A Guide To Real Estate Partnerships
Interested in buying a multifamily property, single-family home, retail storefront or office building as an investment property? Doing so on your own could be challenging. Real estate is a popular investment. Because of this, the price of apartment buildings, homes and other investment properties tends to be high.
A real estate partnership, though, can help. In these partnerships, investors band together to purchase and manage real estate investments. If you invest through a partnership, you might be able to own at least a slice of an investment property without spending as much of your money upfront. Real estate partnerships are one of many options you can explore when deciding how you want to invest in real estate.
This doesn’t mean that real estate partnerships are right for everyone. As with all financial arrangements, these partnerships come with their own pros and cons. Is this move a smart one for you? You’ll have to consider your financial health, your experience as an investor and your comfort level with sharing ownership and management of an office building, apartment development or retail location.
What Is A Real Estate Partnership?
A real estate partnership is an investment strategy that allows two or more participants to invest their dollars into one property. Investors can choose whatever type of property they’d like in which to invest, including apartment buildings, warehouses, self-storage facilities, office buildings, single-family homes and retail centers.
The goal, as with any investment, is to earn money. Partners in a real estate partnership can earn monthly income from the rents that they collect, including from tenants in an apartment building, companies renting out space in an office property or industrial users leasing space in a warehouse.
Investors can also earn money through appreciation. The hope is that when a real estate partnership invests in a property, that property steadily increases in value. Eventually, the partnership can sell the property for a larger price tag, dispersing the profits to partnership members.
The key is for every real estate partnership to spell out exactly how the profits will be passed out and when members agree to sell a property. A partnership agreement might state, for example, that the investors will sell the property after 10 years, though market conditions might change any timeline. Remember, too, that once you invest in a real estate partnership, you won’t have access to that money again until the property is sold.
Real estate partnerships typically fall into one of two categories: active, in which all participants are responsible for the daily management of an investment property, and passive, in which investors provide the funds to purchase the building but aren’t involved in the property’s daily upkeep or operations.
These partnerships are popular because they are an example of a pass-through entity. Pass-through entities aren’t required to pay corporate income taxes or other entity taxes. The investors in a partnership instead pay individual income taxes based on their shares of whatever profit an investment earns.
There are tax rules that investors must follow, though, when reporting their income. A real estate partnership must file Form 1065 with the IRS, reporting the income of each individual partner with the IRS’ K-1 form. As will all tax related issues, you should consult with a licensed tax professional before making any decisions that will have an impact on your business or personal income taxes.
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Types Of Real Estate Partnerships
There are two main types of real estate partnerships, real estate general partnerships and real estate limited partnerships.
General Partnership
In real estate general partnerships, one or more equal partners invests in and owns properties. All partners are responsible for managing the partnership and handling the daily management of the investment properties.
In this type of partnership, there is no legal shield for individual partners. If one partner is sued, all partners are considered liable for any damages.
When buildings are sold, all partners will usually share the profits equally, though this will depend on the details of the arrangement.
This could be a good arrangement if you want more control over investment strategies and the management of your real estate investments.
Limited Partnership
A real estate limited partnership, often referred to as a RELP, includes both a general partner and one or more limited partners.
The general partner is responsible for the management of the partnership and its real estate investments. The limited partners serve mostly as investors, providing money to help purchase the real estate investment but not participating in the daily management of either the property or the partnership.
This provides investors the chance to invest their dollars in real estate without the hassle of managing, marketing or maintaining the property. Limited partners might also receive legal protection. If a real estate limited partnership is sued, the general partner will usually bear the brunt of the legal action, depending on how involved limited partners are in the partnership’s decision-making.
Joining a RELP could be a good strategy if you’re interested in investing in real estate but would rather rely on the expertise of a general partner when it comes to making key business decisions about these investments.
What’s The Difference Between A REIT And A RELP?
