This post is for people interested in owning property as a group

At Radish, we created a new kind of financial/legal structure designed for this. We call it the Radish FriendLLC.

We think this structure has a lot of benefits and applies to a broad variety of community ownership scenarios. In this post, we’ll dive into how it works, the pros/cons, and lay out some of the decisions you’ll need to make when implementing it.

What is the Radish FriendLLC model (briefly).

The Radish FriendLLC model is for a community of friends that want to own and reside in property together.

There are two players in The Radish LLC Model:

1) Owners - People that put in capital to buy/renovate the property

2) Residents – People that live at the property.

And there is overlap between these two groups. At Radish:

• I am both an owner and a resident. I invested money and I also live there now.

• My friend Arthur is an owner but not a resident. He put in money to support the project, but lives somewhere else (and visits a lot).

• My friend Suzannah is a Radish resident but didn’t put any money into the project, so is not an owner.

Same people, two different hats

Owners and the residents wear different hats, have different responsibilities, and govern different parts of the experience. I need to be able to wear different hats, depending on the context. When it comes time to vote on whether we should sell, I am wearing my owner hat. When we are discussing how our food system is going to work, I am wearing my resident hat. There are two decision structures and two different groups that make those decisions.

Owners are most impacted by decisions about the property itself. Residents are most impacted by decisions about how the community operates.

The money flows

The residents pay rent to the community. The community uses some of that for its own expenses (food, internet, etc). A "property rent" is paid to the LLC ("Big Cabbage LLC"). The LLC takes care of its expenses (property tax, insurance, maintenance, etc) and the investors get a return from what remains.

Each resident pays rent based on how big/nice their space is. Each owner gets a dividend from that rent based on what percent of the LLC they own.

For people that are both owners and renters, there is a "net payment" - essentially the difference between how much space they rent and how big of an owner they are. Some get back money every month and some pay in.

Example of net payments

• Alice, Bob, and Corey have a FriendLLC called ABC LLC

• The property is $1m. Alice put in $750k, Bob put in $250k, Corey put in $0

• Alice, Bob, and Corey all pay different rents based on the space they live in. Corey lives in the biggest unit and pays $3k of rent per month.

• There are $2000 of monthly property expenses (property tax, insurance, maintenance etc).

Pros and cons of the FriendLLC

Pros

What the Radish FriendLLC is really great at: FLEXIBILITY

Each system comes with its pros and cons.

The gigantic "pro" in the Radish LLC model is FLEXIBILITY. The model readily adapts to changing owners, changing resident needs, and a changing property.

Want to have someone move between units without changing their ownership? No problem, just swap rents.

Want to have someone move in who is not an owner? No problem, just charge rent.

Want to have one person put in a lot of money? No problem, just give them more dividend.

Want to raise another $5k to install a hot tub? No problem, just give people new shares for what they put in.

Want to bring on investors who don’t live there? No problem, just issue them shares and dividends.

Want to create a membership system where non-residents can pay money into the system? No problem, just have them pay into the LLC.

Contrast this with a system where everyone owns their own unit on a property. All of the above transactions would be complicated and require a reworking of the agreements.

Also great for: When your friends have different financial resources

Arthur got the early alpha on Doge coin. Suzannah’s been grinding it away at that non-profit.

Arthur is going to fund 30% of the thing and not even live there. Suzannah can just afford to pay rent but not invest. This is all okay!

Some people within a friend group have greater means or desire to invest. That’s just reality. This model is designed to work with that reality, not an idealized world where everyone splits everything equally.

Also great for: Dealing with the outside world

The technical term for this structure is a Real Estate Limited Partnership. This is a very common way to hold conventional real estate.

Your instinct might be "BOO, I want to do something special and unique and different."

But … there are lots of advantages to mimicking something conventional.

Banks will understand it, your accountant will understand it, your insurer will understand it. Try going to any of these parties and saying "we are a Community Land Trust" and see what they say. By using a conventional real estate structure, it means your loan will come with a lower interest rate, your insurance will be cheaper, and you can get any ole accountant to do your books.

Also great for: Fundraising

The Radish LLC model is great for fundraising because it allows any of your friends to invest, whether or not they live at the property.

Radish would not have been possible without this feature. The original supporters who made it possible were believers in the vision, but didn’t want to move right away (or ever).

At Radish currently there are 19 owners and 13 residents. Most owners don’t live there currently.

[Quick footnote on Securities Law: Securities compliance is something you need to talk to a lawyer about. There are exemptions that can help friends raise money into an LLC together. But make sure you are on the right side of the rules here]

Also great for: Liability

The "LL" in "LLC" stands for "limited liability."

And if you are an owner of coliving property, you want your liability limited. If someone sues you, you don’t want them going after your personal assets (outside of the property).

If your name is on a title personally, someone can sue you personally. If an LLC is on the title, this is less likely.

Caveat: This topic is more complicated than the basic description above. Talk to a real lawyer.

Downsides

Downside #1: Exit

The big downside of the FriendLLC model is ease of exit. When everyone owns their own unit, they can just sell their own unit whenever they please. When they own a share in an LLC that owns a property, this becomes harder.

