Continuing our conversation from the other day, this email will keep the focus on real estate partnerships.
Specifically, what are the 9 questions you need to ask before entering into a real estate partnership.
Ready?—Let’s get started.
Question #1 — When would I need this money back if I invest today?
Like most things in life, it’s all about the money at the end of the day. Real estate investments can take time to pay off which means patience is a must.
But patience is hard to come by when unexpected expenses arise (car accident, medical bills, divorce, etc.) and you’re short on cash.
So, before entering any partnership, it’s critical that both parties ask themselves ‘When would I need this money back if I invest today?‘
In asking this question, what you’re really trying to do is obtain an honest assessment of your financial situation—do you have enough excess capital built up that committing $50,000, $100,000, or $250,000 to an investment is a responsible risk?
If you come to the conclusion that you’ll need your money back from the investment within the next five years, it’s not a good idea to enter into a partnership.
Question #2 — How long do we plan on holding this property?
Piggybacking off the previous question, this is another query that’s all about timing.
You and your partner need to be on the same page about how long you want to hold a property before you buy it.
If you enter into a transaction expecting to hold a triplex for 20 years as a stable source of income, while your partner enters expecting to remodel it and flip it in the next decade, the partnership will sour in a hurry.
This all may seem obvious to you of course, but you’d be SHOCKED at how often people partner to purchase an investment property only to realize after close that they’ve got wildly different plans for the future.
Question #3 — What happens if we need to exit (get money out of the deal) unexpectedly?
As mentioned in Question #1, real estate investments aren’t intended to be short-term affairs in most instances—that’s why it’s so important for you and your partner to have a clear picture about how long you’d like to hold onto a given property before cashing out.
Unfortunately, life can throw a wrench in the most well-laid plans. Therefore, it’s critical for you and your partner to agree on how you’ll exit the property if an emergency situation arises.
Example—you and your partner plan on holding onto a small apartment building for a period of 15 years. However, your partner’s wife has a stroke 3 years into the arrangement and will now require live-in nursing care seven days a week (a very expensive proposition).
How will you amicably exit the deal?
Engaging in a game of ‘What if…’ with your partner might be a little uncomfortable, but it’s a small price to pay to get on the same page about an untimely exit.
Question # 4 — What happens if we can no longer give our time, labor, or money to the partnership?
There is no crystal ball in real estate investing. You might enter a partnership in your early 20s fully expecting to be able to commit 10 hours a month to the various chores required to maintain your investment (bookkeeping, landscaping, unit repairs, etc.). But for most people, the passage of time adds new priorities to the proverbial plate, and those shifting priorities require a reconsideration of what’s possible from a scheduling perspective. By the time you’re in your mid-30s or early-40s, your family (let’s say you get married and have kids) and your career might chew up far more of your free time than you ever anticipated.
When that happens, something’s got to give, and it’s highly unlikely you’re going to take time away from your family or your job for the sake of your real estate partnership. Therefore, it’s critical to connect with your partner to determine how you’ll handle changing contribution levels.
If you’re supposed to split all responsibilities equally, what are you going to do when the life circumstances for one partner change in a way that makes an equitable split impossible to maintain?
Question #5 — How will you handle differing opinions related to the property where there is a 50/50 split?
In other words, if you and your partner are 50/50 on the investment, but you disagree on when to repaint the duplex, how will you break the tie?
This is a tough one, but critical, as most non-professional partnerships are a 50/50 endeavor.
Whether your solution is complicated (e.g., hiring an arbitrator to break the tie) or simple (e.g., flipping a coin), you need to get all the details ironed out before you enter the partnership.
Question #6 — Do your skills or histories complement each other or replicate each other?
In thinking about a potential partnership, it’s good to get a clear understanding of what each partner is bringing to the table aside from capital.
Is one partner an experienced plumber and the other an experienced electrician?—If so, such unique skill sets can simplify the division of responsibility when it comes to property management.
Conversely, if both partners are seasoned accountants with no experience in construction, landscaping, property management, etc., it might be more difficult to decide who deals with unit maintenance and who deals with capital projects.
While it’s OK to work with partners who possess skills that are similar as long as roles and responsibilities are equally shared, it’s generally easier to work with a partner who holds a skillset that differs from your own.
Question #7 — What happens to the partnership in the face of a 'Disastrous D'?
Default. Divorce. Disability. Death.
Whereas Question #4 is meant to address a change in resources, this question is all about getting clear on what happens in the event of a true disaster.
Your partner becomes insolvent and can no longer support their end of the partnership.
You get divorced from your spouse, and are at risk of losing your stake in the investment.
Your partner is in an accident that leaves disabled and unable to carry out their responsibilities.
You die—does your partner get the first right of refusal on your half of the property?
Honest, open contingency planning for these unlikely but catastrophic events can do more than help you avoid massive headaches and legal fees—it can also cement the trust between you and your partner, which leads to a more stable, fruitful relationship long term.
Question #8 — Why?
Even though this question comes towards the end of this list, it may be the most important to ask of each partner.
Why am I doing this?
Why are you doing this?
Why are we doing this?
When entering an agreement, you can never ask ‘why’ enough, because it’s only under relentless inquisition that potential partnership-destroying bombshells can be discovered.
Question #9 — Are you willing to hire a contracts attorney to sort out the key details of the partnership (division of labor, capital distribution, etc.)?
You know what?—I take it back. There is no way Question #8 could be the most important question to ask of your partner because THIS is definitely the most important question.
It’s the most important because it:
- Involves an unbiased third party
- Who can come in evaluate your potential partnership
- Help you divide up responsibilities and rewards FAIRLY
- And can create a legally binding document that—once signed—cements a fair, equitable relationship between you and your partner.
Getting a contracts attorney to sort out the key details of your partnership and put those details in writing might seem like a silly expense for your new venture, but it will pay massive dividends down the road.
A final thought...
No one said these questions would be easy to ask.
And no one remotely suggested that they’d be easy to answer.
But the risks you accept by avoiding these tough conversations at the front-end of your partnership are too great to bear.
Ask the tough questions. Have the tough conversations. Get uncomfortable and come to an agreeable solution NOW before your money is tied to someone else’s…
Because the price of walking away from a potential partnership is $0, whereas the price of walking about from a partnership that sours could be in the millions.
-Shannon
310-853-0335 | ShannonShue@KW.com