one building with one operator you know from a meetup. What's that as a percentage of your investable capital? If it's 15%, fine, this is a learning position and you'll take the scars. If it's 60% you're not a JV capital provider, you're an operator with no control and no information rights.

Which reminds me. Information rights. Monthly rent roll, monthly draw schedule against budget, bank statements on request. Put it in the agreement with a deadline attached. I've seen people fight for consent rights and then forget to require the reporting that would tell them a consent was needed.

This thread is where it finally clicked for me why someone would rather hold a note than a member interest.

Orchard, is preferred equity on the table? Fixed return, hard maturity, no promote, and you sit above the operator's common but below the senior lender. You give up the upside. You also stop caring whether his exit cap assumption is honest. Given you said you've never done this and you're funding 94%, the boring fixed-return version might fit you better than arguing about the third tier of a waterfall you don't yet know how to model.

I could have this half wrong, I'm still learning where preferred equity actually sits when things go bad.

The thing I'd check is whether his company can physically absorb this. Ask how many units he's currently renovating, how many project managers he employs, and what else closes in the next 90 days. An 18 unit gut with a 14 month schedule needs somebody on site most days. If he's a two person shop with three deals in flight, the schedule is fiction and the schedule is what your accruing pref is priced against.

Also his affiliate at 5% of collections on 18 units is about a thousand a month. No third party manager takes an 18 unit walk-up in reno for that and does it well, so either he's subsidizing it out of the promote or the units get managed badly.

I've asked for equity on smaller deals myself, more than once, so here's what version one looks like from his chair.

Broad consent rights scare operators because they mean every change order waits on a phone call with somebody who owns land and reads slowly (no offense, that's most JV money). If you make him get written approval for every budget move you'll add weeks to the reno and the weeks cost you the pref.

What I'd actually accept, and what I'd offer if I were him: approval over sale, refinance, new debt, and any budget change over 10% of the total. Everything below that he moves and reports monthly. That gets you the protections that matter without you becoming his bottleneck.

And take the 9% version. Buying off your consent rights for 1.5 points is him telling you the consent rights are worth more than 1.5 points.