The Journey of Real Estate Investment is not always a smooth ride, especially if you are a solo rider. There’s a high probability that most of the time you’ll be bested by a team of investors. Partnership with other investors is what defines a team effort to make a successful real estate investment.
Real estate is an excellent choice of investment for generating good returns as well as diversifying the portfolio. But real estate investing requires both upfront capital and intensive experience.
As a passive investor, you want to enjoy the high returns but don’t want to go through the hassles of property management or landlord activities. Partnering with investors can help bridge this gap. Moreover, it allows you to scale your real estate business and opens doors to deals that were difficult to accomplish on your own.
However, not all partnerships manage to pull off a successful investment. To achieve a successful partnership, you’ll need to structure a concrete partnership. But before that, you must know what a real estate limited partnership is. Keep reading to know more!
What Is A Real Estate Limited Partnership (RELP)?
A Real Estate Partnership is when two or more investors form a team by combining their capital and expertise to invest in real estate properties. It is a private entity that provides previously un-accessible investment opportunities to real estate investors.
Unlike REITs, RELPs is a private investment where investors can participate either actively or passively based on the partnership agreement. RELPs usually have General Partners who are either a corporation or experienced property managers. They generally have more responsibility and liability, as well as a sizeable profit share. Whereas limited partners provide finance only for gaining returns on investment.
Real Estate Partnership Entities
There are a variety of ways to form a real estate partnership. The three most common pass-through entity partnerships are
- Limited Liability Corporation or LLC
Limited liabilities corporations are one of the most preferred business entities for acquiring real estate properties. Used generally for purchasing or transferring ownership titles of a property.
- Limited Liability Partnership or LLP
Limited liability partnerships are entities in which all partners have limited liability. LLP allows partners to limit their liabilities based on the amount they contribute to the business. Limited partnerships reduce risks, leverage individual skills, and divide labor among partners.
This is generally suitable for short-term investors or those who mostly practice flipping real estate. In this case, the flipping of real estate is considered inventory, and the investor is treated as a dealer. Therefore, investors need to form an s-corporation to avoid social security tax on portions of profit earned.
Each of these partnership formation types provides dual benefits to investors. In addition, these entities provide legal protection from claims against other assets belonging to investors that are not part of the partnership.
Real Estate Partnership Taxation
Whether you directly own a real estate or through a limited partnership, the taxation process is similar at all levels. In certain scenarios, Real Estate Limited Partnerships are viewed as a corporation. Therefore, it could lead to different tax structures. However, since the net income is generally passed through to the partners, RELPs do not require to pay taxes directly.
A RELP is responsible for filing Form 1065: US Return of Partnership Income with the IRS. Also, RELPs should provide their partners with K-1s containing the details of their income.
Active vs Passive Partnership
Real estate partnerships are formed based on the type of investment to suit the needs of individual investors involved. There are two types of individuals in a partnership: Active and Passive Partnerships.
In Active Partnerships, each individual participates actively in day-to-day tasks and projects. For example managing a rental property, taking care of the maintenance of the building, rent collection, and others.
Whereas a Passive Partnership is formed to raise funds for investments. Passive partners leverage the skill and knowledge of active partners in exchange for capital for investment. Passive Partnerships provide investors with the opportunity of diversifying their portfolio by investing in real estate with little to no experience.
Role Of Individual Partners In Real Estate Investments
Even though a RELP may be composed of all active members, it is not possible to have more than one general partner. As always there is one general partner who oversees most of the manual and labor works. While the rest of them act as limited partners.
Roles of a General Partner
- The first and foremost task of a general partner is generating leads and finding the appropriate deal.
- They are responsible for forming and structuring the real estate partnership
- Closing on deals fast and securing financing
- Oversees most of the hard work and manages the investment.
Roles of a Limited Partner
- Limited partners are passive investors who invest by contributing capital to the partnership.
- Limited partners have limited liability with little to no daily operations or management responsibilities.
Ways To Structure A RELP To Attract And Retain Limited Partnership
Every real estate partnership is structured around a partnership agreement, and each agreement varies based on the type of real estate investment. Depending on the structure, sometimes the partnership survives sometimes it doesn’t. However, some of the most successful partnerships are due to the implementation of these below-mentioned ways and strategies.
