Introduction

There is a proverb making rounds on the Internet: “if you want to go fast, go alone, if you want to go far, go together.” Despite its dubious origins, there is something to be said about the ability to go far in good company. And since I’m all about going far, it stands to reason that we should discuss partnerships in Real Estate. This topic seems to be of keen interest to my colleagues as well, so let us dwell on it for a little bit.

As always, everything you read here should also be run by a licensed expert to cross-check it.

What is a partnership?

When we talk about partnerships in real estate, we usually mean business partnerships. And a business partnership is a cooperation of two or more parties for the purpose of achieving a continuous business goal.

There are multiple ways to go about this. A joint venture is a contract that binds partners for the duration of a single project. A way to start a continuous cooperation is to start a company.

Why a partnership?

There may be several reasons you would consider making a partnership in real estate.

You want to do more. You want the ability to do things that you would be unable to do on your own. Your ideal property may be just a tad bit out of your reach when you are operating alone. But, with a partner, it might be just right. A partner (or more partners) can help give better guarantees to the lenders.

You want to combine expertise. Maybe you are a financing expert, and your partner is a builder. Both your skillsets are needed for your new development project.

You want to split the risk. In a partnership typically each partner takes on part of the upside, but also part of the downside. In a larger project, it will be hopefully easier to manage the risks and uncertainties around timelines, financing, dealing with unforeseen issues and so on.

You want to learn from someone. You may be curious to try your hand at real estate but are not sure how to start. Perhaps finding a knowledgeable partner who is willing and able to show you the ropes will be what you need to launch a successful career in real estate?

You want to teach someone. You may want to join with friends or family and teach them the ropes. The inverse of the previous point.

It is more fun. Just like any other adventure, it is often more fun to experience your investing journey with a trusted partner.

Why not a partnership?

There are also reasons you might consider not entering a partnership.

You want to keep all control to yourself. While it may not sound charitable, that is actually quite OK in this line of work. There is no price for altruism in this business. If this is something you believe is appropriate for you, then it is what will be.

You do not have an appropriate candidate partner. The worst thing you can do is partner up with someone that you can not work with. While it is true that there are ways to protect yourself you do not want to have uphill battles every day. I am personally wary of getting into business agreements with my family. At the point where your loyalty to the company and your loyalty to people split apart, you can under-serve your business by wanting to accommodate family. Which is great, you are a great human being, but your business may suffer. This is a decision everyone makes for themselves, and there is no magical answer that resolves every scenario.

How a partnership?

The main idea of a partnership is doing things together, for profit, in a way that is also fair towards the partners. While historically there were several ways of achieving this, one partnership vehicle has set itself apart as especially suitable for real estate endeavors.

For real estate purposes, the most often used partnership vehicle is our old friend, a limited liability company (LLC). For this reason, I will limit the discussion below to only LLCs. If your needs go past that, you may be better served by looking at a different blog article.

An LLC is quite versatile, and depending on the partnership needs can serve one of several purposes. You can use an LLC to hold title to a property. You can also use it to operate a property. Sometimes, the best use of the corporate structure is to separate the entity holding title to the property (i.e. one with significant assets) from one that operates the property (which must be adequately capitalized, but does not necessarily hold that much assets).

The logistics of creating an LLC is fairly straightforward. There are a few avenues you can use.

• You can roll your own. It is usually fairly cheap to create your entity yourself. You fill out the necessary form, either online or on paper as the rules may dictate, sign, date and file the forms, and pay the appropriate fees. Fees range from a few tens to a few hundred dollars, depending on the state. If you go this route, you will have to ensure your entity’s compliance yourself. If you are not sure, probably don’t do this.

• You can use a “corporation mill”. This is a company that will do the filing motions for you for a nominal fee, plus the filing fees. They will ensure that your company is compliant at the outset. But from there you are on your own. There are many companies that do this, we used www.corporatedirect.com at some point. I don’t have an opinion which one to choose. I only mention the one we used because it’s very hard to get high quality information about corporation mills using search engines of today. For some reason. The impression I got was that most offer a comparable commodity service. How good a job they do with the documents, is a separate issue.

• Have a lawyer draft the LLC for you. This is by all means the most expensive option. A single LLC setup will cost you around 10 hours of lawyer time, at typical rates of $150 to $300 per hour. The upside is that you will get a bespoke agreement tailored to your own needs, written by a professional who knows what they are doing.

Pros of an LLC for Real Estate

• An LLC is a good way to divide the rights and responsibilities of partners. An LLC must have an operating agreement, which is an enforceable agreement (effectively, a contract) between the partners, that sets forth the rights and responsibilities of each party to the agreement. This document details how contributions, income, expenses and voting power is divided between partners. While the simplest agreement is roughly “split everything equally”, LLCs support other arrangements as well. Once you get to a point where you think splitting equally isn’t for you, you probably need to hire an expert to figure out your specific situation.

• In most states, transferring property in and out of an LLC (while ultimately preserving the ownership interest) is not a taxable event. This means that if you transfer a property into an LLC that you own, you would not normally create an obligation to pay taxes. This is in contrast to corporations, where transfers do trigger taxes. Again, ask an expert to be sure. Also note that this does not mean you necessarily pay no tax. There are states, such as Florida, where any real estate transfer is subject to certain taxes.

• LLCs shield the participants from liability, and limit their liability, in some specific cases. Typically, if a dispute arises with a third party in the course of regular LLC business, officers are typically not held personally responsible. But IANAL, and in reality the answer to whether your particular situation is like this is “it depends”. Ask an expert to be sure.

Cons of an LLC for Real Estate

• LLCs cost money to own. There is a certain minimum amount of money needed to keep the LLC in good standing.

