Business partnerships are everywhere you look, especially when you look at the most successful investors and businesses. The idea of a partnership is simple: Find someone whose interests and goals align with yours, use each other’s strengths to supplement the other’s weaknesses, and succeed in a way that you may not be able to on your own.
To a new investor, this may seem daunting or foolish for a few reasons:
- “Why would someone want to invest with me?”
- “I don’t want to give up part of the deal.”
- “I don’t want to be locked into business with one person.”
- “Partnerships are only for large endeavors or savvy investors.”
On the BiggerPockets Podcast, co-host Brandon Turner often talks about the three fundamental pillars needed to bring a deal together. He calls it the deal delta. You need to have the deal, you need to have the money, and you need to have the hustle to pull it together.
It’s critical that you are very clear on what you provide and what you’re looking for. If you can find someone who brings the missing piece(s), you can partner on a deal. Yes, you will give up part of the deal in some way, but in exchange, you will gain experience and take down a deal you may not have otherwise been able to tackle on your own.
Types of Partnerships
I’m going to break this down into four key categories of partners:
- Active partner
- Loan-based money partner
- Equity-based money partner
This is not necessarily an all-inclusive list, and there is definitely an overlap between some of these, but it serves as a good starting point. I’ll go into each of them and add some clarity, but be sure to check out the five considerations at the end.
1. Active Partner
I view an active partnership as one where both parties are bringing some of the hustle to the deal, whether you’re a new investor partnering with a more-experienced investor or you’re just looking to work together with a fellow investor who complements your abilities.
As a newbie, this is a great option if you have some money and the ability to provide some sweat equity. You can find an experienced partner who gives you the opportunity to buy into the deal with some capital and then work side by side with them to see how everything is done.
This provides you with an excellent opportunity to work with and learn from an experienced investor, and for your efforts, you get some sort of equity in the deal.
If you’ve done a few deals, you can also partner with someone at your level. You each contribute to the three pillars and work hand-in-hand through the process. You may both split the finances evenly and hustle together on all of it, or you may have the experience to handle the rehab while your partner handles the property management.
However you choose to do it, this is a great way to combine your resources and partially mitigate your risk by working hand in hand with a fellow investor.
2. Loan-Based Money Partner
If you can bring the deal and the hustle in the relationship, all you need is the money. You want to find someone who has capital they need to put to work, and then you need the deal and the ability to give them a return on that capital.
One way to do this is by structuring your partnership as a loan. This could be either a long- or short-term loan, where your partner “plays bank” in place of a long-term mortgage or provides temporary short-term funding for a purchase or rehab until you can refinance into longer-term debt.
The purpose of the loan will drive the terms. This is a powerful multiplier in your business, typically allowing you to close faster than with traditional financing and allowing you to make purchases that wouldn’t qualify for bank financing (i.e., properties in poor condition).
Ultimately, the loan has a number of terms, some optional and some required.
- Loan amount – How much will you be borrowing?
- Loan term – How long will you be borrowing the money for?
- Interest rate – What rate will you be paying them for their money?
- Loan-to-value (LTV) – What percentage of the purchase price are they loaning you?
- Payment structure – Are you making interest-only payments and then a balloon payment? Are you paying down principal and interest each month? Are you deferring all payments until a balloon at the end?
- Collateral – What is the collateral for the loan that the lender can take if you don’t pay?
- Fees/points – Do they require fees or points (one point is 1% of the loan) up front?
- Prepayment penalty – Is there a penalty if you pay off the loan early?
- Extension clauses – If it’s a short-term loan, is there an option to extend your loan at the end? What does that cost?
These are just some of the terms and are by no means an all-inclusive list. Work with your private lender to come to an agreement, and then work with an attorney to draft the contract.
Just remember, this is a loan you’re going to have to pay back. It can be a powerful tool, but you need to consider the carrying costs and have an exit strategy. This makes it a great opportunity for a BRRRR or a flip, if you need short-term funds until a refinance hits or if they’re willing to provide long-term funds. But be very cautious about using this type of partner and loan on a long-term deal with no exit strategy!
