Last week, in our Get In The Black Facebook group, I shared a mini-tutorial on a real estate investing strategy that you can use to exponentially increase the number of properties in your portfolio. If you missed it, you can check it out here.
One of the most common questions I get from clients is whether or not it’s a good idea to partner with someone (other than your significant other) on a real estate deal.
The answer is….it depends.
There are a number of ways to partner on a real estate deal to make the deal worth it. Before you do, you should know the implications as well as the disadvantages of partnering.
WHAT IS A REAL ESTATE PARTNERSHIP?
A real estate partnership refers to individual investors who team up into a group, pool their resources, and make real estate investments in a joint ownership arrangement.
The partnership is a legal entity governed by the Federal Uniform Partnership Act.
The partnership may be comprised of individuals and/or corporations. Each partner is considered a tenant in common, which means (1) the costs (including income tax liabilities) and benefits are split among the partners in proportion to each individual’s contributions to the partnership, and (2) each partner is free to transfer his or her interest in the partnership either during life or at death, unless restricted by the partnership agreement.
A partnership is just one alternative to individual ownership of real estate. Other alternatives include corporations and trusts.
4 TYPES OF REAL ESTATE PARTNERSHIPS
1. Full, General, or Regular Partnerships
A full partnership (also known as a general or regular partnership) is distinguished by the active participation of all of the partners in managing the enterprise.
Each partner has an equal voice, regardless of the amount of his or her contribution. Likewise, each partner is personally responsible for the debts and liabilities of the partnership.
A full partnership is a pass-through entity for income tax purposes, meaning income, as well as losses, flow to the partners.
A full partnership can be an informal or formal arrangement. Informal arrangements are evidenced by the appearance of partners’ names and proportionate ownerships on deeds.
Formal arrangements include the execution of an agreement that specifies the rights and responsibilities of the partners.
2. Limited Partnerships
A limited partnership is comprised of at least one general partner and one or more limited partners. The general partner takes an active role in the management and is personally liable for the partnership’s debts.
A limited partner takes a passive role in management and is personally liable for the debts of the partnership only to the extent of his or her contributions.
Limited partnerships are designed to terminate at a specified time, and they offer the same pass-through tax treatment as general partnerships. Limited partnership agreements must be in writing.
One specific type of real estate limited partnership is a tax credit limited partnership, generally organized primarily to take advantage of certain tax credits available for the development or improvement of low-income housing or rehabilitation of certified historic structures or qualified non-residential structures placed in service before 1936.
An alternative to the limited partnership, the limited liability company (LLC) is the newest form of group ownership. An LLC acts like a corporation in that it provides limited liability to all of the shareholders, but it also acts like a partnership in that it is a pass-through entity for income tax purposes. LLCs are now recognized in all states.
A syndicate is simply the description given to a group of investors who join together for the purposes of investing and managing real estate. A syndicate is not a legal entity but generally takes the form of a corporation, or a full or limited partnership.
Typically, the syndicate takes the role of the general partner and sells units of ownership to limited partners. This makes a syndicate a form of securities dealership; therefore, it must be organized and operated in compliance with the appropriate federal securities laws as well as state blue-sky laws that may apply.
4. Joint Ventures
A joint venture, which is a special form of full partnership, brings together investors who contribute their unique skills and abilities to a specific project.
For example, a landowner, lender, builder, golf course designer, landscaper, and other craftsmen and artisans might join forces to develop a country club, receiving in return a proportionate ownership interest.
THE PROS OF PARTNERING ON A DEAL
Opens up investment opportunities
Investment opportunities often expand as the pool of money increases. Thus, pooling funds permits the purchase of larger or better parcels at better prices.
Without pooling, some projects would be impossible because of their high costs. More funds can also mean more properties can be purchased, which can lead to better opportunities for geographic diversification as well (e.g., buying similar types of properties, such as apartments, in several different cities and/or states).
Can promote diversification and reduce risk
Pooling funds allows a single investor to spread investment dollars over a larger number of properties.
That can increase the chance of making a profit or limiting a loss, even if one property performs poorly (though diversification alone doesn’t guarantee a profit or protect against the possibility of loss).
THE CONS OF PARTNERING ON A DEAL
Complicated and costly implementation
There are a great many legal complexities to forming a real estate partnership. An experienced attorney should be consulted.
Also, because laws are constantly changing, legal and tax advisors should continue to be consulted on a regular basis. Access to competent advice is an ongoing expense to the partnership.
Lack of liquidity
Real estate partnerships are illiquid and should only be made by investors who have no need for liquidity.
Ill-conceived partnerships may create problems
As in any other kind of partnership, misunderstandings can arise and abuses of trust can occur. Unexpected liability and expensive legal actions may result. Thus, it usually makes sense for any partnership agreement to be done in writing.
Subject to risks associated with real estate in general
An investment in a real estate partnership is subject to the same special risk considerations as those associated with the direct ownership of real estate.
Real estate valuations may be subject to factors such as changing general and local economic, financial, and environmental conditions, as well as interest rate changes and default risks.
As you can see, partnering on a real estate deal can be very good for your wallet and your overall net worth but you should do your due diligence and make sure your partnering with the right people.
Are you currently in a real estate partnership? Why or why not? Hit reply and let me know.