House investment

August 14, 2006 11:11 AM

Three friends from college bought a house together to live in and for investment reasons 2 years ago. We have all invested different amounts of $ into the house and are now trying to figure out the % ownership we each have so when we go to sell we can fairly split up the profits. Any ideas...

I know I know, don't do buisness with friends and if you do get a legal contract. Well we didn't get that memo. We each have different opinions on how to split up the profits but we all want to do what is fair, so I thought I'd ask.me; here is a simplified layout of who invested what:

So there are 3 investors:
a $200K mortgage was split evenly three ways. ($66.67K each)
Investor 1 also put 20% down ($50K)
Investor 2 also paid for part of house improvements ($25K)
Investor 3 also paid for part of house improvements ($25K)

Other than that everything is even, we all live there, we all split bills, we all split the mortgage payments, we all help with home improvement projects. So we are 1st trying to figure out the % ownership in the house, then once we have that figured out what is the best way to divy up any profits (assuming there are profits)?

Thanks,

posted by retro88 to home & garden (19 comments total)

Not sure if this is dopey or not, but when you sell, can you give back $50K to investor 1, $25K each to Investors 2 & 3, and then split the remaining money evenly between the 3 of you? That to me sounds like the fairest way to go about it.
posted by tastybrains at 11:15 AM on August 14, 2006

Everyone assumed 66.6k in liability.

Investor 1 added 50k in additional liability.
Investor 2 added 25k in additional expenses.
Investor 3 added 25k in additional expenses.

Investor 1: 66.6k liability in the share of the house plus 50k in expenses gives him 116.6k

Investor 2 & 3 both have 66.6 + 25, or 91.6k in.

Total invested in cash and liability: 300k. Investor 1 share is 38.86%, investors 2 & 3 each have 30.56%.

Only other fair alternative, if you are all friends, is for investors 2 and 3 to reimburse $12,500 to Investor 1 so that investment in down payments and improvements are equal, then to have a 33.3% share each in the house.
posted by JakeWalker at 11:17 AM on August 14, 2006

I think all investors expect to earn some return on the $ they invest, so simply paying off each other at face value of the original investment and then splitting the profit leaves investor 1 missing some earnings on his extra 25k. SO JakeWalkers' first solution is most equitable.
posted by Gungho at 11:28 AM on August 14, 2006

notansweringyourquestionfilter:

at risk of stating the obvious, whatever is agreed to now should be put in writing and signed by all that agree.

Also, if you are going through this process, you should determine an exit strategy by agreement. What happens if 2 want to sell and 1 does not? Can one investor buy the others out and if so, what is the process to determine the purchase value?
posted by greedo at 11:28 AM on August 14, 2006

JakeWalker has it with the 38.86/30.56/30.56 split. However, I disagree with the fairness of 2 and 3 reimbursing one for 12.5k each. Since 1 had invested that extra money up front, 1 deserves the extra 5% of the growth. And if there aren't any profits, then 2 and 3 are bearing extra loss.
posted by MrZero at 11:29 AM on August 14, 2006

I agree, it seems that JakeWalker's division is the only fair way to do it. I'm really curious what the argument is -- what do the other investors say? How could they not just divide this up by percentages according to what they've each paid in? Seems kinda a no-brainer.
posted by incessant at 11:34 AM on August 14, 2006

Thanks for the input. I will say i'm in agreement with Jake walker.
JakeWalker has it with the 38.86/30.56/30.56 split.
In short this is how i thought about it too, I hope i didn't lead the witness with the way i presented the investment $#'s. One way my friend has thought about it was to not count the mortgage liability in full but rather add up the amount of $ paid each month in total at the time of sale. (Or rather the amount of $cash that came out of your wallet) For example:
Investor 1 has 20% dwn cash + $ paid into mortgage or 450/mo. ( 50k + 10.8K after 24 mo. = 60.8K)
Investor 2 & 3 each have 25k in home improvements + $ paid into mortgage (25k + 10.8k= 35.8 k)
Which would work out to be 45.92/27.03/27.03%.
posted by retro88 at 11:48 AM on August 14, 2006

Were the improvements done long after the house was bought? In that case, if I were a very greedy investor #1, I would argue that I'm owed more than 38.86% becase the other guys got to hold on to their money for longer (accruing interest) while mine was locked into the house.

