Starting a "partnership," but which Legal Entity?

Question

So I believe I know the answer, and I am going back to a few books to read more on each to make sure my situation fits.. but this will be my first partnership and I realize I lack the experience and maybe knowledge to make this decision.

Background:

I am working on making my first investment purchase! I found an interested partner through networking with friends- basically putting the idea out into the world that I wanted to buy real estate investments and was looking for a partner. A friend directed me to one of his friends... and bam. I've been up for hours chatting through ideas and different properties in the market we are looking at.

Our agreement:

I will take out a loan at a local branch bank. 100% financing, 0 down. 4% APR. 30 years. My partner and I will split expenses, profits, liabilities. He will be managing the property.

To protect each other from and the property I believe we need to form a legal entity instead of a partnership. I think a member managed LLC is ideal as it will allow us to share decision making responsibilities. Transferring the property to LLC will also transfer the taxes.

This is my understanding from what I have read. If I am wrong or should consider anything differently, please advise.

Thanks!

Dave Toelkes · Answer

Daily rentals have a lot more management overhead and therefore command higher management fees.  A daily rental manager needs to provide some sort of reservation service (preferably it includes an online presence), physically inspect and clean the property each day as your renters check in and out, and provide a linen exchange and laundry service for the sheets, towels, etc.  If the management company also provides daily housekeeping services as well, that also increases the overhead cost.  I don't think 30% is excessive for what a daily "rental" requires.  In my local area, "condotels" are charging 40% and up.  The owner still pays all utilities separately from the management services fees.

Until you interview a few property managers and investigate their scope of service, you won't know how much to include in your cash flow analysis for property management.  In my opinion, the management fees for professionally managed daily rentals tend to consume all the free cash flow, so there is little to nothing left over after debt service and other costs of ownership and operation are paid.

BTW, a multi-member LLC is a partnership in the eyes of the IRS when it comes time to file your income taxes.  A partnership tax return will still be required for your federal tax return even if your business entity is an LLC.

Valentina Naumenko · Answer

I recommend LLC

Steve Vaughan · Answer

Your money, your credit, your house.  Hire a manager if you need to, but I wouldn't equity split and partner up Willy-nilly.

You didn't say if this is a buy and hold? So not just a partnership, but a perpetual one?

Just read the other horrible p-ship nightmare story on BP right now. Too many chiefs.

Shady LLC transfers later can cause problems, too. Would make a good soap opera as you realise your financing and insurance is messed up in the name of asset protection.

I would keep it simple and hire someone if needed. Mgt is not that hard if house is in your backyard.

Robert Ombres · Answer

I understand the going rate for property management to be 6-10% for traditional rentals. Is that the case with nightly rate vacation rentals as well? I believe I've heard higher rates at around 30% for this type of service.

We will be using a small local bank and I will be discussing the intentions of transferring the property to the legal entity so there are no suprises. I don't anticipate problems here but I won't know until I speak with them regarding this. I know there is a lot of discussion on the topic and it seems people have differing opinions and experiences.

Thanks for the responses!

Robert Ombres · Answer

I appreciate your response. It does point out things to consider.

The buy is for a house I intend to buy and hold. It will be used as a vacation rental. I used the BP calculator and found it to cash flow with the traditional long term lease so I believe it to be a safe fallback in case nightly rentals don't work out for it. The property is outside Asheville, NC. If you know Asheville market, you know the area is (has been) seeing quick sales, rising prices, and rising rental rates. The area is flood with tourists throughout the year. It's not Orlando, but we see a lot of tourist visitors.

I have less experience with vacation rentals than I do with traditional rentals and that experience is from renting. My partner however has been doing vacation rentals in this area for several years and traditional long term rentals longer. I feel comfortable partnering and sharing some profits with someone who has the knowledge and experience I lack. I even feel it a safer deal because of it.

I could buy the property and pay a manager. I've read that management companies for nightly rentals charge around 30%, is that right? If so, that doesn't sound like a good deal to me. Someone not vested in the property isn't going to work as hard as someone who is. They aren't going to treat it like it's theirs. My partner will, because it sort of is.

I don't mind people being critical- It provides things to consider. That's why I posted- more eyes and experienced investors to share their opinions. However, I don't want to get a bunch of posts in the tune of "Don't do it, that's scary/risky/not as profitable as/etc" As a beginner, I do need to be cautious and take advice. But, also as a beginner, I need to make deals. As long as they're not bad deals from the start- they don't have to be great deals where I'm the only person profiting. So please continue posting critical points for me to consider. But if you don't even answer the question posted, you're not contributing at all other than being negative solely because it's something you wouldn't do.

People partner on deals all the time. I imagine that a lot of times, one person holds more risk than the other(s). I am asking how to protect myself, my partner, and the property through a legal entity. So... how would YOU do it?

Starting a "partnership," but which Legal Entity?

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