3. Equity-Based Money Partner
As the title states, this is a partnership where your partner provides the money in exchange for equity in the deal, instead of treating the funds as a short-term loan. This type of partnership can be extremely advantageous to both you and your partner by maximizing your cash-on-cash return (COCROI) while providing an attractive return to your partner.
There are a lot of different ways this can be structured, and all aspects of the deal need to be taken into consideration. How much is each partner contributing up front? What percentage of the deal will they receive? Are cash flow and equity split the same way? Who is responsible for covering additional out-of-pocket expenses, and how is it split? How are proceeds or losses split upon sale or refinance?
All of these terms are critical to have spelled out and to consider when presenting the deal to a potential partner. In many cases, you can think of this in a similar manner to selling your partner a dividend stock or a bond. They make an investment up front, they receive a dividend payment (cash flow), and they receive capital gains when you sell and realize your profit.
You may be asking, “Why would I want to give up part of my deal?” Consider the following $250K deal that produces $500/month in cash flow, where you contribute 10% of the down payment and get 15% of the deal. Sounds horrible, right?
Let’s take a look!
Your 15% position gives you 18% COCROI, and your partner gets 11.3% for only contributing capital. Not bad, right?
And that’s a much lower split of the partnership than I’d be willing to take! You can see how giving up equity in a deal can be extremely advantageous for both you and your partner.
I’m not going to get into syndication because I am absolutely not an expert on this at all. Just know that syndication is considered a security and is therefore subject to the rules and regulations of the SEC. Be sure you do a significant amount of research and consult with an attorney before getting into a syndication.
5 Secrets to Successful Partnerships
Understanding the different structures gives you flexibility in how you pursue deals, ultimately allowing you to grow faster than you would if you tackle everything on your own. That said, there are a couple of key considerations I’d recommend in any partnership.
1. Good Relationships
You should be building lasting business relationships with those you partner with, not just one-time contracts. This means you should make sure your terms are attractive to your partner, and absolutely DO NOT ever take advantage of someone who does not know real estate.
Your reputation is everything, and the last thing you want to do is destroy that reputation by chasing a better return at the expense of a business relationship.
2. Clear Terms
No matter the partnership, make sure you draw up very clear terms that discuss the different outcomes and aspects of the relationship. Who is responsible for what? When and how often do you get paid? What is the exit strategy? It doesn’t matter how long you’ve known the person; draw up the terms and put it into a contract so there is no emotion to it.
3. Funding Source and Requirements
Consider your funding source and requirements. When using a bank for a loan on a property, the bank will often (always for a conventional conforming mortgage) have specific requirements for the source of your down payment funds. They must either:
- Be in your account for two months, or
- Come from a person who is also on the loan.
In order for a money partner to work if they don’t want to be on the loan, you often must utilize a commercial or non-conforming loan product where the funds don’t need to meet those requirements.
4. Don’t Be Afraid to Ask
If you have any questions about partnerships vs. syndication, speak with an attorney. The last thing you want is to have a partnership go sideways because you improperly and unknowingly formed a syndication.
5. Plan for All Outcomes
Talk to your partner about what happens if the deal doesn’t close. Due diligence is a critical time where a significant amount of money can change hands for appraisals, inspections, contractor walkthroughs, etc. What happens if the deal doesn’t close? Who is responsible for those funds? Make sure you have a plan!
Go for It
Like most things in real estate, there is no formula or single way to do things. You have to get out there and figure it out! All but one of my deals thus far have been taken down with partners, and it has been a powerful multiplier in my business.
If you find a good deal, you can work out the terms in a way that is advantageous to all parties. So go into your partnership negotiations with an open mind and work together to take down the deal.
How have you used partnerships in your business?
Share some of your favorite partnership stories in the comments below.
Note By BiggerPockets: These are opinions written by the author and do not necessarily represent the opinions of BiggerPockets.