Should You Consider a Real Estate Investment Partner
Real estate investing can be a major undertaking. The process of doing due diligence on cities and neighborhoods, touring properties, pricing the cost of repairs, and obtaining necessary capital can require significant time and knowledge.
While most real estate investors go out on their own – there’s something to be said for independence in making decisions – a solo strategy isn’t right for everyone. Some investors find confidence in working with a partner, either for a single project or on an ongoing basis. A partner can provide additional capital for investing, advice on breaking into a new area of the investment market, or tools to expand reach.
Lenders look at three factors when deciding whether, and on what terms, to lend to a real estate investor: experience, credit and cash. If an investor is not already strong in all three of these areas, then working with one or two partners with complementary strengths can help obtain more favorable financing terms.
However, bringing a partner on board isn’t the right strategy for everyone, and there are potential hurdles to consider. If you’re weighing the possibility of pairing with a partner, it’s important to understand the pros and cons as well as the challenges to navigate when pooling assets for investment purposes.
The Role of a Real Estate Investment Partner
A real estate investment partner is very similar to a business partner. Assets are pooled, resources are combined, and decisions are generally made jointly. Partners work together to find the best properties and determine how to move forward.
In many cases, partners each bring their own strengths and priorities to the table in a way that improves on what a single investor can accomplish. For example, one partner may have an extensive background in market research, while the other may have connections with a wealth of contractors and other home renovation experts. By working in tandem, partners can maximize opportunities by playing to multiple strengths simultaneously. In addition, by pooling together their strengths in each of the three factors that lenders consider (experience, credit and cash), partnerships might be able to obtain more favorable financing terms than the individual partners could obtain on their own.
However, the dynamics of a partnership can vary from one set of partners to another. In some cases, one partner may function as more of a silent investor, providing financial backing and taking a cut of profits without weighing in on the day-to-day decision-making process. This can be common in rental property ownership, as there are fewer major management decisions involved in overseeing an established property.
What works for one investor may not work for others, so setting boundaries regarding the role each partner plays is crucial to managing expectations. Partners should work to determine the best arrangement before making any investment decisions. Failure to do so can be a liability later, as partners may butt heads over how to proceed with a particular property.
The Pros of Working with a Partner
For investors who are open to collaboration, working with a partner can be a compelling opportunity. There are many advantages to working with a partner, provided partnership styles and goals are compatible.
Enhanced Base of Knowledge
As the adage goes, two heads are better than one. Even experienced investors can learn from others in the field, and creating a partnership is often an excellent opportunity to expand real estate knowledge and improve strategy. When partners come together and share their resources – and split the due diligence – making educated decisions about property purchases can become much easier.
A partner can also make exploration into other areas of investing less daunting. For example, if one partner has only worked with rental properties but would like to expand into fix and flips, an experienced home flipper can be a perfect partner. This way, risk is lessened during the learning process without sacrificing a potential successful outcome.
Potential lenders will also be comforted by the enhanced base of knowledge that a partnership offers. For example, lenders offer the best terms on fix and flip loans for the most experienced real estate investors. Lenders give experience points for each verifiable closed transaction over a recent number of years and will offer lower interest rates and require less down payment from those investors with the most experience points.
An increase in resources is among the biggest benefits of taking on a real estate investment partner. Someone else to contribute to the cost of a property makes it much easier to invest in higher cost areas in California, like multi-family rental properties, and ensure that there is adequate capital to make all repairs and renovations. For investors who prefer to move quickly and pay in cash, a second wallet can make a big difference.
Resources can come in the form of both cash and credit, which are two of the factors that lenders consider in evaluating real estate investors. A partner with stronger credit will sometimes act as a guarantor on a loan. And regardless of creditworthiness, lenders will want to make sure that the partnership has sufficient liquidity to cover the down payment and monthly payments until the transaction is complete. By pooling together cash and creditworthiness of more than one partner, particularly partners who may be stronger in these areas, the partnership can obtain lower interest rates and a lower required down payment.
Resources in real estate investing go beyond financial contributions, too. Partners can share access to the other professionals involved in the investment process, like attorneys, contractors, plumbers, electricians, and even places to purchase affordable equipment or renovation tools. This can save money overall, lowering the capital costs involved in bringing a property up to par.
Purchasing a property solo has the potential for big rewards – but it also can mean bigger risks, too. Investing in a property that could require too much work or may not be able to sell at a desired price point can be a gamble that may not pay off. However, with a partner, this kind of dice roll can be a little easier to manage. The risk is shared, which means a smaller personal contribution.
In addition to splitting risks between two portfolios, access to more resources can mean an increased likelihood of finding more affordable labor and products without sacrificing quality. This can boost the probability of success, even in an investment that appears to be a gamble.
