A Real Estate Investment Partnership is a legally binding agreement to operate a business together in the real estate investment industry. Partnerships have advantages and disadvantages that must be considered when you’re determining if you actually need a real estate partner.
If you proceed you should consider who your partner should be and how you should structure your real estate investment partnership agreement.
Working with a partner can be the best decision you can make, or it can result in your worst nightmare if you do not choose wisely. It is up to you to decide whether to go it alone or enter into a partnership agreement with someone. Read on to learn if partnering is the right move for your real estate investment strategy.
Do I Need a Real Estate Partner?
The only reason to partner with someone is if they bring something to the transaction that you do not have. You need to do an honest, critical self-evaluation to determine where your strengths and weaknesses are, and what strengths you need in a partner.
For some, this means a partner will bring money needed for a transaction, for others, the partner brings a new set of skills. A partner that is in a similar financial situation AND has the same skills as you is really not bringing anything you need to the transaction.
It is the introduction of complementary skills or assets that makes a partner valuable in the real estate investment world.
For example, if you lack the financials that a lender requires, finding an investor with strong financials brings something to the transaction that you don’t already have. Similarly, if you have the financials, but are a novice to rehabbing, a rehabber with significant experience and track record of successful flips is a great partner to team up with.
Who Should My Partner Be?
Once you determine that your investment strategy improves with the addition of a partner, the next step is to find the right partner (other than examining what they bring to the transaction).
Take your time and do your research. Foremost, you should only partner with a person that you trust 100%. You and your partner will be co-signing onto obligations of significant size and impact, so if you have any doubts as to whether your potential partner is trustworthy, move on and find another partner.
Your partner should also be someone with the same real estate investment strategy. If you are doing a rehab project that you intend to flip for one time profit, make sure that your partner is not looking for a project to hold as a rental for a monthly income stream.
It’s important to remember that not every real estate partnership will work out. However, setting your partnership up the correct way from the start, and drafting a limited liability company (“LLC”) agreement, also called an Operating Agreement will help set that partnership up for success. Not every state requires an LLC to have an Operating Agreement, but not having an Operating Agreement exposes your business to significant risks such as a heightened risk of litigation if a business partnership dispute arises.
Real Estate Partnership Operating Agreement
A good real estate partnership agreement will spell out in detail what is expected from each partner. It should explicitly state financial expectations, division of labor specifics, and expected time commitments from each partner. The partnership agreement should also spell out profit and loss allocations, tax responsibilities and who has the right to make decisions and bind the partnership to legal contracts.
Lastly, the Operating Agreement should specify how the partnership will end, including what would happen if one partner needs to leave the partnership at some point before the property is disposed of, what would happen upon the death or bankruptcy of one of the partners, how the property will be valued prior to sale, etc.
The clearer and more specific the written agreement is about all of these details, the less likely it will be that disputes arise.
Keep reading to learn exactly what should be included in a real estate partnership operating agreement.
What Should a Real Estate Partnership Agreement Include?
Management of the Company
LLCs are usually either member-managed by all the equity holders of the business, or the LLC is manager-managed. The member or the manager may be an individual or an entity. If the members agree that they would like a manager to manage the company and make business decisions related to the company, then remember to include this in the Operating Agreement. Otherwise, the default in most states, unless drafted otherwise, is that the LLC will be member-managed.
Define what percentage of the company each member owns. The default will be an equal split, but not if members draft the Operating Agreement to state otherwise.
Profit and loss allocations are determined through negotiation. Sometimes, it is an even split, and other times, one member may want more loss distributions than another member for tax purposes. Consider whether the members would want distributions to be made at regular intervals or whether the members may withdraw profits from the business at will. Will the company distribute enough to cover any tax liabilities?
Operating Agreements usually clarify how a membership interest may be transferred to another party. What will happen upon the death, disability, or divorce of a member? The business partners may have wanted to work exclusively with one another, but upon a business partner’s death, the surviving spouse or child could become an unexpected business partner.
Discuss how the members will resolve disputes when it comes to business matters. The members may not want the first step to be litigation. Mediation may be a better first choice.
Consider how many votes each member will have—one vote per member, or according to the members’ percentage interests in the company? How will the members resolve deadlocks? On which matters may a member make unilateral decisions on behalf of the company, and on which matters will they be required to bring the business decision to a vote among all the members?
Do I Need An Attorney to Draft My Operating Agreement?
Unless you understand everything you are reading and the legal definitions, please do not try to draft a Real Estate Partnership Operating Agreement yourself. One day you may have to rely on that document in the courtroom. Draw upon the knowledge and experience of your attorney who, most likely, has seen business partnerships at all stages of their life cycles.