150k for 14% of a luxury flip. Which questions are the real ones?

Three structural points on what you posted, in the order they change the outcome.

The hold assumption drives everything. Your carry is roughly 33k a month, so each month past 13 costs the deal 33k plus any extension fee. At 613k of projected profit, an 18 month hold consumes about 165k of it before you touch the ARV question. At 24 months there is nothing left for the split and the pref starts eating into return of capital. Ask him for the 18 and 24 month rows. If they do not exist, that tells you how the deal was underwritten.

On the ARV, new construction comps do not support a renovated 1990s house at the same number, and a different school district is a different market at this price point. Strip your comp set to renovated resales in the same district and see what is left. Two comps is a thin basis for a 5.4M exit, though what you can inspect depends on your state, since roughly a dozen do not make sale prices public.

On the waterfall, the fees change your effective economics. A 2% acquisition fee is 62k and 5% of construction is 45k, paid regardless of outcome. That is 107k of certain payment against 613k of uncertain profit. The pref accrues at 8%, so confirm whether it compounds and whether it is paid current or accrues to the back end, because on a 15 month hold that difference is real money to you.

An offering of a passive interest in an LLC can be a securities transaction, so have a securities attorney read the documents before you commit anything.

Check whether your 14.3% is 14.3% of the equity or 14.3% of the profit. Those are different sentences in the same document and people conflate them constantly. Also read who is in the equity stack with you. If the operator's own 200k is actually his fees credited back in as capital, you and the other cash investors are the only ones with money at risk.

Things I'd hunt for in the draft, in the order I read documents:

The capital call section, which kestrel named. Look for the words "pro rata dilution" and then look for the multiplier. I've seen 1.5x and I've seen 2x, and at 2x a single missed 200k call can take a 150k position down to almost nothing.

The guaranty. Somebody personally guaranteed that 2.9M senior loan. If it's the operator, find out whether the operating agreement indemnifies him out of deal proceeds ahead of your pref, because that reorders the waterfall in a bad month.

The removal provision. Can the equity replace the manager, and on what vote. If the answer is no and he holds a majority of votes, you're along for whatever he decides in month 19.

The extension mechanics on the loan, which are usually in an exhibit nobody sends. Ask for the term sheet itself, not the summary.

fathom's list is the right list. I'd add the definition of "Capital Contributions" and then check every later clause that uses the term, because that's where fee credits sneak in.

The other thing is the reporting clause. Monthly or quarterly, and does it include actual construction spend against budget by line. Without that you find out about the overrun when the capital call arrives.

And rigging, a passive interest like this may well be a security depending on how it's structured and offered, which is a question for a securities attorney and not for us.

Before any of the document work, I'd want his last three deals. Not a summary deck, the actual closing statements on the buy and the sell, and the final construction cost against original budget. If he's done four luxury flips and three ran 20% over on reno, that's your contingency number, not the 10% in the pro forma.

Ask him for the one that went badly too. Everyone who's done more than three has one. How he describes it tells you more than the numbers do.

One thing I'd want to know for my own comfort: what's the lot worth bare? If the improved house stalls at 4.6M and the dirt in that district is 1.8M, you know roughly where the floor is and the 3.1M purchase looks different. Lot value doesn't rescue a bad flip, but it tells you whether you're buying a house or buying land with a house on it.

Ask which subs are already booked. Not "do you have a crew," but names and start dates for the millwork, the tile setters and the finish painters. Five years running a service business has taught me that the schedule people show you is the schedule they wish they had. At luxury finish level the specialty trades set your timeline, and a 13 month pro forma with unbooked trades is a 17 month deal with paperwork.

The pref keeps confusing me as I read about paper, so here's the beginner question. Is the 8% preferred a payment I actually receive during the deal, or just a number that accrues and gets settled at sale? And if the deal makes only 200k instead of 613k, does the pref come out first and leave the operator with nothing, or does he still get his fees?

vellum, the fees usually get paid whether or not anything works, which is why canton's question about past deals matters more than the split.

rigging, the thing I'd sit with is that this deal has one exit and a deadline. My whole approach is holding things where time is on my side. Here time costs 33k a month and the only way out is a buyer at 5.4M. That's not a criticism of the deal, it's just a completely different animal from what I do, and two weeks is not a long time to learn a new animal.

Every unit I own has taught me something and most of the lessons cost between 4k and 15k. This one would cost 150k to learn. That's the part I'd weigh, and it's got nothing to do with whether the operator is good.

I'd say no and keep reading, and I'd tell him that. If he's real he'll take you on the next one, and you'll know a lot more in a year. If two weeks is a hard deadline for 150k from someone five months in, that's information too.

Nobody's mentioned staging and marketing yet. At a 5.4M exit that's real money. Furnishing 4,900 sq ft to a level that price point expects runs 8 to 12k a month around here, plus install and de-install, plus the photography and video that agents at that level expect. Over a 5 month marketing window that's 50 to 70k. Is it in the 900k reno line, in the 430k carry line, or nowhere? I've seen it be nowhere more than once.

lantern's point is the kind of thing I only learned by having a portfolio big enough for line items to go missing. rigging, ask for the budget as a spreadsheet with every line, not the summary with seven numbers. Then add up the lines and see whether they equal 900k. Sometimes they don't and that's the fastest read you'll get on how carefully anything was built.

Different angle, since I'm trying to work out where I fit in all this. Is there a version where you don't put money in and instead spend the next 13 months around the deal doing something useful, walking the site, tracking the budget, sitting in the showings? You'd learn more than 14.3% of a waterfall teaches you and you'd still have the 150k.