Coming up with the correct division of profits in this scenario is left as an exercise to someone with more experience in finance :)
posted by jewzilla at 11:48 AM on August 14, 2006

Jewzilla,

True, Good point,
FYI: Home improvements were evenly done throughout the 2 years. However one thing that was agreed upon was that since investor 1 put 20% dwn, the other two would pay for all home improvements and this $ would be weighted equally.
posted by retro88 at 11:54 AM on August 14, 2006

The idea of actual money spent doesn't seem fair, as you mention above (45.92/27.03/27.03). This is because it unfairly weights cash spent, and doesn't consider the liability everyone took on. Signing onto a mortgage is taking on a liability, and that needs to be considered. For what if the house became condemmed, your insurance failed to pay, and it became worthless. This is a risk that everyone took and everyone needs to be compensated for.

I agree that the reimbursement of the $12.5k each isn't financially fair, but I believe it could be a fair arrangement that you can come to between friends.... the most FAIR way to do it is the split I mentioned in my first post.
posted by JakeWalker at 12:13 PM on August 14, 2006

I would agree with JakeWalker and add that if you want to get fancy, use the present value of each investment as the values, instead off the original amount. For example, the $50K downpayment is actually worth more than the subsequent $50K in home improvements because it came earlier (I assume). If all cash outlays were at the same time, then it's the same as how JakeWalker calculated it.
posted by GuyZero at 12:17 PM on August 14, 2006

some more food for thought...

Ok, So if we go with majority it will be split up as follows: as JakeWalker said: 38.86/30.56/30.56. So the next question is what do we split up, what is our profit?
If the house sells for say $390K, say of the original 200K loan we have 190K remaining. So we first pay off the rest of the mortgage and are left with, $390K-190K=$200K in our hands. Is this our profit? Or do we next pay back investor 1 the original 20% dwn (50K) and investor's 2 and 3 the original 25K each they made in home improvements Now $200K-50k-25k-25k = 100K, is this our profit that we split accordingly?
posted by retro88 at 1:00 PM on August 14, 2006

Yes but then how does one determine the present value of the mortgage payment and associated liability risk? Housing inflation rates or the more general inflation rates?

Take the simplest route if you all want to remain friends, or this could never be resolved.
posted by geoff. at 1:02 PM on August 14, 2006

I think a key consideration is how much of the mortgage is paid off. If, as implied above, only a small portion of the mortgage has been paid off (32.4k / 10.8k per person in total payments - principal and interest), the 39/30/30 split is profoundly unfair to the 50k down-payer.

Here's how I would structure it:
Assume (from your comments above) that the 50k (total) in initial improvements are taken at par with the 50k downpayment. This gives us a 300k investment.

At day zero, 1/6 of the investment (50/300) is owned by the first participant, and 1/12 is owned by each of the other two. The remainder is effectively owned by the bank.

From that point forward, each participant is effectively buying additional "shares" in the investment from the bank - some of that goes to interest (or other overhead) and some goes to principal. Only the amount going to principal is equivalent to the initial payments.

I would argue that the fairest way to divide ownership would be to calculate 1/6, 1/12, and 1/12 of the final value of the investment (actual sale price). This is taken from the net profit (sale price - outstanding liabilities) and awarded to the three participants. The remainder of the net profit is divided three ways.

This method will come out at the 39/30/30 split if the house if fully owned, but will be significantly different if not:

For example, if the house sells for 400k but there is 200k left on the mortgage (and/or in repairs, closing costs) that gives a net profit of 200k:
A gets 1/6 of the value or 66.7k
B&C get 1/12 of the value or 33.3k each

after this is taken out there is 166.7k remaining which is divided 3 ways equally leaving:
A - total of (66.7+22.2) = 88.9k or 44.4%
B&C - total of (33.3+22.2)= 55.6k or 27.8%

The only problem with this method would be if the house is not actually sold and the participants cannot agree on a fair value. If that's the case, I would recommend using a time value of money approach based on the interest rate paid on the mortgage. There could also be a reasonable debate about whether or not to include closing costs as part of the value of the house or as part of the profit (negative in both cases).
posted by aquafiend at 2:10 PM on August 14, 2006

I didn't see your last comment before posting; I think I answered the question anyways (with different numbers).

