Second homes and investment properties fascinate investors, who turn to Inman’s weekly Property Portfolio email newsletter as well as agents who work with this special class of client. This month, we’ll go deeper on everything from the latest at Airbnb and Vrbo to the changes investors are making to their portfolios in a shifting real estate market.
With interest rates at historic lows during the pandemic, many new investors rushed into the real estate market to snap up a wide variety of properties. As rates begin to climb back up, those same investors (and others looking to diversify their portfolio) may be considering adding more properties but are unable to afford such investments on their own.
The solution? Finding a partner to invest with.
Investing in real estate with a partner can be extremely appealing and comes with many advantages. However, there are also some potential pitfalls. Here are seven pros and cons to consider before taking on a real estate investing partner.
Types of partners
As with all relationships, not every real estate partnership is created equal. There are two main types.
- 50-50: Each partner invests time and money evenly, and they split the profits evenly. This seems like the ideal, but in reality, few beginning real estate investing partners come into the relationship with matching skills and equity.
- Traditional equity plus sweat equity: More often than not, one partner has the desire and skills to invest in real estate but lacks the financial capability. In this type of partnership, a formalized agreement lays out the exact way in which these two types of equity are fairly balanced so that everyone feels their contribution is equal.
4 pros of having a real estate investing partner
Pro: Financial assistance
If you find yourself looking for the funds to match your enthusiasm and sweat equity, this is the main perk of having a real estate investing partner. This financial boost makes it possible for people who otherwise would not have opportunities in real estate to get into the market and to start building wealth.
Pro: Less risk
Any type of investment comes with a certain level of risk. Investing with a partner means that risk is shared. Partnerships can also reduce certain types of expenses when the time comes for selling the investment property.
Pro: More expertise
If you enter the partnership with extensive experience in electrical or plumbing work, you might be comfortable rehabbing an as-is or foreclosed property — but you may not know exactly how to acquire that property. You might need help figuring out if the property you are considering is truly worth it and might want another person’s insight when navigating the actual purchase process. Adding a partner essentially doubles the skills you bring to the table.
Pro: Offloading unwanted tasks
If your expertise lies in spotting great investment opportunities, but you prefer to be more hands-off, finding a real estate investment partner who handles the day-to-day operations is critical. A trusted on-site manager can give you much-needed peace of mind.
3 cons of a real estate investing partnership
Con: Damaged relationships
This is potentially the largest risk of real estate investing partnerships. It’s also the reason it’s not recommended that you go into business with close friends or relatives. Many people overestimate their ability to contribute capital and time to investment projects.
This could result in goals not being met and tasks going unfinished. If you are rehabbing an investment, that added stress is going to make it harder to run a smooth operation in the long run.
You can protect your professional relationships by having a clear legal document that explicitly states the duties, rights and responsibilities of both partners, but it’s still no guarantee the partnership will survive conflict.
Con: Underestimating the capital required
There is no guarantee that your investment will stay under budget. Material costs rise, labor shortages require higher wages, and unforeseen expenses often pop up. If this happens, and you are responsible for the capital side of the investment, a lack of adequate contingency planning can undermine your investment.
If you and your partner are working on a rehab to rent, with an eye to refinance for more cash for another property (colloquially known as the BRRRR method), make sure to add at least 10 percent to 15 percent to your estimate for costs. This can help you respond to surprises that might otherwise derail your investment strategy.
Con: Decision-making is shared
Although this could also be listed as a pro, for many people used to going their own way shared decision-making is a challenge. You cannot unilaterally decide to make changes to the property or to put a bid on a location you haven’t discussed with your partner.
Think of it this way: If you assume sole responsibility for a decision, you are also solely responsible if it fails. Make regular meetings a practice with your investing partner to discuss important decisions.
What to look for in a real estate investing partner
When choosing a real estate investing partner, it makes sense to take your time. Your best friend or a close relative may not be the optimal choice — it’s a business partnership that should include a balance of expertise and similar investment goals, not a favor to a family member.
Consider partners who:
- Have a special skill you don’t have, such as finding unlisted properties
- Bring a solid financial foundation to the table (good credit, cash for closing costs, etc.
- Can take the lead on daily operations and repairs or rehab
- Are able to take on their share of the partnership
Protect your investment: Put it in writing
Gone are the days when a handshake deal was enough to ensure that everyone got what they signed up for. Formalize your real estate investing partnership with a legal document that outlines each partner’s rights and responsibilities.
Make sure it’s clear what each person is responsible for, practically and financially. Have this agreement in place before you sign any closing documents.
This type of agreement also outlines who is responsible for what costs when it comes time to liquidate your investments. For example, the average cost to sell a house in the U.S. is just under $34,000. You’ll want to know how those expenses are split up before it’s time to sell.
Weighing the pros and cons
Ultimately, using real estate investment properties to diversify your portfolio is just one way to build wealth. Just as you would research potential properties before purchase, take ample time to weigh the pros and cons of taking on a real estate investing partner.