Basics of the Agreement
At its core, a real estate investment partnership agreement is the fundamental document binding together a group of individual investors with a shared goal of financing the purchase and preservation of property. This document is signed by each investor and describes the percentage of interest in the property each individual owns, as well as protocols for managing the property and handling profits and losses. Spelled out in detail in the agreement, these issues must be addressed before any purchases are made.
In order to understand how a real estate investment partnership agreement functions , it is important to consider the way a limited liability company (LLC) is set up to protect business owners from exposure to lawsuits. Much like an LLC, the real estate investment partnership agreement allows all investors to benefit from buying property together while legally limiting their liability if a property is damaged. Unlike an LLC, however, the real estate investment partnership agreement does not require registration with the state, and its formation is far simpler and less expensive than an LLC, which makes it the superior choice for first-time real estate investors.
Essential Features of the Agreement
An agreement governing a real estate investment partnership should address everything an investor would need to know to feel comfortable. While the specific provisions will depend on each particular project and the investment structure, there are some components that should be in any investment partnership agreement.
The agreement should be clear about the roles of all the parties and what they’ll be responsible for. For example, if one partner is going to be a "silent" investment partner, he or she should be able to count on the other partner performing all management roles. Conversely, if one partner wants to be in control of operations, this should be clear in any agreement. It’s also important to delineate parties’ management responsibilities and major decision making authority, particularly in a majority-ownership share structure.
The method of distributing profits is a crucial point that should be emphasized. In many cases, an investor may simply expect to receive a share of the profits in proportion to the percentage of the initial investment, but this is not always the case, particularly if a general partner can be expected to exit with a return on investment.
Other key components might include termination and dissolution mechanisms, property selections and acquisition guidelines, and appraisal methods.
Factors to Consider Legally
When it comes to entering into a real estate investment partnership agreement, the legal considerations are many. These agreements can fail to comply with state laws if they are improperly drafted and entered into, and fail to protect the parties if they are drafted poorly. This can end up costing partners and investors thousands of dollars in legal fees and damages.
Real estate investment partnership agreements need to be carefully drafted in order to provide the partners with protections in the event of a lawsuit or the dissolution of the partnership. The partnership agreement serves to set out clear guidelines for how the partnership is supposed to operate.
These types of agreements must be drafted and entered into in compliance with each state’s laws where the property is located and where the partners are. For example, since most states will require real estate investments to be registered as a limited liability company, but some will require that the LLC be organized in the state or the property is located. Some states will require that all partners be registered as general partners while others do not.
Real estate investment partnership agreements should include guarantees from each partner for specific investments or specific properties. If an investment is lost, partners without any liability in the LLC are off the hook and they get to walk away unharmed. Having guarantees in place will provide leverage in negotiations with unguaranteed partners as well as enabling recovery of damages by the other partners.
Partners should also understand that they cannot recover any "tax credits." When partners invest in a real estate deal they may also get a tax credit that can be applied against their own personal tax burden. If the deal goes south, the tax credits still exist – and have a dollar value as assessed by the IRS components. That value may be assigned to the partnership as damages by a court in the event of an event that requires a dissolution of the partnership. However, this type of award is rare and uncertain. It is best that the partnership avoid these risks by ensuring that the LLC agreement includes the value of such credits as part of the agreement.
Advantages of a Partnership Agreement
A well-drafted real estate investment partnership agreement can make all the difference in your investment experience. The primary goal of a partnership agreement is to avoid disputes by establishing specific processes from the outset for managing a partnership. Such processes are important in a small partnership, but they are essential in a larger partnership where there may be many members with many different interests. There are three primary reasons why every real estate investment partnership should have an agreement: risk management, dispute resolution and exit strategy.
The first reason why all real estate partnerships need to have agreements is for risk management. In order for a real estate investment partnership to be successful, it needs to have a clearly defined investment strategy that is understood and agreed to by all partners. An investment strategy sets forth how much capital members invest and how those investments will be used. It also provides guidelines for how the partnership will invest that capital. One of the best ways to manage risk in a partnership is to be clear and transparent about how money is being invested and disbursed. Having an investment strategy in writing helps to ensure that all partners agree on the risks involved in the business.
