Grab a Partner, Make Some Dough
One of the most frequent questions I get from Property Ladder viewers has to do with partnering up with friends or family members to invest in real estate. Whether you want to flip a property or hold onto it long-term, collaborating is appealing for a number of reasons. Joining forces may allow you to get your foot in the door of an otherwise too-pricey market. And obviously, a group of investors shares the risk as well as the rewards (i.e. each of you makes less and loses less). Especially now, when the real estate market is considerably less robust than it has been in the past few years, knowledgeable investors with experience and novice investors with enthusiasm can team up and possibly create just the formula required for success in a tight market. But if you are going to be successful, you must do your homework. Probably like you, I know a great number of people I feel would potentially make great business partners. Conversely, I know intuitively that some of my best friends in the world are not cut out to endure the "Real Estate Investment Experience".
When you couple a construction-rehab experience with a large investment, emotions easily get out of hand. Remember, the more partners involved, the more opinions to be considered. What happens when one partner thinks the existing linoleum is fine, another has his heart set on tile, and a third thinks only hardwood will do? At every turn there will be sacrifices and compromises - all of which can strain relationships. The journey can be insatiably enjoyable for some, while others may find it terminally exhausting! There is nothing like a construction project to bring out the best and worst in people. It is a backdrop for excelling, failing and personal growth all at the same time. In the worst of extremes, litigation can ensue simply based upon unrealized expectations, (personal and/or financial). Before you take the plunge with a particular partner, imagine every day life with them in it every single day. Picture a disagreement. Now take in your life without them. How do each of these scenarios make you feel? Because in a partnership, all three are distinct possibilities and you need to prepare for them and determine how you will respond to each. I've seen friends become partners and then quickly become ex-friends. Are you confident that your friendship can handle the strain of this often-stressful business? Could you live without this person or people in your life if things turn sour? What are these friends bringing to the deal that you can’t? Can they fill in where you are weak and create a solid team geared for success?
Whenever I work with a partner or partners, I make it clear from the beginning that the project that personal feelings will not be involved. In a perfect world, you will know your partners as well as you know the investment. That means, inside and out. How does he/she react to pressure? Disappointment? Catastrophe? If you pair up with someone who can't ride the inevitable waves of flipping and construction, you'll be wasting valuable rehab time coddling and soothing fragile egos. Remember that money may be your collective motivator, but there is no guarantee that you will get a return on your investment. Even if everything looks great on paper, real estate investing and construction are a gamble in any market. The best approach to have is to hope for the best and prepare for the worst. Even if you suffer a financial loss, what have you learned? If any newfound wisdom can't possibly make up for a gaping hole in your bank account, perhaps real estate investing or flipping (with or without a partner) isn't for you.
If you've gotten this far and are still interested in partnering, make a commitment to have fun and enjoy the experience. Next, draft a simple plan for the investment. Be sure to account for all of the following. I elaborate on all of them in my book "Flipping Confidential" (John Wiley & Sons, pardon the shameless self-promotion):
- Acquisition costs
- Carry cost through to sale
- Construction/rehab costs
- Legal fees
- Sale costs (marketing/real estate commissions)
Use recent market sales numbers (prices for which real estate has sold, not what's for sale as there's a huge difference) to determine the projected value of the investment after you make your improvements. Don't forget to listen to your gut. I've passed up partnering opportunities that sounded great in theory but that just didn't feel right. I've also taken a dive into a (seemingly) bottomless money pit and later regretted not listening to that little voice that warned me not to jump in.
Over the years, I've learned a few tricks to make a partnership sing:
Appoint one person as the Managing Partner (MP); he or she essentially runs the show. When the group is at an impasse, the MP gets final say based upon the investment goals of the partnership rather than the individuals involved. He/she is always held accountable by the partners. If the group cannot agree on who should be appointed Managing Partner, this could be a sign that a working partnership may not be possible. Do not pass go, do not partner up, do not make countless amounts of dollars.
There are many approaches to compensating partners. In general, I recommend a structure that provides the following:
Preferred Return -
An investment return to Partners based upon capital paid in. Generally 8% - 15% on their investment depending on the cost of money and other factors that affect interest rates.Compensation -
Pay all partners a fair or equal value amount for their time and level of risk invested in the project. Agree in writing before starting what "fair compensation" participants will receive for their physical efforts. Pay the Partner from operating funds and remember the work completed is a Construction Cost rather than an equity build. This area is the most lethal for disputes amongst partners.Management Fee -
A fee paid to the Managing Partner for his/her managing efforts and responsibilities related to the investment. Generally, 25% - 50% of net profits after preferred return. (Full disclosure is a must and any compensation to the Managing Partner should be clearly defined in the Partnership Agreement.)Profit Distribution -
After all expenses have been settled, the Preferred Return and Management Compensation fees are settled, I advise to distribute net Profits based upon a percentage of paid capital. At this point, everyone has been paid for their efforts, therefore remaining returns should be based upon capital paid in, fairly and equitably.Contract Work -
Many partners venture unknowingly into this potential minefield assuming they should be compensated based upon time spent on the job - possibly even being ineffectual. If the partners agree in advance that all invested time (outside of agreed to partnership responsibilities) will be paid fair compensation, then you should safely avoid unfulfilled expectations.
If the enumerated points above seem too complicated for you, this simple formula may be easier to understand: the money people get their money out first, before any return is distributed, plus a certain mutually agreed upon percentage in interest, then all expenses are paid for and anything left over can get split evenly amongst the partners. I always recommend consulting with an experienced Real Estate Attorney and Tax Consultant before kicking off a partnership. It may sound like yet another expense you may not want to incur, but in the end having these people on your team can save you untold amounts of money and frustration. An Attorney can efficiently advise on the Partnership Agreement and help you structure your Partnership so that liability exposure is minimized. A CPA or Tax Consultant can assist in structuring the proper Partnership form and tax strategies during ownership and upon eventual sale-hopefully one that will put some dough in your pocket and allow you to appreciate your old friend/new partner in a whole different light!
KIRSTEN KEMP, host of the hit TLC series PROPERTY LADDER is a veteran realtor and real estate developer with her own enormously successful design company. With years of experience in flipping properties.