Real estate can be a valuable part of your investment portfolio. It provides asset diversification, a hedge against stock market and interest rate fluctuation, an opportunity for appreciation and, potentially, some tax benefits. However, owning investment real estate can be a complicated undertaking. Add in a real estate investment partnership structure, and the complexity only increases.
Putting aside the work that goes into selecting and acquiring a property and the capital (or debt) required to pay for it, you have to lease and maintain your property, pay bills for all taxes and operating expenses and keep accurate books and records for the project. While the difficulty of these tasks varies based on the nature of the property and your personal skills and finances, many people choose to partner with others to share the responsibilities and benefits of owning real estate.
If you decide to invest via real estate partnerships, selecting whom to work with and how you will invest with them is of critical importance. A strong partner can help boost the profitability of your investment, while a poor one can cause you monetary damage, anxiety or stress, and may also jeopardize your reputation or credit.
One of the most common types of real estate investment partnerships are formed when friends or family members decide to pool their resources to buy and manage property together. This enables people to buy assets of greater value than they would be able to afford independently.
Operationally, the investors will often divide the work based on their respective skills and resources. For example, one person may perform or oversee maintenance and repairs, while others are responsible for leasing and dealing with tenants, maintaining the books and records, making distributions of income to the partners, and preparing tax documents. The various tasks can be allocated evenly or unevenly among the parties, or hired out to third parties for a fee.
There is a certain innate appeal to working with people you already know and trust. However, real estate partnerships with friends or family members often puts strain on the relationship. This is particularly true if someone fails to properly handle the tasks assigned to him or her, if the investment does not perform as anticipated, if additional capital is needed post-closing, or if the parties have different expectations about the timing and nature of the exit strategy.
In another common form of real estate partnership, one party will be the majority owner of a property, and another party will have a smaller percentage equity interest, but will be responsible for property management and operations. The operational partner will typically receive a management fee for those services, in addition to distributions on account of their ownership interest.
The operational partner’s “skin in the game” distinguishes this situation from the case where an owner simply hires a professional manager for a fee. In the latter situation, the manager is an outside professional with no stake in the outcome of the investment (beyond getting hired again the following year).
Operational real estate partnerships are common for investments that have more than a handful of tenants, for “value add” projects where renovations are made up front to upgrade, repurpose, or reposition the property in the marketplace, and for operational real estate such as hotels, nursing homes and self-storage facilities. These types of real estate partnerships may also be used to make single-tenant properties that require renovation or other capital improvements more akin to “armchair investments” from the majority owner’s point of view.
The operator is usually a real estate professional with direct experience managing the type of asset in question. Accordingly, the operator will have discretion to handle the day-to-day management of the property, while the majority owner will retain control over major decisions such as lease terms or budget, the scope of renovations and the sale or refinance of the project.
There are also a number of passive real estate investment opportunities available where investors can contribute capital, and a sponsor (generally a professional real estate operator) will manage all aspects of the investment, including major decisions. The sponsor may or may not contribute their own equity to the project. These investments are usually structured as either a limited partnership or limited liability company, and the partners or members do not necessarily know one another.
Regardless of the type of partnership you choose, there are several steps you can take to help ensure that your investment is handled according to your expectations.
1) Put your agreement for all real estate investment partnerships in writing.
2) Know your limitations and goals.
3) Conduct as much due diligence on your partners as you do on the property.
4) When in doubt, use professionals.
No matter how you decide to proceed, documenting your understanding in advance with your partners and outside professionals is critically important. It is easy to correct or forgive mistakes or deviations from the parties’ agreement when the investment is performing as expected. The bigger test is how your partners behave when something goes awry. Doing your homework to prepare for the worst in advance will help manage expectations.
Following these tips cannot guarantee that your real estate investment partnership will be as profitable and seamless as you might like, but it will improve your chances that you will have a positive investment experience with your partners.
[Editor’s Note: To learn more about this and related topics, you may want to attend the following webinars: Due Diligence in Real Estate Deals, Investing in Commercial Real Estate and Investing in Residential & Multi-Family Real Estate. This is an updated version of an article originally published on January 10, 2018.]
©All Rights Reserved. May, 2020. DailyDAC™, LLC d/b/a/ Financial Poise™
Tracy Treger is Principal at Syndicated Equities. Tracy helps high net worth individuals and family offices to profitably invest in real estate. She also assists investors in identifying appropriate replacement property to complete tax-deferred exchanges under Section 1031 of the Internal Revenue Code. Drawing upon her 20 years of legal experience in the areas of…
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