What would be the right way to split the profits of the sale of a co-owner property?

Question

In the event of selling the property, how would the proceeds be divided when one person covers the down payment, and the other is responsible for the mortgage payments? Thank you.

Answer 1

In the event of selling the property, how would the proceeds be divided when one person covers the down payment, and the other is responsible for the mortgage payments?

This is just one of the issues that need to be discussed, resolved and documented in writing before making the investment. Putting it in writing lets both parties see the numbers. Resolving it before any money is at risk will reduce a disagreement later.

Other issues that need to be resolved in advance: special assessments, repairs, upgrades. What happens if somebody wants out earlier than the other?

There is no solution that is right, but there are solutions that are numbers based. The complexity comes from the additional tasks, assuming this is a income producing property: time to search for the property; time to find a tenant; and time to handle the tenant issues.

Note: even if the other stuff is ignored the percentage split will change over the lifetime the property is co-owned. The split if it is sold 6 months after purchase shouldn't be the same as the split decades later.

Answer 2

There is no "right way". It's whatever the two of you agree is fair, based on how much money each of you has put into the purchase.

Answer 3

Ideally this would be discussed before making the investment.

If it were me.

I would add up the total that each party has invested into the property.

Downpayment + the interest, stock gains, or some other value that takes into accouunt tha added value of money over time. vs monthly payments, totaled and including that same factor.

So you invested this years ago then Bob spend down payment + 10 years of bank interest..

and john spent monthly downpayments + interest calculated from when each mortgage payment was made, 120 payments + 120 adjustments for interest with the most valuable payment made the longest ago. Or if using an averaged return rate... take the averaged interest value (pretend the payments were made 10 years ago, but give 1/2 the interest).

After the total has been calculated, split the net profit based on the percentage share that you both have invested.

Answer 4

I'll outline a few methods in mostly decreasing order of complexity.

Any of these can be "fair", and they only differ by a small amount in the conclusion.

Interest

You have a 30 year amortization 5% interest loan. That is a reasonably fair way to calculate time value of money here.

Down payments and monthly mortgage payments both change the remaining debt total in exactly the same way.

For each payment P that was M months ago, its current value is P * 1.05^(M/12) (or P * (1.05^(1/12))^M).

On the time scales you are dealing with, using 1.004 for 1.05^(1/12) may be simpler, giving you P * 1.004^M as the "current share value" of investing P dollars M months ago.

Now this is hard to deal with when there are dozens of monthly payments. Luckily there is a short cut.

If you have been paying mortgage payments for N months, and just made the Nth one, the present value is:

X * 1.004^0 + X * 1.004^1 + X * 1.004^2 + ... + X * 1.004^(N-2) + X * 1.004^(N-1)

we can simplify this to:

X * (sum(i from 0 to N-1) 1.004^i)

then using a famous (in the world of mortgages) trick:

X * ((1.004^N-1)/ (1.004-1))

or

250 * X * (1.004^N-1)

So if you sold it after 30 months, the monthly mortgage payments impact on the debt would be 31.81x the monthly payment ("average interest" including compounding would be 6% or so).

Meanwhile, the initial payment would be 1.05^2.5 = 1.130x its base value.

Simpler "Cheater" math

As you are planning on selling within a few years, we can use a linear approximation and get a reasonably good result. You'll note that the above 13% return is very close to 5% per year times 2.5 years.

Similarly, the 6% average interest on the monthly payments is about half that amount.

So you can get an answer within a few percent by simply doing:

Initial Investment times (100% + Yearly Interest * Number of Years)

for the down payment, and

Monthly Payment times Number of Months times (100% + (Yearly Interest * Number of Years/2))

This short cut - this linear approximation - undervalues the initial investment by less than 0.5%, and overvalues the monthly payments by 0.2%.

The longer the period of time, less accurate this cheater method becomes.

Keep it Simple

Just add up the amount invested. At the 30 month mark it overvalues (compared to the Interest method) the value of monthly payments by about 6%.

Present Value

Instead of using the Interest, we use some other discount factor for the time value of money. Maybe you use the fed prime rate, or the cost of borrowing unsecured debt, or anything else.

You can negotiate what is a fair rate. I simply used the Interest rate originally for a few reasons. It is what a bank (or other professional) judged the cost of loaning you money to be, and the bank is a disinterested 3rd party.

Also because if, if the mortgage allowed you to pay extra in a month (like many do), the Interest would actually describe the results on the total debt owed.

It isn't quite a slam dunk, because imagine if the value of the property soared. Someone who threw a bunch of money into the property after it soared would be getting a great deal, as they aren't taking nearly as much of a risk as someone who invested before it soared.

Similarly, if the person making the monthly payments defaults and you sell, the person who made the first investment doesn't get to choose to ramp down their investment. In a purely financial calculation, that person should seek to default and force a sale if the value of the property goes down, and if the value of the property goes up they should seek to put off selling - meanwhile, the down payment provider should seek to sell as soon as possible if the value of the property goes up to protect their share from being diluted.

Under this semi-adversarial model, we need a clear description of how the decision to sell the property will be made, and what actual consequences there are for default by the person making monthly payments if they fail to make the payments.

What I would do

Assuming I'm not that worried about adversarial strategies, I'd use my first option. I would also draft a contract about how selling the property in question is decided, and what happens upon default of the mortgage payments.

I'd take this plan to a lawyer I respected, and have their paralegals draft an agreement. In doing so it is likely they'll actually have a variation on how to price the investments that is legally common - and I'd probably end up using that, instead of the bespoke math based version I mentioned above, simply because other lawyers and judges and the like will be familiar with the common version.

This is an agreement about life-changing sums of money. In the event that relationships break down I would want firm legal grounding.

If this is a purely financial agreement with a stranger, I'd probably pass on the entire thing; this kind of bespoke finance is hard to get right.

If this is a mere friend or acquaintance, my rule is don't get involved in financial entanglements with friends unless you are willing to write off the money in question, or write off the friendship and go to court and still probably lose most of it.

If this is a partnership situation, then I'd be looking into local marriage (common law and not) laws. Buying a home with someone you cohabit with often works very differently than you would think.

Answer 5

This should be agreed on before anyone puts any money into the property.

IMO the fair way to do it retroactively would be that, if the downpayment was x% of the purchase price of the house (disregarding the loan), then they should get x% of the sale price, and the rest should go to the person paying interest.

My logic is this:

Suppose you buy a 500k house, X pays 100k and Y pays 400k. Then you sell the house for 600k. It's not hard to see why X should get 120k (600*1/5) and Y should get 480k.

But what if Y had to get a loan for the 400k, and ends up paying a total 200k of interest. Since Y paid a total of 600k of the total 700k spent, shouldn't X get only 14k (100*1/7)? Well, money now is worth more than money later, so it's not fair to compare X paying 100k immediately to Y paying 800k over a number of years. However, clearly Y has already decided that paying 600k over several years is of equal value to paying 400k right away. Otherwise, they would not have agreed to the loan. Therefore, if a 600k loan is equivalent to a 400k lump payment, we can still use the same proportion as if they had both paid with a lump sum.