That 150k buys three whole houses where I look, and the 3.1M purchase would buy the street. I'm not saying that makes it wrong, the returns aren't comparable either. But 33k a month of carry against three or four possible buyers still makes me flinch.

The part I'd want spelled out is that you get zero for at least 13 months and possibly 24, and if the pref accrues rather than pays, you get zero the whole way. I want income without a second job so this is the opposite of my thing, but a lot of people sign up for these imagining a distribution schedule that isn't in the document.

If it doesn't sell in the window, is renting it even an option in that agreement? I've been reading nothing but screening and leases for two months and my first thought was whether the operating agreement or the senior loan even permits a lease. Some construction loans don't.

I added up the pro forma and it's internally consistent, which is different from being right. Purchase 3.1 plus 60 closing plus 900 reno plus 430 carry plus 297 selling equals 4.787M against 5.4M, so 613k. Fine.

Now move two inputs. ARV at 5.0M with selling costs at 5.5% of the lower number gives you about 4.72M of basis against 5.0M, so 280k. Same deal, ARV down 7.4%, profit down 54%.

Move the hold to 18 months and add one extension fee. Carry goes to roughly 595k and the fee is maybe 29k, so at a 5.0M exit you're at about 4.9M of basis against 5.0M. Roughly 100k on 1.05M of equity over 18 months, and your 8% pref alone would want about 126k of that at the equity level. The operator's 107k of fees is paid in all three of these cases.

That's what's wrong with the numbers. Nothing in the arithmetic, everything in the two inputs he picked.

ledger did the work. I'd only add the fourth row, because underwriting is mostly about the row you don't want to write. ARV 4.7M, 20 month hold, reno 8% over. Basis lands around 5.0M against a 4.7M exit and the equity is impaired, meaning the 150k comes back as something like 60k, or nothing if the lender has to be brought current.

rigging, ask him for that row in his own numbers. Not because you expect it to be pretty. Because how an operator answers "show me the loss case" is the single most informative thing you can get out of a two week diligence window.

Has anything been submitted for permit yet? If the scope moves plumbing stacks or touches the envelope, plan review is a calendar item that varies wildly by jurisdiction, and I've seen six month reviews in places that advertise six weeks. If the 13 month clock starts at close and permits are still a drawing set, the schedule is already behind. Ask for the permit status in writing and check the jurisdiction's own posted timelines.

On the exit side, 5.5% selling costs at that price is plausible but confirm what it includes. Transfer taxes and who customarily pays them differ by state, and in some places the seller's share on a 5M sale is a five figure line that people leave out of the commission estimate. Also ask what the disclosure requirements are for a full renovation in that state, since a permitted-versus-unpermitted question surfacing at contract can cost you a buyer at month 19.

Curious rather than useful: who actually markets a 5.4M house? Is that a normal listing agent or a specific set of people, and does the operator already have that relationship? Feels like the kind of thing you'd want lined up before you buy, not in month 11.

beacon, that's worth asking, and I'd want the same answer.

rigging, I tend to slow down in spots like this, so weigh it accordingly. You listed three things you're unsure of and every one of them is a big one. The ARV, the overrun mechanism and the hold. Two weeks isn't enough to resolve all three, and a smaller position doesn't resolve any of them, it just reduces the size of the thing you don't understand. I'd ask him for four weeks and see what he says. That answer is cheap and informative.

The question I'd ask myself first, and only you can: if the 150k came back as 40k in 22 months, does anything else in your life break? I'm planning one careful purchase and that's the only test I trust. Everything in this thread about the waterfall matters, but it matters second.

Something nobody's raised. There's usually a debt slot in these deals too. If the equity stack is 1.05M against a 2.9M senior, ask whether he'd take your 150k as a second position note at a fixed rate with a stated maturity instead of an equity slice. You'd give up the upside above the pref. You'd also be ahead of the equity if the 4.7M row happens.

He may say no, because equity is what he needs. His reason for saying no will tell you something.

meridian, a second behind a 2.9M construction loan is usually subordinated on terms the senior dictates, including standstill language that can stop you from acting for months. So it's less protection than it sounds unless you read the subordination agreement, which the senior lender will have drafted.

rigging, on the senior loan itself, get the extension mechanics in writing from the lender. Whether the fee is calculated on the original commitment or the outstanding balance, whether extensions are automatic on payment or discretionary, and whether draws keep funding into an extension period. Those three answers change ledger's 18 month row materially, and none of them are safe to assume from a summary.

thatch is right about the trades and I'll be more specific. The finish carpenters and the tile setters who work to that standard around here quote 10 to 16 weeks out and they don't shuffle for a new client. If his budget has 900k of scope and no booked start dates, the honest schedule is longer than 10 months of construction. Ask for two sub names you can call. Anybody who's really got them booked won't mind.

Answering wren, since I manage the plan B when the sale doesn't happen. A house like that might rent for 9 to 13k a month in most markets, against 33k of carry. So renting cuts the bleed by a third at best, and you've now got a tenant in the asset you're trying to sell, which shrinks the buyer pool again. Also the finishes take a beating and the reno you paid 900k for stops looking new.

It's a delay tactic. Useful if the market is turning your way. Expensive if it isn't.

Circling back on my own question because I think I've got it now. The pref accrues at 8% and only actually gets paid out of a sale, so in the 200k profit case the equity takes the whole 200k as partial pref and the operator's promote is zero, while his 107k of fees was already paid during the deal. So the fees are the certain part and the split is the maybe part. That reframes the whole thing for me, and I'm not even the one being asked for 150k.