Real Estate Partnerships: Pros vs. Cons
About the author: Andrew Syrios is a real estate investor and writer living in Kansas City, MO. He is a partner in Stewardship Properties along with his brother and father. Their company owns over 500 properties in four states.
Real estate investment partnerships can be an excellent way to either grow your business by adding a talented partner to your real estate team or raise necessary financing in a very capital-intensivey industry. This is for new investors especially, who rarely have a lot of seed capital to get started with. That being said, there are several noteworthy downfalls to real estate partnerships, so you should only set one up after carefully considering and addressing all of those potential problems–and determining whether they can be outweighed by the good.
First and foremost, however, it’s important to note that there are several types of entity partnerships. Most are set up in LLCs (Limited Liability Companies), but they can also be in LLPs (Limited Liability Partnerships), or S-Corps. Regardless of the particular entity though, broadly speaking, real estate investment partnerships fall under two categories.
Active real estate investment partnerships are, as the name would suggest, when all of the partners are active in the day-to-day work of the business. Sometimes, as is common with law firms, an employee will work their way up to become a partner. In real estate, these partnerships are usually formed between two active real estate investors for the purposes of growing and allowing each partner to specialize in the areas that they excel in. And this applies to multiple types of active real estate investing, including but not limited to fix-and-flip, wholesale, rental, etc.
Our own family investment partnership between me, my brother and father works in this way. My father focuses predominantly on financing, I focus mostly on property acquisition and rehab, and my brother oversees the property management. When my father first started, he partnered with a contractor who did the rehab work while my father found the properties to buy and then did the property management. There are any number of arrangements one can make with other active partners, but the key is to allow each partner to focus on their strengths.
Another way to use partnerships is to raise capital. When starting a real estate investment partnership such as this, the arrangement would not be to split up the different tasks, but instead to make the split between the person doing the work and the person bringing the money. For example, you could agree to do all the work while your partner puts up the money and you split the equity in some way you both agree upon.
Most of this article, however, will focus on the pros and cons of being an active real estate investment partner.
The most important of the benefits of a real estate investing partnership is the ability to raise capital and thereby scale your real estate investment business. This is particularly true when working with a passive investor, either to fund your entire operation or to fund individual deals. Many new investors don’t have a lot of start-up capital, while there are plenty of people out there with money that don’t have the desire to be an entrepreneur. These two types of people can be a match made in Heaven.
Indeed, many extremely successful investors started off this way. One friend of mine has used passive investors in syndications to go from 0 to 3,000 rental units over the past eight years!
Learn from experience
Many young investors with energy and time could greatly benefit from a real estate mentor. A partner (whether active or passive) may not be such a person, but they also may very well be someone with a lot of experience in real estate or business, with knowledge that they can pass down. Even a passive investor (assuming they have experience in real estate) can give plenty of good advice. I was lucky and partnered with my father who gave me a lot of great advice.
Different skill sets
No one person is great at everything. If one person is good at marketing and sales while another person is good at analysis and accounting (which is incredibly important and often undervalued amongst entrepreneurs), that might make for a very good active partnership. It’s generally best to focus on your strengths and hire or partner with people who are strong in areas you are not, rather than simply trying to improve your weaknesses.
Easier to obtain financing
Partners with money also tend to be partners with good credit and lots of assets. Lenders really like to see both of these things and thus these partners (whether active or passive) can help secure financing. Many banks will require all passive partners in a syndication to sign as guarantors on the loan.
The most obvious negative to real estate partnerships is that instead of getting 100 percent of the equity in any given deal, you only get whatever percentage you negotiated with your partners. There are other ways to raise money for potential deals that allow you to keep the entire deal—such as hard money loans—that you may want to consider. That being said, for larger properties in particular, it is very difficult to get private financing to cover the entire cost of the property.
If you are looking for additional help, you can also consider hiring or contracting vendors. Of course, if you don’t have the cash flow or savings to pay them, you should look into a bridge loan that offers rehab financing if you are investing in a fix-and-flip project.
Creating a partnership for real estate investment is not free. Sure, the costs of opening an LLC with another person as your partner is pretty inexpensive. But the costs for more complex partnerships can be as much as $10,000.
The most common complaint you will hear with partnerships is that they often lead to personality clashes. While I partnered with family members, I would generally recommend against it unless you get along well and have a similar idea for your real estate investment partnership business plan. If your business relationship sours, it can bleed into your personal relationship as well.
It’s important to do your due diligence on any potential partner, even if they are just a partner bringing money to the table. We have worked with plenty of demanding private lenders that would make for terrible and overbearing partners. And it’s much easier to end a loan than to end a partnership.
If it’s an active partnership, you should also avoid the temptation to work with someone who has a similar skill set to yourself. We tend to get along better with those like ourselves, but there’s no real point in partnering with someone who can do the same things you can. You want to partner with someone who can do the things you can’t!
But the most important thing is to make sure that you can get along with the person for the long term and that they aren’t a mean-spirited person. It’s a common saying that "all partnerships end." And while that may be true (at least in the long run), you don’t want a partnership to end quickly or on bad terms. Breaking up a partnership can be very messy, tiring, and expensive. So, it’s critical to only partner with someone you can see yourself working with for a long time.
You may get along great and have complementary skill sets, but if your goals aren’t aligned, it can present major difficulties. For example, if you want to buy 100 properties and your partner wants to buy 10, or you want to buy multifamily properties and your partner wants to buy only single-family properties, that could obviously be a big problem.
Along the same vein, if you do decide to partner with someone, make sure to put together a rock-solid partnership agreement with an attorney. Make sure that the expectations for each partner is clearly laid out and understood by all parties. Incorrect expectations almost always lead to resentment which will usually, in turn, break up a partnership. And as noted above, breaking up a partnership is a messy, tiring, and expensive affair.
Real estate investment partnerships can be a great way to get started in real estate or take your business to the next level. On the other hand, partnerships reduce your equity and create the potential for all sorts of personality conflicts. The verdict? They should only be used carefully after thorough due diligence and consideration.