Brian asks: “My girlfriend and I are in the process of buying a house with a close friend of mine, with the aim of selling it on in 3-5 years. What is the best way to split the equity/proceeds from the sale?”

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Q&A 52 – How To Split Equity When Buying Property With Friends – Shownotes

Today’s question comes from Brian:

My girlfriend and I are in the process of buying a house with a close friend of mine, with the aim of selling it on in 3-5 years and we’re unsure of the best way to split the equity/proceeds from the sale.

We’re buying a house in London for £450,000, my friend is investing £80,000 into the initial deposit, fees and renovations, while my girlfriend and I are investing £20,000. My friend won’t be living in the house, but I’ll be living in it with my girlfriend and paying the full mortgage. We’re all first time buyers and are very new to this.

We all want to agree something that suits our needs. He’s looking to invest his money in something low risk, with a better return than an ISA. I and my girlfriend are looking to move out of our parents’ houses and get on the property ladder, with the aim of using our share from the sale of this place to buy a house of our own afterwards.

Any advice / approaches we could take will be gratefully received.

 

 

Don’t Do It, Man!

This is a great question. I’m going to start with a huge disclaimer and then get into the detail.

Firstly, I’d like to say that these things very, VERY often end in tears. When working with friends, family and especially with girlfriends and boyfriends, unless everything is locked down from a legal standpoint, things can get very messy, complicated and expensive if things go wrong.

So, my overarching advice would be to see if there are alternative arrangements that could be sought which suit you all better. Maybe your friend could go alone with a smaller, better return property investment with his £80k and you and your girlfriend could continue saving and paying rent until you are in a more secure and stable financial and social position.

 

 

Ways Of Splitting Equity

However, that wasn’t your question, so let’s look into what would be fair in this position, starting from the easiest proposal to the most difficult.

Let’s start with obtaining a mortgage.

Your question suggests that you are looking at a £450k house with a total deposit of £100k split between you and your girlfriend (£20k) and your friend (£80k). This would suggest a total LTV of 78%.

 

How Do You Split The Mortgage? 

The first problem here is who will take out the mortgage. You suggest that you and your girlfriend who be taking out the mortgage. The issue with this is that you will have to declare the £80k investment (akin to a loan) from your friend. In this scenario, the bank will take this into account and then may not offer you a mortgage on the £450k house.

Alternatively, your friend could take out the mortgage in his name only and you and your girlfriend lend him £20k. This is more realistic from the standpoint of obtaining the mortgage, but your friends’ income alone will have to be sufficient to obtain the £450k house, which it may not be. Additionally, if your friend is taking out the mortgage and not living in the property, he will need to take out a buy-to-let mortgage, which restricts your ability to charge non-market rate rents and also he will obtain a higher interest rate % compared to an equivalent residential mortgage.

This now becomes even more complicated following the autumn statement, as if the purchase is a buy-to-let (which it will be if your friend takes the mortgage and deed), then there will be another 3% stamp duty to pay after next April!

The final alternative is that you all apply for the loan together. However, this would then be considered a “group mortgage” which is a little more niche and hence you may not be able to get the best rates on the market.

So, let’s assume that you go with a joint-mortgage as I imagine that it will be the only one that you can get.

 

How Does That Split The Ownership?

You and your girlfriend are both putting in 10% of the mortgage each, and hence it would make sense that you own 10% of the property each as per the title deeds. This will need to be done via a tenants in common agreement to split the share of ownership.

Effectively, because you and your girlfriend are living in the property, you will then pay “rent” to your friend. However, this level of rent will have to reflect your original investment.

 

How To Repay The Mortgage Capital And Interest?

My suggestion for this would be to work out the interest and capital repayment split on the mortgage. For the capital portion, this would be paid in proportion to your current level of ownership.

With simple figures, let’s say the £350k mortgage (with an initial interest rate of 2%) leads to a total repayment amount of £1,482. This will be split about £582 as interest and £900 as capital. Therefore, the capital portion will be paid 80% by your friend (£720) and 10% each by you and your girlfriend (£90 each).

This means that whenever you want to leave the agreement (through a sale or any other exit event), you will still be liable 80%/10%/10% for the remaining mortgage, which will still be in line with the % of the property owned.

Then, for the interest, you will need to decide between you how much you pay each. This will be somewhere between:

• you and your girlfriend paying 80% of the market rent for the area
• you and your girlfriend paying 20% of the mortgage interest

80% of the market rent for the area might be £1,200 a month, but obviously this will depend on where the property is.

80% of the mortgage interest, which in our example is around £466 a month.

Where you settle here is completely dependent on your negotiation. A fair amount may be slightly towards the interest amount, but obviously your friend would rather that you cover the whole interest payment on the mortgage (£582) plus an amount of interest on his investment. Therefore, you may settle on you paying your friend £900 a month in “rent” (on top of what you’ll pay towards the repayment amount) which covers the full interest plus some return for his investment.

 

A Fair ROI For Everyone?

If you did settle at that level, you would effectively be paying £900 a month instead of £1,500 that you might be paying on the market, and your investment would be £20,000. Therefore, your return is effectively £600 per month (or £7,200 per year) on your £20,000 investment, which is a very healthy 36% effective return. Also, note that this doesn’t include the capital gains you hopefully will earn from your 20% investment as well.

For your friend, they will have invested £80k and will be obtaining £900 a month and only paying £582 in interest, thereby making a monthly profit of £318 monthly profit (or £3,816 a year). This is only a 4.77% return on his money, but he also gains from the 80% return from the property and IN THEORY, this return is more guaranteed than renting the property on the open market.

However, given these figures, you may agree on a £1,000 a month effective rental payment to more fairly split the ROI. This is for you guys to negotiate between you. But, whatever you decide upon, you need to get it in writing.

 

What Happens If…Or When…Things Go Wrong?

Is this complicated enough yet? No? Well, now we need to consider what happens when something needs fixing? Who is due to pay? What about if you make capital improvement? Who decides? And, what about if you want to sell? What happens if you and your girlfriend break up? What if your friend needs the cash?

There are literally hundreds of questions you need to answer and get in writing before entering into such an “equity split agreement”.

What may be easier is to simply loan your friend £20k and he agrees to pay you a fixed return of X% whilst you are living in the property and paying £y rent. Then, if you move out of the property, the fixed return may fall to Y%. This way, your friend will own the property and they’ll be much fewer complications. However, in this scenario, we are back to whether your friend can obtain such a BTL mortgage by himself and the capital gains, income tax and stamp duty complications he’ll have based on this year’s budget and autumn statement.

So, I’m going to revert back to my original advice – forget about this plan. It will inevitably be too complex if you do it properly, or too dangerous if you don’t.

Instead, you should keep on aggressively saving in order to get your deposit together for your own home, and your friend should visit a financial advisor to decide on how he wants to best invest his £80k.

 

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