Another way to think about it would be to imagine if the whole structure had been three separate loans from the bank (again assuming that the 50k in improvements was equivalent to a downpayment).

In this model, each participant has a 100k stake. Participant A has put 50k down and owes 50k and B&C have put 25k down and owe 75k.

Based on the interest rate on the mortgage, you could figure out how much of each mortgage payment went to principal and how much to interest. Add the principal to the downpayment for each participant and you can come up with a percentage of the net profit that they deserve.
posted by aquafiend at 2:27 PM on August 14, 2006

I think everyone should get the same percent return on their investment regardless of the liability that was involved. I think this mainly because the chance you won't at least make a profit on something like a house is pretty small.

Investor 1 has 20% down cash + $ paid into mortgage or 450/mo. ( 50k + 10.8K after 24 mo. = 60.8K)
Investor 2 & 3 each have 25k in home improvements + $ paid into mortgage (25k + 10.8k= 35.8 k)
The house sells for 390k. 390k-167.6=222.4k of cash after fully paying off the loan.

Splitting the gross based on everyone making the same percentage of profit.

60.8k*x+35.8k*x+35.8k*x=222.4k
132.4k*x=222.4k
x=1.6797

Investor 1: 60.8k * 1.6797 = 102.12k or 41.3k of profit
Investor 2 & 3 : 35.8k* 1.6797= 60.13k or 24.3k of profit

This is a very different from the other options you are considering and seemingly less fair to Investor 2&3. But if you can put a money value on the ammount of time you invested in making home improvements (time really is money people). For example 10k each (but you can use different numbers for each person if every did a different amount of work).

70.8k*x+45.8k*x+45.8k*x=222.4k
162.4k*x=222.4k
x=1.3695

Time + Money:
Investor 1: 70.8k * 1.3695= 96.95k or 36.15k of profit
Investor 2 & 3 : 45.8k* 1.3695 = 62.72k or 26.92k of profit

I don't think it is important to consider interest rates or inflation. It would only make the case for Investor 1 stronger.
posted by robofunk at 3:25 PM on August 14, 2006

aquafiend

Not sure i follow your last suggestion:

In this model, each participant has a 100k stake. Participant A has put 50k down and owes 50k and B&C have put 25k down and owe 75k.

Based on the interest rate on the mortgage, you could figure out how much of each mortgage payment went to principal and how much to interest. Add the principal to the downpayment for each participant and you can come up with a percentage of the net profit that they deserve.


If you get a chance can you elaborate on this example?
posted by retro88 at 5:06 PM on August 14, 2006

Sure.

Let's say for example the interest rate was 5% and the monthly payment was around $500 each and the house was disposed of after 2 years of payments.

If we treat the house as 3 separate chunks of 100k (representing the 300k initial value above) then A has a 50k mortgage and B&C have 75k mortgage.

Use an amortization table calculator (such as ) and you can figure out how much principal remains at the end of 2 years.

In this case, the balance remaining for A is 42.82k meaning equity of (100k-42.82k)=57.18k. The balance remaining for B &C is 70.4k meaning equity of (100k-70.4k)=29.6k.

In this case, the total equity in the house is 116.38k. A owns 57.18/116.38 = 49%, while B&C each own 25.5%.

Remember that this is the percentage ownership of total equity, so if you get 390k for the house and still owe 158.62k (as in this example) then you split the profit of (390-158.62)=231.38k. No other adjustment for downpayment is required.

In this example, I used the online calculator I linked to to figure out the interest versus principal paid. To do this, I set the interest rate the same for both payment schedules (As vs B&Cs) and manipulated the repayment term to set the monthly payments to be the same (A=11 yr, B&C=20yr).

This simulates how much equity A, B & C would own if they had all taken out separate loans with the downpayments that they had (and underscores how valuable a large downpayment is in the long term).

To do this "for real" I would use a better table - for example, google "excel amortization table" and you'll find a number of tutorials on building a better table (in excel).

Personally, I think my other method is more fair (and also collapses to the same solution that everyone likes in the case that the house is paid off in full), but 'A' would be well within his or her rights to insist that this one be considered.
posted by aquafiend at 8:31 PM on August 14, 2006

whoops, that link should have been: link
posted by aquafiend at 8:32 PM on August 14, 2006