Playing Well With Others: What Investors Should Understand Before Joining Forces

By Charles P. Castellon, Esq.

Both experienced and new real estate investors can benefit from forming alliances to work together in deals. This article will highlight some of the most important issues investors should consider before joining up to make money.

The first question to consider is why investors should work together in the first place. The power of leveraging is the first thing that comes to mind. Investors can unite to share in or contribute to, the risks, work, capital, rewards, knowledge, experience and leads, among other things. Spreading the risks of a deal is often called “hedging.” Sharing the rewards can be a great way to minimize the impact of the many bad things that can happen to an individual investor working alone.

There are some important issues any potential partners should discuss before entering a deal. One consideration involves the capital contributions each team member will make. Who will put up cash to buy the property? Investors can lend money to each other or their company, buy a share of the property or company that owns it or any combination of these options.

Someone can offer his or her credit to qualify for financing. This can be a dangerous idea, the impact of which is often under-estimated. When family and close friends decide to do business, one partner can contribute a good credit rating to for the loan application. Investors should understand there is no such thing as being “just a co-signor.” Whoever signs a promissory note is personally liable and puts personal assets and that excellent credit rating at risk if the deal fails and the debt isn’t paid.

Another important contribution is the work or “sweat equity” put into improving a property. This is where having a partner who is a contractor otherwise experienced in renovations can be gold. It’s often more difficult to find good deals than finance them. This can make the person who finds the deal a valuable contributor entitled to a piece of the action for generating the lead. Everyone needs a good bird-dog.

Another issue to consider beyond contributions is how the alliance will be structured. There is a broad array of available options but this article will focus on three of the most common choices. The first is to join together by forming a corporate entity such as a limited liability company. LLCs are popular with investors for reasons including the ease of use, flexibility and versatility. Less corporate formalities are needed compared to other types of companies. Very importantly, it’s challenging for a creditor to pierce an LLC to pursue corporate assets to satisfy the personal obligations of an LLC member. A carefully-written operating agreement should clearly spell out all the duties and obligations of the company’s members.

In Florida, a strange legal outcome that may result is the creditor getting a kind of lien, or “charging order” against the LLC without the ability to force distributions of assets. In some cases, the creditor can end up receiving a tax liability for the profits of the company without reaping any benefits.

There are downsides to using an LLC, including expenses from keeping the company’s books, state government fees and preparing tax returns. Overall, if the members want the equivalent of a business “marriage,” and expect to do more deals together, an LLC would likely work well. If a lesser commitment anticipating a one-shot deal is desired, there are alternatives.

A Florida land trust is one such alternative. Land trusts remain very popular among investors for many reasons. The benefits include the privacy that comes from keeping the true parties in control of the property—the “beneficiaries,” out of the public records. A land trust can also help prevent liens such as those resulting from code enforcement violations from infecting other properties the investors own. Another nice benefit is that beneficiaries don’t legally own the real estate. The beneficial interest in a land trust is generally personal property that can be easily sold from one beneficiary to another without transferring title to the property, which is legally held by the trustee. This benefit can help avoid a “partition” lawsuit that would force a sale resulting from a dispute where co-owners disagree on what to do with the property. There are many other benefits to using land trusts.

A third option that would be most appropriate for collaborating on a single deal instead of ongoing business is a joint venture. A joint venture agreement is created to describe the parties’ contributions and duties as well as their returns and respective shares of the risks. The joint venture agreement serves a similar role as the operating agreement for an LLC.

There are numerous considerations to be discussed before entering a JV agreement, or for that matter, any of the other alliances described here. They include but are not limited to, business objectives and goals, the structure of the JV, the respective contributions and duties of the parties, how profits losses and liabilities are to be shared and management or control of the venture.

This is a basic overview of the issues associated with investors doing business together. Before entering into any entangling arrangement, it would be wise to seek expert legal and tax advice. As the carpenter says, “measure twice, cut once.”