Real estate investment trusts, better known as REITs, are similar to real estate limited partnerships in that they offer investors the chance to pool their funds and invest in real estate. REITS are also a passive investment: Investors put their money in a REIT and hope that the real estate generates steady income and increases in value. But they don’t make any management decisions.
But there are some key differences.
First, REITs are often registered with the Securities and Exchange Commission and publicly traded on a stock exchange. Real estate limited partnerships are private equity funds that are never traded publicly. That makes REITs easier to buy and sell.
Then there are the terms of both investment types. While real estate limited partnerships tend to have an end date, REITs don’t. Instead, they provide an ongoing income stream. With real estate limited partnerships, the profit payoff usually happens when the partnership sells its real estate.
Finally, there are the barriers to entry. RELPs typically require investors to put up a minimum amount of money, often $2,000 or more. RELPs are also targeted to high-net-worth individuals or accredited investors who have a minimum net worth. REITs are accessible to a greater number of investors, with their shares often priced under or about $50.
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Real Estate Partnership Pros
There are several benefits that come with entering a real estate partnership:
- Potential for profit: You have the potential to earn a greater profit with a real estate partnership. That’s because when you and your partners combine your resources, you can purchase a larger or more valuable property, one more likely to appreciate and generate a strong cash flow each month.
- Shared responsibility: When you invest in real estate with a group, you can benefit from the knowledge and experience of your partners. You can also divvy up the workload, with some partners focusing on long-term planning while others concentrate on the day-to-day management of the partnership and its investments.
- Flexible relationship: Maybe you want to invest in real estate, but you don’t want the work of managing the property each day. You can invest in a real estate limited partnership, where you act as a limited partner. In this arrangement, you provide part of the capital to purchase a property, but you aren’t involved in the day-to-day management of any assets.
Real Estate Partnership Cons
- Risk: Even though you’re investing with partners, you’ll still face risk when purchasing a real estate investment. There is no guarantee that your investment will increase in value. You might even lose money.
- Requires upfront capital: Investing in real estate isn’t cheap. Though it varies, you might have put up $2,000 or more to even participate in a real estate partnership investment.
- Interpersonal conflict: Even though the participants in a real estate partnership will sign documents spelling out how the profits are split amongst partners and when a property is sold, there can still be disagreements about how to manage the property and how to maximize its value.
How To Structure A Real Estate Partnership
Ready to pool your dollars with other investors to purchase an office building, apartment complex or warehouse property? Here’s how to form a real estate partnership.
1. Estimate Your Available Cash Flow
How much buying power do you and your partners have? It’s important to know. The amount of cash you and your partners can come up with will determine how much money you can invest in real estate investments.
Be careful not to overestimate the amount of money you can contribute to the partnership. Look at your own monthly cash flow to determine how big of a contribution you can make without draining your savings.
2. Consult A Real Estate Attorney
Before signing any documents, consult a real estate attorney. This legal professional will make sure that you and your partners are following all the regulations required when forming a real estate partnership. The attorney can also help you and your partners draw up the documents that specify the share of the profits that everyone receives when selling a property and the dates on which you will sell your investments.
3. Decide On A Structure For Your Real Estate Partnership
Now it’s time to decide whether you want to form a real estate general partnership or real estate limited partnership. There are pros and cons to each approach. The best structure depends on how involved each partner wants to be when it comes to making the daily decisions that come with running a real estate partnership.
4. Draft A Real Estate Partnership Agreement
Be careful when drafting an agreement with your partners. This agreement should state the shared goals of the real estate partnership and should list the roles that each partner will play, whether that partner is a general or limited partner. The agreement should state which partners will face legal repercussions if the partnership is sued.
Next, work with your attorney to form a corporate entity. You might consider meeting with an accountant, too, who will consult with the partnership on financial and tax issues.
The Bottom Line
A real estate partnership can be your gateway to investing in real estate. But this doesn’t mean you can’t become an investor on your own. If you are interested in financing the purchase of a single-family, multifamily or other type of investment property, you can apply for a mortgage with us today.
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