You and your business partner can pool resources to buy an investment property. But first, make sure you know what you’re doing.
When buying a home or investment property with a business partner, you have some important decisions to make. One of those is how you’ll form your business partnership to hold title to the property.
No matter how you structure your purchase, it’s critical that you choose a partner who has similar goals for the property and form an agreement that outlines your duties and obligations and protects both parties.
“Investing in real estate with a business partner can be a fruitful endeavor if your goals and expectations are aligned,” says Brie Schmidt, real estate investor and owner/managing broker at Second City Real Estate, based in Chicago. “It is important to look at the partnership like a marriage and understand each other’s personalities and how each person plans on running the business.”
- How to buy property with a business partner: pros and cons.
- Find the right business partner.
- Discuss ownership terms.
- Create an operating agreement.
- Explore financing options.
- Have a solid business plan.
How To Buy Property With a Business Partner: Pros and Cons
Want to purchase property with a business partner? Here are some pros and cons to consider.
- Access to additional resources: Investing with a partner can give you access to additional capital. With more funds, you may be able to purchase a larger property or a property in a more expensive area with more earning potential.
- Generate cash flow: You can purchase a multifamily home or vacation property to earn rental income. If you prefer a hands-off approach, a professional management company can help.
- Appreciation: Property appreciation relates to a home or investment property increasing value over time. When the value of a property increases during ownership, the owner can build more equity or potentially sell for a profit.
- Share responsibilities: When you split ownership of a property, you share all responsibilities with your business partner, including costs. For example, if the HVAC system breaks down, you and your partner can split the cost of repair.
- Potential tax benefits: According to D. John “Jack” Morgeson Jr., a LegalShield partner attorney with DSK Law in Orlando, Florida, there are potential tax benefits, including mortgage interest deductions, property tax deductions, insurance and repair cost deductions.
- Shared control: When you share ownership, you have less control over what happens with the property. You and your business partner must agree on how the property is managed, and the more partners you add, the less control you have.
- Split profits: You’ll need to share any earnings with your business partner. This can also mean it will take longer for you to earn a profit.
- Potential conflict: There’s a possibility for conflicting opinions and disagreements when purchasing property with a business partner. Morgeson recommends a written operating or investor’s agreement that clearly sets out the rights and obligations of all parties.
- Costs: Maintenance and repairs add to the cost of property ownership. If there are disputes, death or insolvency of another partner, there could be additional legal expenses to address these concerns, Morgeson says.
Find the Right Business Partner
Realistically, you can invest in real property with anyone, but it doesn’t mean you should. Look for people in your life or community who are serious about investing and have the capital necessary to participate. It also helps to find someone you get along with and who has similar financial and investment goals. If you have different views on how the property will be managed, conflicts could arise.
According to Morgeson, issues relevant to selecting a business partner in this regard may include:
- The partner’s solvency.
- Credit rating and history.
- Civil and/or criminal history or record.
- Personal integrity.
- Community service and/or history.
- Length of time one has known such prospective partner.
You should also establish how responsibilities and capital contributions will be handled.
“I have seen partnerships established where both members are local and work together on the acquisition and management, and each owns 50% of the property with equal capital contributions,” Schmidt says.
“I have also seen partnerships where one person is local and the other is not, the local person handles all the acquisition and management of the properties and receives a 20% interest and the out-of-state investor contributes all the capital and receives 80% of the partnership,” she adds.
Discuss Ownership Terms
You and your business partner have several options when it comes to how you’ll structure your business entity to purchase the property. But it’s essential to consider the pros and cons of each business structure.
For instance, if you create an LLC to purchase a rental property, it can limit your legal liability and protect your personal assets. An LLC also benefits from pass-through taxation, separates your business from personal assets, offers more privacy and makes it easier to invest with partners. However, buying an investment property as an LLC often costs more, offers fewer financing options and you’ll forgo preferential capital gains treatment.
“Common structures may include partnership, limited partnership, limited liability company or corporation,” Morgeson says. “Conceptually, the partners/members/shareholders obtain proportionate share interest in the particular structure based upon investment amount, which structure/entity then holds title to the real property as a business entity asset.”
Create an Operating Agreement
Before you search for properties, you need to form an operating or investor’s agreement with your business partner. An operating agreement is a contractual document used when creating a limited liability company with your business partner. The document outlines financial and functional decisions, and Schmidt says it should establish:
• Which member(s) have decision-making responsibilities.
• Who picks the investment property.
• Who manages the property or picks the property manager.
• How roles and responsibilities are split.
• When contributions and distributions will be made.
• Who is responsible for distributing the K-1 federal tax forms to the other members.
• When the LLC will dissolve.
• The exit plans and when will they be executed.
• What happens if a member dies.
• Tax elections.
According to the Small Business Administration, an operating agreement protects each member from personal liability to the LLC, helps clarify verbal agreements and protects your agreement in the eyes of the state. Not all states require an operating agreement, but some do, including California, New York, Missouri, Maine and Delaware.
Explore Financing Options
Unless you plan to pay with all cash, you and your business partner will need to secure financing. You can do this once you know what each partner is willing to invest and the total cost of the property.
You have a few ways to finance an investment property, but it’s important to keep in mind that not all residential lenders will lend to LLCs or other business entities, especially if the members can’t become personally liable for the entity’s debts. A lender may only extend a mortgage to a small LLC or corporation if the owners volunteer their personal assets to back the debt.
“If you are financing the properties, you will need to create relationships with commercial lenders,” Schmidt advises. “Any funding to a business entity is done through commercial loans, which may or may not require a personal guarantee and annual review of your PFS (personal financial statement).”
Have a Solid Business Plan
Every investment needs a dispute resolution process and a clearly defined exit strategy in writing.
“Without a clear written agreement in place, litigation by way of partition action may be required in order to address one’s wish to depart with his/her accrued overall share of the investment,” Morgeson says. “Such process will almost certainly include costs of appraisal(s) of the subject property, as well as experts and other litigation costs. In short, these types of disputes can be very expensive in and of themselves.”
Schmidt also stresses the importance of due diligence. “They can be disastrous if the partnership starts to sour or the business does not function as each person thought it would,” she says. “It is important to protect yourself and your capital by entering into business with someone who you can grow with long term.”