When investing in real estate with any number of partners, it is important to understand the complexity behind this decision. Whether you are interested in partnering with a fund, a family member, or a group of friends, there are hurdles that will need to be overcome that can impact the future of the investment. Therefore, when identifying potential partners or investing with others, you should take a close look into whether that partnership is a smart decision. Below we will take a look at questions that partners should consider, and how differentiating individual strategies may pose a future risk in the operation of the real estate.
1.) How is the managerial structure outlined?
When establishing the partnership this may be a simple decision – there may be one partner who is savvier to the market and who is willing to be the managing member; or, the responsibilities may be split depending on each investors area of expertise. Assuming the investment strategy is to hold long term and allow the asset to appreciate, then the challenges here lie within the uncertainty of the future, specifically following the death of a partner. Depending on their personal strategy, their death may trigger issues in the new structure of the partnership. For example, if a partner intends to pass down the shares of their investment to their children or widow, who is now responsible for what responsibilities? Often times, those who inherit properties want to be included in decision making and have input that differs from the initial investment strategy. This can cause tension and often results in economic loss related to the asset. Therefore, partners should agree on and outline the managerial structure that will be established in the event of one’s death. They should also establish how the holding entity will be structured (LLC, TIC, Corp, etc.). This may be a solemn discussion, but it is one scenario that commonly negatively impacts the performance of a real estate property. If an investor finds that they do not want any managerial duty and want freedom to pass the management responsibilities to an experienced professional, then selecting a fund to invest in may be the best suitable strategy.
2.) Will the partnership survive a recession?
Every investor develops their own strategy when they begin delving into real estate. Some are interested in building wealth while continuing to live on the income from their established career, while some are investing their reserves or life savings and are dependent on their investments monthly return. Although both strategies have their pros and cons, investors partnering who have different strategies may be faced with hardship if there is a recession. Let’s look at an example:
You and four of your friends decide to purchase a neighborhood retail center. You all put in the same amount of money and as a group decide to leverage the deal 50%. Let’s say that two of the partners live off the income, while three of the other partners do not. Now, what if a recession hits and the managing partner believes that the most strategic approach would be to pay off the loan and keep the reserves in the business as opposed to distributing it– This would be highly problematic for those who depend on the income for their livelihood. Therefore, the varying dependence on the income between the partners poses a major threat – For those who have resources and want to position the real estate in a cash strong position may feel they are risking their investment, while those who rely on the revenue will be faced with economic uncertainty. For this reason, it is necessary that partners understand each individual position, and assess if the partnership would be manageable in the event of an economic down cycle.
3.) What are the goals of each investor and how are their strategies influenced by their personal lives?
Partnering with other investors is essentially obtaining new business partners. Each individual will have their own expertise to bring to the table, and their own beliefs that can influence the ongoing business strategy. These partnerships can prove extremely beneficial because it gives a group more insight into opportunities for growth. However, at the same time, these different mindsets and lifestyles can be detrimental if they differ too much. This is because these mindsets can influence the way in which each partner wants to manage their business. Similar to that of the previous example, the goals for each party involved can impact the ongoing performance of an asset. For example, if one partner has ongoing medical bills, or they have a lavish lifestyle in which they dine out often and go on expensive vacations, then this partner may want to have a higher return on their initial investment. Another partner involved may be more reserved, interested in minimizing there lifestyle expenses to reinvest in building a portfolio. Each of these can again have pros and cons. That is the beauty of investing in real estate – Individuals can develop a strategy that adapts to their goals and needs in life. However, when identifying a new partnership, those that see the long game different may want to reconsider their decision to proceed with the business partnership.
The Final Take Away
There is one common denominator present in the questions above – It is necessary that partners have an alignment of interest to ensure their long-term partnership remains stable. Understanding each partners goals, wants, and needs, as well as their adversity to risk and reinvestment strategies, and outlining how the partnership will approach different setbacks, is an essential process to establishing a future for success.
Relationships are key to the success of your business. Read more about this value and why in this article.