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Real estate partnerships have been around since the cave man's days. This is because people have learned to pool their resources in order to reduce their risk and increase their leverage. Pooling resources enables them to have a larger down payment, stronger financial statements, or greater experience.
The primary question, "Is a real estate partnership a good way for you to invest?" cannot be easily answered. First, you need to consider who your partners are. Are they strong financially? Can you trust them? Just because they are family members, or your best friend from high school, does not immediately qualify them as trustworthy. You also need to consider whether the investment makes sense.
Check out the key issues. Will you make a return on your investment? How long will it take? Does it sound too good to be true? Remember the old business rule "Caveat Emptor," or "let the buyer beware." Are you comfortable with the level of risk? How long are you going to be tied up with the partner/s? What is your exit strategy? What are the tax ramifications? Are you going to be a majority or minority partner?
In today's real estate investing environment there are many kinds of partnerships. You can invest in a real estate investment trust (REIT), a tenant in common (TIC) project, with partners in business, in a separate limited liability partnership (LLP) or as a limited liability corporation (LLC). Partnerships seem to work best when all sides have some experience, similar investment goals, are not dependant on the income to live, and have taken time to plan out a good partnership structure.
There needs to be a consensus within the partnership on how key decisions are made, and if there is a need to for a managing partner or partners. If ownership in the partnership is equally allocated, then it is critical to have a method to break decision deadlocks such as an outside party that consults, a mediator, or a family member. The best way to reach a consistent approach to your investments is by drafting a written real estate partnership agreement with the help of an attorney. (Note: This attorney will then become the partnership's attorney and not your own personal attorney. If you anticipate conflicts of interest, you may want your own attorney to review the partnership document.)
Trust between partners is built with regular auditable reporting in addition to regularly scheduled meetings and/or communications. You may find that you want to be a silent investor rather than an active investor. If this is the case, you still need to receive regular reports of progress.
Finally, you need to realize that real estate investing is a risky business. You need to anticipate the timing of your investments. You may invest ahead of the curve, or your timing might be off and the property does not appreciate or generate cash flow in the way you expected. Not all real estate investments (either partnerships or individually) make money, and sometimes the economy does not cooperate.
Recently a couple who owned the same 19-unit apartment investment property for 40 years (which had made money for the last 39 years) was forced to sell the property. This was due to a major vacancy factor in the market resulting in six-year-long vacancies in the building. Older properties, such as theirs, are often unable to attract and retain tenants. In another situation, longtime friends (and partners) came into conflict over their real estate investments when a partner's new wife thought they were not being treated fairly. They all ended up spending thousands of dollars in litigation expenses. Sometimes our instincts to protect our families comes in conflict with the priorities of our real estate partnerships.
In order to help a real estate investor think through the process of establishing a real estate partnership, included is a checklist of issues to consider when assembling a partnership. A CPA must be involved to make sure the tax implications have been reviewed, and that you have a way to exit the partnership if and when you want to.
Checklist of issues to be included in partnership agreement:
1. Purpose for forming the company and goals the company wants to achieve
2. Partnership allocations
3. Capital investment (Initial contributions)
4. Value of the investments
5. Legal ownership entity: Corporation, LLC, LLP
6. Management strategy for the partnership
7. How and when to make partnership decisions
8. How and when to make the decision to sell the investment or buy more
9. How to decide on rent increases
10. Do you need a managing partner?
11. Who is the managing partner?
a. Term
b. Removal of manager
c. Authority of manager
d. Power and actions of manager
e. Compensation of manager
f. Right to delegate
g. Authority to convey property
h. Standard of care
i. Restrictions on the authority of the manager
j. Indemnification
k. Duty of Loyalty
12. Tax issues:
a. Who gets tax benefits
b. In which proportions
c. Who prepares the K-1 and by which date
d. How accounting costs are shared
13. What happens when there is a cash shortfall
14. Failure to pay contributions
15. Loans by members
16. Meetings
17. Quorum
18. How to allocate profits and or losses
19. Liability insurance
20. Directors insurance
21. Life insurance and how the cost of the insurance is to be funded
22. Liquidating distributions if and when the company is dissolved
23. Books and records
24. Death or incompetence of a member
a. Will transfer
b.Transfer to a permitted transferee
c. Limited or unlimited power of appointment
d. Sale of share to a partner … right of first refusal
e. Estate planning transfers (Review life insurance issues so that share dispersals are limited to the same number of parties. I.e. shares go to wife not to the six children each with one portion of a vote.)
25. Dispute resolution
a. Mediation
b. Arbitration
As you can see from the checklist, being involved in real estate partnerships is not easy, but careful planning will get you on the road to success.
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