By William Bronchick, ESQ.
If you are low on cash or have cash and are low on time, a partnership or equity-sharing arrangement may be for you. Using partners to finance real estate transaction is the classic form of using “OPM” (other people’s money). Experienced investors are always willing to put up money to be a partner in a profitable real estate transaction. As with many businesses, talent is more important than cash; if you can find a good real estate deal, the money will find its way to you!
Partnership arrangements work in a variety of circumstances. The most common scenario involves one party living in the property while the other does not. Another scenario may involve all of the parties live in the property. These arrangements are common among family members. Parents often lend their children money for a down payment on a house, with a promise of repayment at a later date. If the repayment of the debt is with interest and/or relates to the future appreciation of the property, we have a basic equity-sharing arrangement.
Another common financing arrangement between multiple parties is a partnership wherein none of the parties live in the property. Larger investments in limited partnerships and LLCs are “pools” of money that are known as “syndications.” These investments are generally classified as securities, so compliance with state and federal regulations is complex. Thus, syndications are generally not recommended for financing smaller projects, since the legal fees for compliance with securities law will far exceed the benefit of raising capital through multiple investors.
BASIC EQUITY SHARING ARRANGEMENT
The common equity sharing arrangement involves one party living in the property and the other putting up cash and/or financing. Both the occupant and the non-occupant enjoy tax benefits and share the profit, as described later in this chapter. First-time homebuyers make the best resident partners while family members, sellers, and real estate investors fill the non-resident partner role.
Scenario #1: Buyer with credit, no cash
A lot of potential homebuyers have the income to qualify for a mortgage loan, but only with a substantial down payment. With a small down payment, the monthly loan payments may be too high. A potential homebuyer could borrow the money for the down payment, but nobody but a fool (or a parent) would lend $25,000 or more unsecured. Furthermore, loan regulations generally do not permit the use of borrowed money as a down payment.
An equity-sharing partner could put up the money in exchange for an interest in the property. The resident partner would obtain the loan, live in the property, make the monthly loan payments, and maintain the property. The nonresident partner that puts up the down-payment money is free from management headaches and negative cash flow. After a number of years (typically five to seven), the property is sold, the mortgage loan balance is paid in full, and the profits are split between the parties. Obviously, the strategy works best in a rising real estate market.
Scenario #2: Buyer with cash, no credit
The second equity-sharing scenario would be a buyer with cash, but an inability to qualify for institutional financing. The resident partner would put up the down payment, the nonresident partner would obtain the loan. After a number of years, the property is sold, the mortgage loan balance is paid in full, and the profits are split between the parties.
YOUR CREDIT IS WORTH MORE THAN CASH
Just because you put up credit and no cash, this does not mean you aren’t at risk. Cash is easy to come by, but good credit takes years to build, and only months to ruin. As I write this book, an investor friend of mine (we’ll call him “Brian”) recalls his first deal. Brian was a neophyte investor that was approached by an experienced investor with the following proposal: “you put up your credit to get the loan, I’ll put up the cash for the down payment.” Brian bought the property with the investor in this manner, but Brian did not manage the property. Brian received a call from the lender a year later and was informed that the mortgage loan had not been paid in several months. Brian was unable to locate his partner who had apparently collected the rents and skipped town. The moral of this story is, use your credit wisely – cash can be recouped in a few months, but credit blemishes can take years to fix. Obviously a good knowledge of how creative financing works will help your success rate in capturing deals. It’s not a bad idea to have an attorney that is versed in both partnership arrangements and real estate in your corner to take a final look at the deal and the associated paperwork.
A joint ownership arrangement can be problematic if the resident does not maintain the property or make the mortgage, insurance or property taxes payments. Furthermore, the property may not go up in value, so the nonresident party who put up his credit or cash may not realize any profits. Like any real estate investment, the shared equity arrangement should be approached with profit, not just financing in mind. In other words, make sure you buy the property at a good price and/or in the right neighborhood at the right time.