When using the Radish FriendLLC model, you need to provide ways for people to exit.

At Radish, we do this in a few ways:

1. As a stopgap, we have a target date to sell the property. For Radish this is 5-10 years. People know, that at a minimum, they will get their money back within that timeframe. Taking in money is harder if you don’t have an exit timeline.

2. We bring on new investors, particularly by encouraging new residents to invest. The new investors can cash out the old investors

3. We can also refinance the property later (when it’s more valuable) and use the cash proceeds to buy out old investors

But regardless, investors do not have control over the timing of their exit. And this is a definite downside of this model. We’ve generally encouraged people to not invest money they do not need back anytime soon (i.e. don’t invest your nest egg).

Downside #2: Tax optimization

This structure is not tax optimized.

If you are both an owner and a resident, you are essentially paying rent to yourself and getting taxed on it. Boo. When you own a place outright, there is no rent check and no profits and no taxes.

[The ability to offset profits through deprecation of real estate means the tax liability is lower than it might appear]

Also: You need to talk to your CPA about what this means for some of America’s (super regressive but generous) tax benefits for homeowners - The Mortgage Interest Deduction and the exclusion on real estate capital gains. These benefits are designed for owner-occupants and you should try to keep that status for tax reasons.

Downside #3: Admin

Managing an LLC and slate of owners is not trivial. It’s nothing too crazy, but will take time from someone. Every group has a finance/legal geek who doesn’t yet know it. Find that person.

I do the accounting and LLC management at Radish and estimate it takes 3-5 hours per week.

How does governance work?

Governance happens at two levels: The owners and the residents.

The owners decide things related to the property itself like "when do we sell" and "do we refinance the loan?"

The residents decide things like "how should our food system work?" or "who should live here?"

We’ve written about governance before.

Here are two tips on owner governance:

1/ Appoint a Manager for the small stuff

You don’t want all the owners voting on small things. When the toilet is leaking, you just want someone to fix it, not to call a meeting.

The LLC can appoint a "Manager" to take care of all the small stuff on its behalf. You can also appoint multiple managers.

What does a manager do? They will probably do the administrative stuff. You also likely want to give them pre-approval to spend up to a certain amount of money.

For example, you might set a max maintenance budget of $10,000 per year and allow the manager to spend up to $2k in a single transaction without a vote of the owners (which covers most standard maintenance issues).

2/ Set voting thresholds for big decisions

Here’s how we did the thresholds in another property I’m involved in (Duck Cloud). You should be making these decisions infrequently.

How do profits work?

In the Radish FriendLLC model, everyone who lives at the property pays rent whether or not they are an owner.

You need to decide how much rent people should pay. This can be tricky to negotiate!

We use a simplifying rule which has been helpful: The 5% rule.

We set rents across the property so that investors make a 5% annual return on their dividend.

Where does this 5% number come from? It’s meant to be a totally vanilla mediocre/middle-of-the-road real estate return. Real estate-y people would call this a "cap rate" – the average return you get on an investment. Different companies publish reports on cap rates. Here’s one for San Francisco.

You could, of course, pick a different number. But if you go too low, you might have trouble attracting investors. And if you go too high, you might have trouble attracting residents.

So we set our sights at 4.5-5% and set expectations with all the incoming residents that this would be the principle we used to set rent.

And, after an initial renovation period, we’ve been pretty good at keeping to it. Property expenses are fairly predictable.

Returns were lower during our initial renovations of the property, but we’ve stayed pretty true to our 4.5-5% target

Here’s what the flow of funds looks like at Radish, which is a $2.5m project (including the mortgage).

Note: The mortgage payment comes out of the dividends. It is not a property expense, it’s a cost of capital. The "total capital" of $2.5m includes the mortgage....

Below is a slide I made for potential investors to show what they get in return for investing. There are two components: Dividends from rents, and gains (or losses!) from selling. I used the St Louis Fed dataset to get typical gains/losses for my area.

You might be asking … do investors need to get returns at all? Well, if you can find investors who don’t need any returns, then give them a big warm hug. But we’ve found that most people are not going to park their money for many years in a risky venture with 0% return. Inflation alone would mean they are much worse off even if everything goes well. I’d be wary of any project that is promising top-of-market returns, but you will likely need to pay out something to people that put their savings at risk.

How do loans work?

Your LLC can get a loan in its name … but the bank will almost certainly require a personal guarantor (or more than one). Banks typically don’t lend to a "naked" LLC that you just created. They want to have recourse to an individual with assets.

You’ll need to figure out how and if the guarantors are compensated or protected for taking on this risk. Some thoughts on that here.

Conclusion

How to use this post?

Don’t blindly announce you are doing a Radish FriendLLC. The best way to use this post is as a discussion guide with your lawyer and CPA. They will help you evaluate whether it makes sense for your situation.

But we think this is a good model in a lot of scenarios that optimizes for something that’s critical in community projects: Flexibility in the face of the unknown.

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