• LLCs must be operated properly to reap the benefits of LLCs. This means that you must have things like a registered agent, you must be registered in states you are doing business in, you must have a bank account etc.

• It might be overhead for a small operation. You could operate a real estate endeavor without one. Don’t let not having an entity deter you from trying your hand at doing a business. In the end, all of this is a tradeoff, determine where this tradeoff is for you, and act accordingly.

Myths about LLCs

These are misconceptions that I’ve heard from people who were asking questions about LLCs.

• LLCs are hard to get loans for. This is not true. It is true that LLCs can not use conventional residential loans. These are loans made with the intention of selling them to FNMA and FHLMC. The reason is that FNMA and FHLMC don’t allow LLCs to be borrowers on such loans, so any loan originators that intend to sell these loans (most do) have to conform to the specific lending guidelines which forbid LLCs on the title. However, there are many other loan products out there, including from FNMA and FHLMC that are available to LLCs. In addition, many private lenders are quite comfortable lending on a solid business plan to an LLC.

• You need an LLC for 2 or more years in order to get a loan. Many lenders are happy to lend to a “startup” LLC. Some projects even require a startup LLC to hold title to a property and take on debt. If your lender of choice does not support LLCs, find a lender that does.

• LLCs shield from any sort of liability. This is not true. LLCs may shield you from liability arising from regular operation of the LLCs. If the liability for example contains a criminal element, all bets are off. Talk to a lawyer to be sure.

• LLCs preserve anonymity. This is kind of true, but not really. There are specific circumstances in which this is true. Unfortunately, due to the way business is conducted in real estate, these circumstances rarely come about. If you always buy cash, you can remain anonymous as it might be possible for you never to have to sign documents that end up in public record. However, if you take out loans, you will need to sign, with your own name, documents that will eventually make it into public record, thus destroying your anonymity.

• You must have an LLC to own or operate real estate. This is not true. Many people own and operate as sole proprietors, and see LLCs as a distraction. While I don’t necessarily agree with this standpoint, it’s a valid standpoint to have, and based on your outlook and risk tolerance you may opt for, or against LLCs.

• There are particular states where you should have your LLCs. Well, not really, the answer is “it depends”. It depends on the goal you have for starting an LLC.

• You should create an LLC in the state where you live. This is not necessarily the case, and again “it depends”.

Where a partnership?

In the USA, corporations are regulated by states. This means that in order to start a corporation (but also other entities such as LLCs) you must decide which state to create the entity in.

There are some general guidelines that help you select. Sometimes a single state does not check all the boxes. Sometimes, the best approach is to have multiple LLCs with well defined relationships. Here are the tradeoffs you want to consider, for an LLC that should hold title to the property:

• Property location. Your LLC does not need to be domiciled (created) in the state where the property is in. However, it must be somehow registered. This means either domiciled in that state or registered as a foreign entity. This allows the company to do business in the state where the property is located. It allows the company to turn to the state to protect its interests, such as in the case of evictions. (An LLC can’t evict someone from a property if the LLC is not registered in the state the property is located in.)

• State laws. Different states have different regulations. Typically, smaller states are more business friendly. Larger states, not so much. California is rather egregious in this respect, and has many ways to reel an entrepreneur in into paying up.

• Holding cost. If you must register your company in more than a single state, you will need to do more work to keep the company in good standing, and potentially have more fees to pay to keep the property up. I think that for a profitable business, the fees should not be a problem. If the fees significantly bite into your revenue, perhaps you need a more profitable business model?

• Taxation. Two states - double the tax reporting obligation. But, crucially, not necessarily double the taxation. States usually apportion the amounts they tax, so you may end up paying less taxes if you need to report to the correct two states, than if you were to report only to one of them. Ask your CPA for details.

• Anonymity. Some states don’t require reporting the names of members and officers of the company. Wyoming is notorious for this regulation. This means that if you prefer not to have your name appear in public record you may be able to achieve this using a WY LLC. This approach has proven to be quite rickety in my experience, so I’m not sure if this is a real benefit to a typical real estate investor.

• Charging order protections. States such as Wyoming or Delaware have strong protections for LLC members with respect to judgments awarded to outside creditors. This means Wyoming or Delaware law allows the LLC members to choose how they will go about paying any judgments - up to and including not doing so at all in some cases. Let’s hope that (1) you don’t get into a situation where this matters to you; and (2) in case you do, that you have a good lawyer on retainer.

• Incidental logistics. It takes 2 days to create a company in Wyoming. It takes up to 6 weeks to do the same in Florida. Sometimes, you may be forced to create a company in Wyoming for a deal in Florida, just for expediency. Nobody is going to wait for your company to be created for 6 weeks. (You will need to register the company as a foreign entity in Florida in addition to registering in the home state of Wyoming.)

When a partnership?

Here are some scenarios in which you might consider using a corporate entity in real estate.

You want to separate the business from your person. While not a requirement, sometimes it’s a good practice to do this. Some states will offer fewer protections to single-member entities, vs. entities with multiple partners.

You have one or more partners. This is the best reason to have an entity in my opinion. The entity allows you to predefine what to do in certain situations in a well-written Operating Agreement.

You want to do large projects. Large projects sometimes require single purpose entities to hold title to large properties.

You want to manage multiple properties centrally. You could have a management entity operating your properties. However, you must keep local regulation in mind. Most localities require that managing 3rd party properties is done by licensed professionals.

Wherefore a partnership?

Instead of a conclusion, I want to note that the above document does not necessarily contain answers. It does, however, contain concerns and questions, which you could use as a conversation starter with a corporate lawyer who would be able to coach you, and offer actual good advice.

I hope this helps you on your way. Let me know what you think, send me an email by clicking a link at the bottom of this page.