How to structure a real-estate partnership?

MoneyRunner asks:

A friend and I are in the process of writing an operating agreement for an LLC and I’ve got a question for you. We have raised capital for the down payment on an apartment building. I have raised $15,000 ($10,000 my own and $5,000 from family) while my friend has raised $25,000 (all from family). We both have a 50% ownership in the LLC. Once we start to produce income, is it fair to distribute funds according to initial capital invested? Is it even possible to do 50/50?

Firstly, I don’t like buying long-term assets in partnership … times change … longer times change even more 😉

For example, to help a friend out (really!) my wife talked me into buying a half share in a downtown property. In ordinary circumstances it would have been a great, long-term hold.

However, two brothers-in-law had gone into partnership to acquire it and some years later one of the brothers-in-law wanted OUT. The problem was, the other B-in-L couldn’t afford to buy him out, and didn’t want to sell.

These sorts of decisions break up families … and was threatening to do exactly that to this family. Our friend, the third brother-in-law (and the only one of the three NOT involved in the deal) asked us to help out by buying out the one B-in-L who wanted to sell.

And, that’s what we did: bought 50% of a building that we know that we can never sell without causing the same situation to erupt again. My wife talked me into in … that’s my only excuse 😉

But, if you still DO want to go into partnership, here’s what I suggested to MoneyRunner:

All is fair and possible in business and investing … as long as you both agree!
You will most likely need a shareholder’s agreement drawn up by your attorney, if the equity and/or profits are not to be split equally.
However, a simple way to deal with your situation is:
1. Both put in $15k as capital (it makes no difference HOW or WHERE you each got the money).
2. Let your friend put in the extra $10k as a loan.
3. Agree a rate of interest (say, mortgage rate plus x% e.g. if the current mortgage interest rate that you are paying on the property is 6%, your friend might get 10% for his $10k).
4. Split the equity and remaining profits (i.e. rent MINUS mortgage + interest owing to friend + expenses) 50/50
Here’s why you will still need a shareholders agreement:
– Rules as to how/if/when your friend’s loan is to be repaid,
– Rules as to who can force a sale of the property and how you deal with each other’s share in the property in the event of a dispute.

However, there are other ways to enter a ‘partnership’ that stop all of these issues:

My first real-estate purchase was with a friend of mine who found a new condo development in foreclosure; the bank was selling off the individual condos. My friend thought that we would get a better deal if we bought two condos together.

… and, we did!

We negotiated a price of $55k for each condo.

How did we deal with the partnership issue? Simple!

We each bought one codo in our own names. Then, when I stupidly decided to sell (I was still young and reckless, and this was my first ever real-estate purchase), I didn’t need to ask him. I sold it for just over $75k about 2 years later [AJC: But, it would be worth closer to $500k now, 25 years later] … not a bad deal, and no stress on our ‘partnership’.


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2 thoughts on “How to structure a real-estate partnership?

  1. All sound advice.

    Speaking as a lawyer who has written a fair number of JV agreements, I’d also suggest spending a bit of time trying to reach an agreement on how and in what circumstances additional capital may need to be contributed by the partners (e.g. if the rent doesn’t cover the outgoings or major repairs are needed) and what happens if one of them can’t or won’t contribute his share. A sinking fund can often be a good idea.

    Depending on the deal, the JV agreement may also contain provisions setting out who is going to do the work and how much (if anything) they will get paid for doing it.


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