The second reason why a partnership agreement is beneficial for any real estate investing partnership is that it can help resolve disputes. Disputes in small real estate investment partnerships are common and getting everything in writing can help members of an investment partnership resolve conflicts. For example, if one partner in an investment partnership is responsible for managing an asset, the other partner may want to see a written contract that details what is included in the management duties, such as meeting financial goals and reporting to owners. Disputes can also come up about disbursements. This may include questions such as how disbursements to owners are calculated, when disbursements are made, whether disbursements are made in cash or by check and whether the amount of a distribution varies from year to year. The best way to handle these disputes is with a written agreement that outlines the procedures and expectations of the investment partnership.
The final reason why every real estate investment partnership should have an agreement is for exit strategy. Investing in real estate can be very lucrative, but it can also be risky. Not every partnership will be successful. However, a successful real estate investment partnership doesn’t have to be a gamble if it has a strong exit strategy. Having an exit strategy in place is one of the most important parts of your partnership agreement. The exit strategy should outline how a partner can exit the partnership and what the process entails. The exit strategy should also include what happens to the assets if one partner leaves the business or if the entire partnership dissolves.
Avoiding Common Errors
When it comes to real estate investment partnerships, it is not the good deals that you want to release to everyone that can be a problem in real estate investment partnerships, it is the bad deals. It is the bad deals, the bad examples that make headlines and cause real estate investors to steer clear of buying into the real estate business. These bad examples not only affect the people involved (the investors) but also all of the persons who got hurt because they believe what they read on various news outlets about the real estate investment partnership being a potential scam or another one of those fake deals.
Furthermore, when lawsuits are filed, it hurts every real estate investor out there because it essentially destroys the reputation of the legitimate real estate investor. Many individuals who had great success in real estate, shy away from a few bad apples who continue to pop up from time to time in real estate investments. This also includes many of the big time, high end investors who actually have the potential to recover the failing real estate market, will not do so, because of the fear of being deemed taken or scammed, because of the few bad apples.
What I often see is individuals who have no clue about real estate investments, they just know they want to be a part of the real estate business. The problem with this scenario is that individuals without any real experience are the individuals who get taken all the time. Even in the instances where you do have investment attorneys working with you, it still does not deter you from being the individual taken by the scam artists of the world .
The most common mistakes I see with investors, have nothing to do with the individuals or the regulations of the partnership agreement. It has to do with the feeling of excitement of being part of a big time deal. The individuals are so anxious to be a part of the project, that they fail to READ and UNDERSTAND the partnership agreement.
The biggest mistake that I see individuals make with partnership agreements are two parts: 1) Not getting their investment attorney involved with putting the terms of the agreement together; and 2) Not having the investment attorney review the partnership agreement before signing. What ends up happening is the investors sign documents not truly understanding what they are signing. While it may look like a money making deal, it is really a money losing, problem creating deal. This creates distrust between the investors and either the terms of the agreement, if they do not understand the terms. In many instances, it creates distrust between the investors and the investment attorney, who the individuals then blame for steering them incorrectly.
One of the most under rated portions of an overall successful partnership investment deal, is the written agreement. The written agreement is truly the friend of the investor and the investment attorney, because without it, the partners really do not have any recourse if things go wrong. But, having the correct attorney help put the agreement together is paramount to having the correct attorney review it before the deal is signed.
Creating a Solid Agreement
1. Do your due diligence. Take the time to get to know your partner, both in a personal sense and in terms of their business background and reputation. While it’s not required to have a formal "partnership" or "joint venture" agreement in place when buying and selling investment property, it is necessary to have a strong relationship with your partner before entering into a deal with them. This relationship will make the process of drafting a contract much easier.
2. Use a standard format template and customize it to the needs of your partnership. This is what we found to be the most cost effective method for preparing a written agreement for a real estate investment partnership. The template should include standard language regarding the following key components of any partnership agreement: One of the most important things to keep in mind is that language can be broken down into either covenants or conditions. If a covenated provision is broken, there will be no forfeiture. So if you wanted the required provision to trigger the forfeiture clause, then the provision must have been a condition and not a covenant.
Utilizing Legal Counsel
When forming a real estate investment partnership, the role of an attorney or other legal advisor is vital to a wise and formalized deal structure. Your legal partner can help you survive an IRS audit and position you to obtain financing for the deal. Legal professionals are also able to draw up your partnership agreement in a way that protects your investment and your individual interests. An attorney or title company can often advise you in the due diligence process to make sure your hard earned money is well spent. If you are purchasing or selling property , you will need a title company or attorney to allow for a seamless transfer of the property to the new owners. In some states it is required to have a real estate attorney involved in real estate transactions, but in all fifty states investors should hire a legal professional to complete a closing.