We hear about tech startups that scale from Silicon Valley all the time. It’s infectious to think that a simple idea can command a billion-dollar valuation nearly overnight.
Naturally, real estate investors want a part of the action! It begs the question; how might you grow your portfolio more quickly?
This question comes up often in local investment clubs.
Joint ventures and collaborating using real estate partnerships are the first strategies that come to mind when you think about growing your businesses.
Many investors have their own individual shortcomings that prevent them from scaling and growing to the capacity they envision. Understanding how to build key relationships and find capable partners is a critical skill set to achieve real estate success.
“Joint venture in real estate” is another way of saying that you will enter into a partnership.
You and another individual (or many individuals) decide to invest together. There are many risks and benefits to partnering with others. It is important to fully vet any potential partners for their investing temperament and how similar it is to your own.
Benefits
There are a number of benefits to partnering with someone else. Think of it as a marriage. You are working with someone that you know, like and trust to build a shared dream. A shared vision. What can be better than that!
Increased ConfidenceHaving a partner can build your confidence to act on your goals. As the old saying goes, there is strength in numbers. When someone else believes in the idea and wants to go after it as much as you do, the effects can be great for both of you. The shared passion only breeds more of it, making a partnership a productive vehicle for growth. There’s a reason Warren Buffet keeps Charlie Munger close by his side.
Shared ResponsibilityNobody wants to bear all of the burden themselves. A real advantage of investing with a partner is that you have someone to share the responsibility with. This means financial, emotional, legal, management…you name it. It is all shared – unless you state otherwise in your partnership agreement documents. More on that later.
Idea Validation Having a partner helps you quickly validate an idea and tease out its strengths and weaknesses. It can be a competitive advantage to have level-setting conversations in-house.
Risks
Poor strategy for conflict resolutionJust like in a marriage, you risk having conflict in your business when you enter a partnership. The funny thing about human beings is that no matter how similar or like-minded we are, we are all prone to conflict. It is a part of life. The key is to have strategies in place to resolve the conflict.
It is important to lay ground rules for communication during difficult situations. When things are good this can seem like a waste of time but it is very helpful to have mutually agreed upon standards on how you will function within the confines of your partnership.
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Can be financially tied through creditDepending on the strategy you implement you and your partner can become financially entangled. This means that your credit may be at risk to their financial actions within the business. It is prudent to carefully vet the spending habits of any potential partners. If you happen to connect with a spendthrift, you may be financially liable for purchases that make on behalf of the business – even if you did not initiate the purchases.
Not having the same investing temperamentThis one is probably the largest risk and the hardest to evaluate. Basically, you want to make sure that you and any potential partners see investing in the same manner. For example, some people have long-term outlooks on any investments they make. This means that any property you purchase, they will want to hold on to for many years, often 20+ years. You may have a more opportunistic mindset. You may be open to holding but more than willing to sell if the market turns in your favor.
What’s Your Exit Strategy
In the beginning, this may not seem like a significant issue if you two were to partner, but it can be in reality. Let’s say that you and your partner purchased a duplex for $50,000 and it rents for a total of $1100 or $550/side. Hurray! That is a great investment. You are clearing the famed 2% rule. This house is an excellent investment. You were able to purchase it with cash so there is no mortgage or pressure to eliminate debt. Let’s say that after 5 years, you have made all of your initial investment back and the market is picking up. Duplexes in the area are selling for an unthinkable $105,000. In our mind, while the property would still work on a fundamental level, this valuation is unsustainable for the area. You think you should sell.
The problem arises when you talk it over with your partner who wouldn’t dream of selling. Or even refinancing. He is risk-averse and will not even entertain your conversation about selling the property. Fast forward a few more years and the tides have turned yet again. This time, it’s a buyer’s market. Duplexes in the area sit on the market for 6 months before selling for $45,000. You are livid. Sure, by this time, you have made your initial investment back many times over, but it doesn’t matter. You feel frustrated because if you had sold at the height of the market you could now own 2 or 3 duplexes with the proceeds from the sale of your first.
This is a classic example of how partnerships can harbor frustrations when the two partners do not have the same investing temperament.
The Paperwork
—– why do I need to formalize my partnership?—– how do I do it? DO I need a lawyer?
A common way to formalize your partnership is to create a legal entity such as a limited liability company (LLC). This is very similar to marriage. Both partners will become members of the LLC. It is important to consult legal advice during the attorney prior to undertaking legal matters. Another great resource to consult is an accountant CPA. This professional will be able to advise you on tax matters. All legal entities are required to file taxes by the IRS. Typically LLCs must provide all members with a K-1 document.
Although this is typically discussed verbally the joint venture relationships structure Will be clearly defined in the operating agreement of the legal entity.
Key sections of the operating agreement include:
- Members
- Tax Matters Person
- Voting Rights
- Buy-sell agreements
What’s Next
Ultimately, Do your research about the person you will be doing business with. Look past financial gain. Take your time and don’t rush into a real estate partnership. Sort the details first. There will always be another real estate deal if being a professional investor is truly the goal.
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