How to Legally Protect Yourself in a Real Estate Partnership
Guest Written by Richelle Ouellette
Investing in real estate with a partner (or multiple partners) is a great way to get into the game as a newbie. It allows you access to people with resources you don’t have, such as a capital, or experience, and can open doors (pun intended) to opportunities you might not be able to tackle on your own.
A common mutually beneficial partnership might look something like:
Partner A: Deal finder - the person who usually has less experience and capital to invest into a deal, but who might be able to make up for that lack with hustle. Knocking doors, researching and analyzing deals, putting together necessary paperwork, providing sweat equity for repairs that need to be made, etc.
Partner B: Cash provider - the person who is funding a deal, whether as a cash or credit partner. They are the ones coming up with the money to make the deal happen, and they may or may not have experience investing in or developing real estate projects.
Very often, real estate investment partnerships look like some combination of two (or more!) people with percentage ownership and equity and profit sharing varying according to the specific scenario and who brings what to the table. Together, you can decide what split makes the most sense.
No matter the terms of your partnership, it is extremely important to legally protect yourself in any arrangement. Occasionally, people overlook this step, assuming things will work out with a business deal because of existing trust, or because partners are family members or friends.
Recently, attorney Lori Daves shared some tips with attendees of the Open House Women Investor group on how to make sure you CYA (my words, not hers) when entering a transaction within a partnership. Here is an overview of what we learned.
Tip 1: Form an LLC
If you have any equity in an investment property, it is highly encouraged to form a Limited Liability Company and transfer title to the property from individual owners to the LLC.
By transferring ownership to a legal entity such an LLC, you can limit your personal liability if anything were to happen on or related to the property that results in a lawsuit against the property owner.
For example, let’s say one of your renters slips and falls down the stairs at your property and decides to sue you, the owner, for something they determine was unsafe conditions. (Crazier things have happened!) If the title is deeded to an LLC, all of your other personal assets, businesses, or other real estate are protected. If the tenant wins the lawsuit, reparations can be paid from assets owned by the LLC (equity from the house in question, any funds in the LLC’s bank account), but your personal residence, other rental properties, car, retirement funds, etc. remain protected.
In order to form an LLC, follow the simple filing requirements in your state (requirements vary state by state) and then check in with your county tax office to see what they require to transfer title.
If you have a mortgage on the property, make sure to double check with your lender’s policy as some banks have a “due on sale” clause meaning changing ownership may make the balance of your mortgage due immediately — not an ideal scenario for most! Your lender will likely allow you to transfer the property to an LLC as long as you continue paying the mortgage, but you’ll definitely want to make sure you’re not breaking or missing any rules.
If the steps are confusing, you can always have a lawyer help with this process!
Tip 2: Don’t put too many assets in one LLC
Placing multiple properties in a single LLC dilutes the power of protection an LLC offers. If you know you will be purchasing several investment properties, it may be a good idea to consider a Series Limited Liability Company or SLLC. This structure is very similar to a standard LLC, but provides insulation across multiple “series” - each being protected from the others.
So, in the same scenario described above if property A belongs to Series A and is involved in a lawsuit, property B in Series B and property C in series C will be protected assets, and so on and so forth.
One of the main benefits of a Series LLC is saving on the expense and time required to form separate LLCs for each investment property. Forming a new Series under an SLLC is a much easier and cheaper process — you can do it on your own or with a lawyer’s assistance.
Tip 3: Determine who will be active and who will be silent partners
In any legal entity - LLC, joint venture, partnership, etc. — some members are active participants with voting rights while others may be silent owners, with rights to shares of the company and its profits, but no legal authorization to make major decisions related to the business.
Be sure to consider which members have which rights, and consider how shares will be divvied among members on a percentage basis, and when. Will there be annual distributions? Will funds be held in an account until sale?
The terms of your agreement depend entirely on the investment type (is it a fix-flip or buy-hold, single or multi-family, are there two partners or ten?, etc.) so we recommend seeking legal advice to create and sign formation documents including an operating agreement with all persons involved in an investment deal or partnership.
There are lots of factors to consider when starting a partnership, and these tips are just a starting point of things you should be thinking about when entering any type of real estate investment project — short- or long-term — to make sure you cover your ass…ets. Best case scenario, your properties stay insulated in an LLC and never face a lawsuit, your partnerships progress greatly and you agree on everything and never even have a need to revisit your operating agreement, but worst case scenarios happen, and no matter the situation you’ll want to make sure you and your personal belongings are legally protected to minimize impact.
Taking the steps and spending the money to form an LLC and draft an operating agreement may feel like extra work and a bit expensive at the front end of a deal, but when you consider the cost in relation to the value of your assets, the price is minimal and the protection it can offer is priceless.
