Whether you’re a first-time investor or someone who’s been in the real estate trenches for years, at some point you may want to consider bringing an investor partner into your venture. No doubt you’ve heard, if that’s the direction you decide to go, that it’s prudent to enter into a real estate business partnership agreement, before moving forward.
The big question you might have, before adding this facet to your real estate development business, is what does a real estate business partnership agreement look like? What are the key benefits to this type of agreement? What should be included in the agreement? And how does it protect both parties?
Here are four key principles to keep in mind when contemplating, and crafting, your own real estate investor partnership agreement.
Understanding the Real Estate Business Partnership Agreement
Why Sign a Partnership Agreement?
The key benefit to a real estate partnership is that it allows all parties to pool their resources and capital, as well as split the operating costs and expenses of the business in the pursuit of real estate opportunities.
The key benefit of a real estate partnership agreement is that it clearly lays out the rights and responsibilities of each member of the partnership. The goal is to eliminate all vagueness and confusion at the outset so that later on when issues arise — such as disputes over rental income, property management, rights to sell, etc. — all parties can be guided by the agreement to the best course of action. (Not simply defer to whoever yells the loudest.)
Who Does What (and When)?
One of the first — and most important — elements of a real estate business partnership agreement is to establish the specific roles and responsibilities of each member of the partnership.
Rarely is a partnership equally-balanced in every area; in fact, when vetting a partner, it’s crucial that your new cohort possesses strengths in areas that you are less adept. (The goal is balance, not redundancy.)
Defining the exact roles and responsibilities of each member in the partnership takes into account things like individual strengths, weaknesses, resources, education, competencies and unique characteristics. (Finding an area not covered by one of the partners, in an initial draft of a partnership agreement, is a great way to find “blindspots” in your venture.)
Key areas of the partnership to define in your partnership agreement include:
- Real estate acquisitions (both traditional and short-sale)
- Property sales (Different than marketing)
- Business Development/Strategy
- Construction Management
- Commercial real estate
- Rental properties
- Property management
It goes without saying that the partner who has the biggest core competency in a specific area of the venture should be “in charge” of executing that area of the business.
One other consideration to keep in mind is the time commitment each partner will put toward the partnership.
- How many hours per week (including weekends) will each member contribute?
- How will vacations be handled?
- How will family and other business commitments be accommodated?
This isn’t to say that duties in the partnership can’t evolve or that partners can’t take on new roles or that hourly commitments can’t be adjusted. Just that, being crystal-clear about specific roles and duties will not only clear up future confusion about “who does what” — but also give each partner the confidence that comes with owning specific areas of a business.
How Does the Money Work?
Ah yes, the money. It could be said that clearly articulating the financial model of the partnership might be the most important part of the agreement. And without that, the partnership might need to be postponed until such considerations are ironed out.
This means answering questions such as:
- What’s the initial capital contribution of each member?
- What is the rate of return for each member? (And in what form?)
- How will (and often) profits be distributed?
- Will there be a salary?
- How are financial decisions made?
- What is the risk profile of the partnership?
- Is there an exit strategy?
- What distinguishes deals within the partnership and without the partnership? (Perhaps the thorniest issue of all)
Many partnerships are created with the belief that everybody in the partnership has the same goals of simply making deals and generating cash. But each person has a unique set of objectives — passive income, retirement, family obligations — and being clear about how each member of the partnership will benefit (and contribute) financially to the partnership is crucial. (And is not unlike creating two different versions of a business plan for real estate investing.)
How Will Partners Be Protected?
There are many benefits that come with entering into a real estate business partnership: increased capital, expertise and connections, for starters. But with increased benefit comes increased risk. That’s because no matter how much time you spend vetting a potential partner, you simply don’t know exactly how a person ticks until you work with them on a consistent basis.
Fellow partners aren’t the only financial risks to a partnership out there. Malicious lawsuits, in whatever form, can jeopardize the partnership (and your financial well-being) if you don’t have protection systems put in place.
This means paying particular attention to areas such as:
- Liability protection
- Tax allocation
- Ease of formation
It goes without saying, but we’ll mention it anyway, that it’s important to consult a tax/financial professional before putting these asset protection systems in place. Far better to over-protect and be safe, then under-protect and find yourself vulnerable.
Removing One Obstacle at a Time
Though developing something as detailed and metric-centered as a real estate rental business plan or a partnership deed for real estate business can be daunting, it’s important to remember the document is not the goal. The clarity and peace of mind that comes when the document is finished is the goal.
And by using your real estate business partnership agreement to establish clear roles and responsibilities — along with legal protections and profit disbursements — you’ll be removing bottlenecks from your partnership. And give it the room to breathe (and thrive) beyond your wildest dreams.