Summary: In this two part series, we’re going to dive deep into real estate partnerships. We’ll start by discussing the pros and cons of real estate partnerships. We encourage new investors who are considering partnering to really focus on the section where we cover the cons of partnerships. Ignoring the downsides is so easy. In Part 2, we’ll cover partnership agreements. We will discuss the matters you’ll want to consider when crafting your document. We’ll end Part 2 by discussing a form of ownership called tenants in common. This will give you more flexibility and options when exiting your partnership.
[Disclaimer: We are not accountants, lawyers or financial advisors, so please consult your own team of professionals about the topics covered in this article.]
Students in our course often ask us about partnerships. We recently ventured into a real estate partnership with one of our students. We decided it’s about time we have an article about it!
Over the years, Leti and I have previously been involved in several bad partnerships. As a result, we didn’t have a great impression of partnerships. More recently, we realized this was a limiting belief. An opportunity arose to partner with one of our students. We ventured forth and conquered our limiting belief!
The following is a summary of the pros and cons of partnerships:
- When structured properly, real estate partnerships can work and be great. However, most people don’t take the time to think through their choice of partner or come up with a solid partnership agreement.
- There are a lot of downsides to real estate partnerships. I go through these in-depth. I really encourage you to go over this list multiple times and think through how these apply to you. How are you going to mitigate these downsides?
Pros of Partnerships
Most people reading this article probably have no trouble identifying the positive aspects of real estate partnerships. Partnerships are one of the most common topics we get questions about from students in our course. Let’s run through some of the benefits of partnerships:
Scale up faster with a partner
Having a partner can potentially allow you to get into larger properties faster. Most students in our course start out with single family homes or small multifamily properties. What if you could team up with a partner and combine resources to buy a 20 unit property? With larger properties, you gain efficiencies of scale. Larger properties can potentially help you grow your rental portfolio faster.
Combine knowledge/experience/network
Combining your strengths is an argument we hear people make frequently. What if you could find a partner that fills in your gaps in knowledge, experience, or network? What’s not to like about that?
Having a thought partner
A big part of having a long and successful investing career is to avoid big mistakes that set you back financially. Having a thought partner can potentially help you avoid mistakes. They help you see what you might have otherwise missed. To gain the most knowledge from your thought partner, you need to meet with them regularly and think through your property in a systematic way. As a result, you won’t miss anything!
More financing options
If you’ve ever applied for a Fannie Mae or Freddie Mac multifamily loan, you’ll know that their requirements are that you have 1) prior experience owning and managing multifamily properties and 2) you have adequate net worth and cash reserves. New investors are just getting started. The need for prior experience can be a challenge. You don’t have the experience with multifamily…yet! Also, having the proper reserves may be a challenge. You have your salary from your job and that’s about it. Your partner may be able to help you solve these problems.
Split the work
If you’re diligent about splitting the work and each partner works in their own “zone of brilliance” this can be a really great benefit. Each partner can focus on what they’re good at. Turning a property around requires a lot of coordination and effort. Imagine all of the work it takes to renovate every single unit of a 20 unit apartment building. Sharing the responsibility really makes this more manageable.
Cons of partnerships
Most people (myself included) who are just getting started in real estate often have difficulty seeing past the upsides of partnerships.
Oftentimes, not enough thought is put into the cons. Mechanisms need to be put in place to mitigate these downsides so partnerships won’t fail.
New investors, I recommend focusing on this section of the article. Re-read it multiple times. Take the time to think about how you are going to mitigate these cons:
Disagreements and conflict
Many enter into partnerships with their best friends or maybe close family members. Many tell us that they’ve never had a fight in their life. They can’t imagine they’ll ever get into a disagreement. That’s a mistake. Disagreements happen when dealing with money or any investment. Leti and I like to take it a step further and tell our partners to expect that there will be disagreements. We’re not talking about disagreements about the color of the paint on the walls. We’re talking about major, heart-wrenching, and high-stress disagreements. Now imagine this level of disagreement with a best friend with whom you’ve never had a conflict!
“Silent” partners
Whenever you partner with someone, you are also partnering with their spouse. This is often not on people’s radars. The term “silent” is ironic because they are rarely silent. Silent partners are often the source of many disagreements and conflicts.
Capital calls
Capital calls are common in real estate. They occur when there is an unexpected repair or issue that requires an infusion of capital. Therefore, problems arise when one partner can’t come up with the funds needed to deal with the issue. One partner often ends up lending money to the other partner. You need to expect that this will happen. If there’s anything that’s certain in real estate investing, it’s that the unexpected will happen at some point.
Limited exit options
Whenever you partner with someone to buy rental properties, you limit your exit options. One of the best ways to exit a rental property is to use a 1031 exchange to take the entire proceeds and put it into the next property. With a partnership, you either have to go along with your partner and invest together in the next property or you forfeit the tax benefits if you pull your portion out.
Loss of control
Leti and I both like to have control over our investments. So, loss of control is a big deal for us. As a result of entering a partnership, you give up some degree of control. For instance, major decisions such as when to sell have to be cleared with your partner. Therefore, this aspect is especially important if you are in a situation where you need the money from your investment property to help pay off any debts. Both you and your partner may prevent each other from selling. You’ll want to think through what you’ll do if this happens.
Summary
We’ve covered the pros and cons of partnerships. In Part 2 of this two part series, we’ll cover the key elements of a partnership operating agreement. We will also discuss one form of ownership called a tenants-in-common. This gives you flexibility when exiting your investment.
