9 Possible Pitfalls of Real Estate Partnerships
As with any venture, once you insert the “human equation” into the picture, things can drastically change (for better or worse). Let’s talk about some of the pitfalls of working with a partner to invest in real estate creatively.
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9 Possible Pitfalls of Real Estate Partnerships
1. Personality Conflicts
Partnerships can be difficult because of the possibility of vast differences in personalities. When you are relying on another person to get things done, and you don’t mesh perfectly, conflict can easily arise. For example, let’s say you’re working with a partner named Bob. What if Bob ended up being controlling, irritating, and domineering? If you are investing in buy-and-hold real estate with Bob, you may need to spend the next 30 years tied to him and his personality problems.
This is why picking the right partner is so important.
2. Differences of Opinion
Everyone has an opinion of how things should be done. If you are in a partnership, you are forced to compromise on many aspects of your business. From paint color to investment type, differing opinions can cause difficulty.
As in any close relationship, suspicion and trust issues can easily arise—especially when things aren’t going well. Trust can be hard to gain and quick to lose. Fraud also plays a role in the demise of many businesses and partnerships. This is why keeping impeccable records is so important to any partnership. You may also want to plan on using a third-party bookkeeper to limit any suspicion of wrongdoing.
4. Delayed Decision Making
When you are acting alone, you have the ability to quickly make decisions based on how you want things. In a partnership, you are often forced to discuss every decision—no matter how trivial—with your partner, which can add a lot of time to your dealings. This is why I generally prefer Bob to be a “silent partner” and to understand from the beginning that I am the primary decision maker.
Of course, I want to discuss critical business issues with Bob, but I don’t want Bob demanding that I talk with him before picking a tenant, paint color, or rental price. This conversation needs to happen very early in the partnership, before any money is spent, and must be written down and signed off on by both parties. I know my strengths, and I’ve been in the business long enough to generally know what I’m doing. That’s not to say I don’t value input, but I simply need the freedom to act quickly and decisively on non-major issues. If your partner cannot accept this, you may need to find a different partner.
5. Smaller Profits
When you form a partnership, your profits, by nature of the agreement, are split. In other words, you will make a lot less money per deal than if you were working alone. However, as I’ve said before and say often, 50% of a great deal is better than 100% of no deal.
The same is true for Bob. People may ask Bob why he would give me (or you) 50% of a deal when he could do it all himself, given that he is funding the total purchase. The simple truth is, Bob would not buy the property himself. Bob would continue going the way Bob has been going and would do nothing differ-
ent—and Bob knows it. So for him, 50% of a deal I (or you) put together is better than 100% of sitting on the sidelines and buying nothing. Besides, Bob doesn’t have to do much work for his part, and he gets front-row training from an experienced investor.
Related: 5 Qualities to Seek Out in Your Next Real Estate Partnership
6. Mixing Business/Friendship
Often, people get into business with friends or family, and many times, that partnership becomes the death of that relationship. Partnerships don’t always work out, and when they don’t, the relationship is often destroyed for good. A partnership is very much like a marriage: don’t get into it unless you’re ready! Again, this is why setting your business up right from the start is so key.
As I mentioned earlier, don’t be afraid to sit down with a lawyer for an hour or two to review your partnership agreement. Your partnership agreement is there to protect you from the things you don’t think will happen, because something always will. When you have a plan for how to deal with problems, the risk of the relationship ending badly diminishes greatly, because both parties have already agreed on what to do.
For example, what if five years down the road, you and Bob jointly own a triplex, and you have a “hell month” when you have to evict one tenant, completely remodel her cockroach-infested unit, and remodel a second unit at the same time? This is exactly what happened to me recently. We had $10,000 saved up in an account for problems in business, and poof!, just like that, a “hell month” drained our account. An eviction, a paint job, and a trashed unit cleaned us out. However, because we had agreed ahead of time, and in writing, that we would split all such future losses (and that I would manage the situation), I simply talked with my partner, and we each wrote a check for half the overages. No one was upset; no one was confused. If you don’t prepare for issues like this, you might end up with some very awkward conversations, angry friends, and a sour business relationship.
7. Unrealistic Expectations
When you rely on someone else, setting expectations as to how something should be done is easy. However, when your partner doesn’t live up to your expectations, it’s easy to grow bitter and blame him or her. One thing I do to curtail this is to consistently underpromise and overdeliver. In fact, I generally don’t promise anything at all. All I can do is show them what I’ve done in the past and give my best guess for what the future will look like. In reality, that’s all real estate investing is: an educated guess. I will show them how I determined the potential cash flow or equity for a property, planning for the worst-case scenario, and make sure they understand I’m not promising that the deal will work out a certain way.
The only time this does not apply is in a pure lending partnership, when I am simply borrowing money at a fixed interest rate for a fixed term. In that case, I do promise to pay a certain rate for a certain time through a promissory note.
8. Legal Responsibility for a Partner
While the legal ramifications depend largely on the entity structure you establish and the choices you make at the beginning, you and your partner are still in business together, which means you are responsible for that person, at least as far as the business is concerned. If he or she skips town, you are still responsible for the whole business, and its obligations. Once again, this is another reason you must make sure your real estate attorney helps you draft any partnership agreements to help protect your interests and your financial future.
9. More Complicated Taxes
When you alone are running your business, the taxes and accounting requirements are much more simple than when you’re working with partners. The more members you bring on as owners, however, the more complicated the bookwork becomes, and the more time consuming (and costly) tax season is. Consider this part of the “cost of doing business” and prepare for it. While you may have been accustomed to having your taxes done for $100 before, you should expect to spend $2,000 or more for this service once you start adding properties and partnerships.
[This article is an excerpt from Brandon Turner’s The Book on Investing in Real Estate With No (and Low) Money Down.]
What has your experiences in partnerships been? Have you run into any of the above?
Let me know with a comment!