1. Getting the right partner
Finding the right partner is one of the basic and difficult steps of structuring an appropriate real estate partnership. A real estate partner is someone with whom you are going to discuss a lot professionally. Therefore, while choosing a partner, you must make sure that the partners have the necessary skill set, expertise, or capital to contribute to the partnership.
Moreover, finding a good partner is necessary for cracking a successful real estate partnership. Therefore, a thorough and complete checkup of your partner’s investment background, credibility, experience, and knowledge is a must. Do your diligence carefully to see if they’ll make a good fit.
2. Having a Common Goal Set
Having a similar mindset between the members is necessary for any association. You need to be certain that you and your partner have a similar mindset and share common goals and objectives. For example, tallying with your partner’s investment strategies, expectations on returns, preference of long-term or short-term investments, etc. The key to a successful partnership is to have similar primary goals, even if you do not agree on every detail.
3. Real Estate Partnership Agreement
Having a written document describing every term and condition along with the role of the individual partner is a must. This document will act as a real estate partnership agreement. A legal agreement helps to prevent future discrepancies between partners and acts as a protection tool for the partners.
The contents of an agreement must describe the role of every partner, the profit splits, the procedure for resolving disputes, and the state of the partnership in case a member decides to quit or dies during the partnership period.
4. Being Rational and Just
To structure a perfect partnership you should avoid overcomplicating things and keep it simple. As a general partner, you must focus more on business operations and the job roles of each member.
There is a significant difference in experience and knowledge between a general partner and a limited partner. As a result, the manual effort that goes into a partnership is much more of a general partner. In such a case general partner should focus on structuring a balanced and reasonable profit split rather than assigning difficult job roles to the limited partners.
It is also recommended to work with the legal team and real estate attorneys while drafting a partnership agreement to keep the terms simple and understandable to everyone.
5. Undersell and over-deliver a neat trick
Although you shouldn’t rely on this strategy too often, it sure is a neat trick for keeping partners satisfied. Once you’ve settled on a partner and discussed previous real estate records and stats. The key trick is to undersell your abilities and performances so that you can over-deliver in the practical world.
Using proper real estate tools will help you in finding the appropriate and suitable deals in the real estate market. As a result, it will help you deliver high-quality results than advertised to the partners.
For example, if you tell your partners that you expect neutral cash flow and break even when in reality you deliver positive cash flow, it keeps the other partners happy and satisfied.
6. Communication is the key
As with any investment, communication is the key therefore, to build a long-lasting and successful partnership you need to have regular and honest communication.
Instead of filling your partners with yearly updates, it is necessary to frequently communicate with them. It is crucial to perform regular check-ins with your partners about the status of the investment.
Sometimes you and your partners may not agree on some decisions. Rather than letting things go awry make sure you are working towards a common goal by discussing it with your partners and trying to understand the reasons behind the decisions. It is highly advised to review your goals weekly or monthly.
For instance, notifying your partners when a tenant exits the building in the middle of their lease term and also notifying them about filling the vacant unit with a new tenant.
Pros and Cons of Limited Partnerships
- Partnerships help fill the gap by bringing expertise, knowledge, connections, capital, and other professional experience to the table.
- Flexible distributions maintain equilibrium between partners. While one partner enjoys most of the tax benefits, the rest can enjoy a significant share of free cash flow.
- Pass-through entity structures like LLCs allow partnership income and losses to be passed through to investors so they can claim them on their tax returns.
- Limited partners can enjoy the benefit of truly passive investment.
- A preferred return system allows paying certain investors first before distributions are made to the other investors
- Due to balanced workload distribution among the partners, the investment strategy is properly executed.
- Without a proper agreement, there are chances of frequent conflicts between partners.
- Poor partnership agreements lacking clear job roles can turn a good investment opportunity into losses.
- The sudden exit of partners can lead to disruption in the capital flow required for maintaining profits.
A roadmap to a successful partnership
For those who plan to diversify their investment portfolio other than stock and bonds, getting started with a real estate limited partnership is a good gateway into the real estate business. And to keep these investors interested in real estate you need to maintain a proper partnership. As an active investor make sure you choose the right person for your investment to grow your portfolio. Implementing the above-mentioned tips will increase your chances of profitability in partnerships and also help you retain good partners for future real estate endeavors.