QUESTIONS TO ASK BEFORE ENTERING A PARTNERSHIP

The real estate partnership was doing well.  The cash flow was good and the properties were appreciating.  The property manager was keeping the houses occupied with Section 8 tenants and checks were deposited regularly.  Then one of the partners passed away.  And his surviving spouse wanted her money.

What should the remaining partners do?

What would you do?

There are a number of reasons we may consider partnering on a real estate investment.  And there is probably an even longer list of questions we need to think about before making a commitment.  So let’s start by asking “Why partner?”.

WHY PARTNER?

A number of years ago I saw this quote painted in a high school gym on the wall above the bleachers, “Individuals play the game, but it takes a team to beat the odds.”  We can accomplish more together as a group than as individuals.

While we each have our own skills, partnering enables us to leverage other people’s experience, perspectives and problem solving ideas. 

It can allow you to focus on your core competency, and let others handle other tasks.  It can also let you focus on what you enjoy doing.

Partnering might help you gain experience in a new area of investing.  I personally have done this a number of times while taking steps into different aspects of real estate.

Another incentive might be to spread capital among a group of assets. From a risk perspective, would you rather have 100-percent ownership of one property?  Or a quarter interest in four different properties?

WHAT IS MY GOAL?

Next we might ask, “What is my goal?”

Are we seeking to be active partners?  Or passive?

Do you want the control, activity, and responsibilities of a general partner?  Or is this a time for limited activity and liability?

It could be an opportunity to learn and expand our knowledge from an experienced investor or operator.  This can be done either as a limited or general partner.

Are there retirement account funds that we want to use and put to work?  When investing with retirement funds I prefer to be either a lender or remain in a position of limited activity and liability.  Personally working on a property owned by my IRA would be a prohibited transaction and subject to severe penalties, so this is avoided.

Another consideration might be estate planning.  We already recognize the many benefits of real estate, including appreciation and cash flow.  But we might not want to pass rental houses to our heirs unless they know how to deal with them.  Might it be better to pass along a limited partner interest rather than a property that heirs need to manage?

Once we understand our own investment goals, we can ask if the investment we are considering aligns with those goals.

WHAT CAN I BRING TO THE TABLE?

Depending on what stage of life we are in, we have different amounts of capital to deploy and experience to bring to the table.  

Taking inventory of our experience may be like scoping out the dishes at a pot-luck.  While we may first consider our real estate experience and training, there are many other business experiences that may be applicable.  This can include training and experience in a W-2 job, sales, property management, accounting, and a wide range of other fields.

Capital may be in the form of cash.  It might be assets sitting in an old retirement account, such as a 401(k) at a previous employer.  How much is deployed effectively?  How much needs to be put to work in a new investment?

Other forms of capital may be raw land or a building that someone wants to build on or renovate.

Another asset that should be required, but not necessarily discussed, is integrity.  Do you do what you say you will do?  How have you demonstrated integrity?

WHAT AM I SEEKING IN ANOTHER PARTNER?

From the other potential partners we seek to fill in the gaps of skills and capital.  Larger transactions require more capital and depths of experience.

We need to identify what level of involvement each potential partner desires to have.  Do they want to be active or passive?  Where are their capital funds coming from?  Do they understand the investment and its potential risks?

Can and should they be trusted?  What do you know about their integrity?

Do you get along with them?  I can get along with just about anyone.  But there are some people that I would prefer not to have to spend any time listening to.

WHAT WILL BE THE LEGAL STRUCTURE OF THE PARTNERSHIP?

Full disclosure here.  I am not an attorney and am not giving legal advice.  This information is based on my experience as a real estate investor.

A partnership should be written.  This is for everyone’s benefit.  Even if it is between only two people.

An LLC, or Limited Liability Corporation, is one of the most common entities used for partnerships.  It’s Operating Agreement defines the terms of the partnership.  Different states have different requirements, so it’s a good idea to have an attorney in your state review the Operating Agreement.  

In a partnership all partners are considered to be active participants in the partnership unless specified otherwise.  The agreement should define the general duties of the partners.

In a limited partnership there will be at least one general partner and any number of limited partners.  The general partners are responsible for the active management, while limited partners typically invest capital and are not actively involved.

Joint Ventures are a possibility when two companies or entities want to work together but do not want to form a new company.  One example could be when a rehabber and private lender want to work together.  This can be done with a simple loan and mortgage.  But what if the lender is willing to take on more risk and share in the profits?  Then they might choose to enter a Joint Venture agreement.

Another option is utilizing a Land Trust.  A Land Trust allows privacy of ownership and protects the interest of lenders and any partners.  A Land Trust Agreement defines who has the beneficial interest and how it is proportioned.  All legal notices go through the Trustee, protecting the identity of the parties involved.

This is just a short description of some of the options available to use.  It is usually best to choose the simplest form practical for the role of the parties involved.

HOW WILL DECISIONS BE MADE?

Is there a partner with a controlling interest?  Will each partner have defined roles?  How will the decisions be made?  There needs to be a balance of input from partners with speed and efficiency.  

Authority can be delegated for specific tasks outside of the Operating Agreement.  This allows for more flexibility in day to day operations.

What happens when partners disagree?

How many partners will there be?  Having an odd number of partners can help prevent votes ending in 50/50 splits. 

HOW WILL DECISIONS BE MADE WHEN THINGS DON’T GO AS PLANNED?

What happens when things don’t go as planned?  How well do the partners work together?  Can they agree on a change of course or a path forward?  Is there a controlling interest?

This is one reason why the partnership agreement needs to be in writing.  So that the partners know what they agreed to.  Memories can fade with time.

WHAT HAPPENS WHEN SOMEONE WANTS OUT?

Occasionally someone may want out of a partnership before the partners have agreed to a sale or exit.  How do you handle a potential sale of a partnership interest?

Remaining partners typically may have a right of first refusal to any offers for the partner’s interest.  General partners may have the first option.

What if a partner passes away and the surviving spouse wants their money now?  This happened in one partshep I was in.  Probate can be costly and time consuming.  It would be unfair to the remaining partners to have to appraise all the properties and determine an equitable amount for the widow.  Then there is the issue of probate.  It is much simpler to have a beneficiary named for each member in the Operating Agreement.  

PLAN FOR THE UNEXPECTED AT THE BEGINNING

There are many issues that can arise in a partnership, just like any business venture.  Even a small group of investors will likely not be able to envision the vast circumstances that can occur.  This is one reason we let an attorney draft our partnership agreements.  They have already seen and been made aware of many scenarios that have already happened.  They can help you ask the right questions.

So start with answering the questions that are important to you, and the ones that you know you need to ask.  Then seek an attorney for covering the unknown and unforeseen circumstances.

Having a plan in writing protects everyone when the unexpected happens.  It provides a path of action the partners can rely on instead of someone’s memory.

WHAT COMMUNICATIONS SHOULD BE EXPECTED?

How do the partners plan to communicate with each other and their investors?

The general partners will communicate frequently with each other.  Asset managers need to watch a property and communicate with the property manager.  Limited partners typically expect less communication, but they want to know how things are going.  Different situations require different levels of communication.  Quarterly reports may be fine for most limited partners.

HELP US GET TO KNOW YOU BETTER

What has been your experience with partnerships?  What have you gained?  And what lessons have you learned that you are willing to share?

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Through the power of a syndication partnership with other investors like you, working with managing partners who are experienced in managing apartment complexes, you can own multifamily assets.  

Or you can choose to loan money, get in with a clear return, and get out earlier.  

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