Most investors see the value in networking, both with other investors as well as with local real estate professionals. Networking can increase access to available properties and ensure quality service when making offers and managing renovations.
Even investors who have extensive networks likely do not know all of the same people. By working together, investors can meet more industry professionals, improve exposure to different resources, and, in turn, open doors to more opportunities in the investing space.
The Cons of Working with a Partner
There are many advantages that come with working with a partner, but partnerships are not always the right choice. There are several downsides that can come from partnering with another real estate investment professional, particularly if both partners are not able or willing to work as one cohesive team. Trust is a big part of a successful partnership, and trusting the wrong person can be a grave error.
The expression “too many cooks spoil the broth” can be applied to real estate investing as well as cooking. In essence, too many opinions and ideas can stilt the investing process rather than benefiting it. When partners are each determined to do things their own way, regardless of what the other party feels is best, tempers can flare in negative ways. This can lead to investments that aren’t mutually beneficial, or squandered opportunities due to clashes in strategy or perspective.
Establishing boundaries and roles in advance can go a long way in minimizing this phenomenon. When both partners are confident in one another’s expertise and preferences, there is less guesswork involved in the investing process.
Many property investors pursue investing for specific reasons, from diversifying a portfolio to driving regular income. However, choosing a partner with a differing view can mean a forced shift in investment strategy.
If your views are not aligned with your partner, you may find yourself unable to focus on your investing ambitions. This can stall or even reverse progress toward financial goals, creating a serious issue that may not be easy to solve.
Challenges in Exiting a Partnership
If a partnership is not working or one partner’s goals or circumstances change, many investors will feel motivated to part ways. However, exiting a partnership is not simple.
Purchasing property together entails commingling assets in a way that can be very difficult to separate. Unlike a bank account in which cash can be withdrawn and divided, real property is tangible. Separating from a partnership means that one partner must buy the other out – assuming partners can agree on the value of a contribution and are willing to let go of a property investment – or sell the property and divide the profits. This process can be costly and legally complex, particularly if neither partner wants to sell.
The possibility of tethering an investment to a partner who can no longer meet expectations is harrowing, so it is critical that investors are completely confident before moving forward.
Establishing a Partnership
If you have found someone you want to go into business with, taking the proper steps toward establishing a partnership is essential.
In general, opening a joint bank account and calling it a day is a poor way to go about creating a partnership. Instead, some form of legal protection is highly recommended. The formation of a legal entity allows for proper reporting for tax purposes and some protection from legal liability. Under this scenario, investment assets are purchased by the partnership entity rather than by each individual investor.
The easiest way to go about setting up a partnership is through a pass-through entity, or PTE. These organizations are standalone entities for tax purposes but are not treated with the same level of separation as a C-Corporation. The most common options for partnerships include:
- LLC, or Limited Liability Company
- LLP, or Limited Liability Partnership
- S-Corporation, or S-Corp
The process to establish a PTE will vary based on the form chosen, but generally involves some paperwork to solidify the legal entity, filing with the proper government bodies, and registration for an Employer Identification Number (EIN) with the IRS. At tax time, the PTE income and losses are reported on individual taxes rather than being taxed as an entity. The eliminates the double taxation that can occur when both corporate and personal taxes are applied to business income.
There are slight differences between LLCs, LLPs, and S-Corps so investors are encouraged to consult with their legal and tax advisors, on both the variations and local laws governing them, before setting up a partnership of any kind.
Real Estate Investment Partner Best Practices
The right partner can be an amazing asset, but the wrong one can be a huge detriment. If you’d like to move forward with a partner, you should know and implement the following best practices prior to making an investment:
- Determine whether a partnership will be active or passive; will one partner take the lead or will both partners play an equal part?
- Identify available resources and discuss budgets, investment strategies, and objectives for property purchases
- Ensure long-term goals for portfolio growth and management align
- Clarify roles and expectations within the partnership; failure to set expectations early can leave partners without a clear direction
- Establish clear communication practices so that both partners are as informed and involved as possible
- Decide which legal entity would best achieve partnership goals
- Never move forward without full confidence; any nagging doubts can be a sign of bigger problems to come
There is no requirement to partner with another investor when investing in real estate, so if a partnership does not feel right, you are never obligated to proceed.
Partnerships can improve the real estate investment process, offering access to more resources and greater opportunities. For motivated investors who want to grow, share knowledge, and branch out into new areas, there are few better avenues than the support of a strong partner. However, moving forward with a partner isn’t always appropriate, and the process of joining forces – and dissolving a partnership should things go south – should always be carefully evaluated with the same due diligence as any other investment.