Partnership Paradigm: Part 1 – Pairing Up
This is a three-part series documenting the creation, maintenance and ending of a partnership we had for our first real estate investment.
Our decision to start investing in real estate transpired after a few years of deliberation, starting in 2015. We paid down a bunch of debt, got married and were planning what we wanted our life to look like. Chad found BiggerPockets. We tossed around a few ideas about potential areas where we would invest. During that time, we also decided to move to Denver, CO.
With our move on the horizon, Chad and I postponed any investing until we settled into our new state. We expected the Colorado market to be significantly cheaper than New York. Our first real estate purchase as a couple was going to be our primary residence. We wanted to start our family and lay our roots. Chad found a real estate broker who set us up with an agent. We had met the agent briefly when we visited Denver in September 2016. Back then, we almost pulled the trigger on a two-family in Golden. We expected to buy it as a live-in flip and then got cold feet.
The agent we worked with also helped us find a short-term rental (STR) to bridge our living situation until we found a house. He and his wife owned one of the apartments that we considered and we wound up renting it. We lived there for three months before we closed on our new home.
The agent and his wife owned several STRs that they typically rented to traveling nurses. They were active on BiggerPockets forums and had made a name for themselves as being STR or AirBNB experts. They also both had their real estate licenses, but were still working their W2 jobs and looking to transition out.
After closing on our home, Chad and I revisited our real estate investment strategies. Chad came up with a plan to approach our agent and his wife about a partnership: we would put up the cash for an STR purchase and they would manage the property. We felt we could capitalize on their experience and tenant pipeline while we took on the financial risk. From our perspective, we thought this arrangement would be mutually beneficial. However, there are many pros and cons to consider when forming a partnership.
We had a few conversations with them about the arrangement and they agreed. Chad searched for a lawyer to help us draw up an operating agreement. He took the lead on this and came up with the following stipulations for the partnership. It included:
- We would put up the funds to purchase a property and have the mortgage in our name
- Our partners would manage the property and be responsible for placing tenants, maintenance, accounting, etc. This included furnishing the rental
- We would split the profits and equity where we would get 70% and our partners would get 30%. The split would go to 50/50 once we were paid back our down payment on the investment. We put down around $123,000
- We would create a limited liability corporation specifically for our partnership
Once the agreement was in place, our partners began looking for properties. One was originally from Colorado Springs and had a family member who was renting single family homes successfully. We agreed to look for investments in this market and planned to visit some properties while checking out some target neighborhoods.
Our partners found a potential investment that was actually two homes on one property. The lot was zoned R-2, which meant the lot could have two residences on it legally. It was close to Colorado College, the Olympic Training Center, a hospital and close to nearby skiing and hiking attractions. It had huge potential for a range of tenants from parents visiting their kids at school to traveling nurses to tourists.
Our partners’ deal analysis projected the property would generate approximately $78,000 a year in revenue with half of that being profit.
The property was a turnkey, meaning it had been recently flipped so no work was needed to update it. Generally, investors look for real estate that has potential to add value to allow built-in equity. And if a property requires improvements, it can usually be purchased as a better deal. Our partners had worked with a client to buy this investment, but the deal ultimately fell through. We didn’t get many details as to the cause of the breakdown, which could have been a huge red flag. We made an offer anyway, which was rejected and we decided that it wasn’t meant to be.
A few months later, the property was still on the market so we made another offer. The owner was hesitant. He told our partners he needed to get the full asking price to break even or make the sale worth it. We asked the owner to concede $5,000, which wouldn’t really change our mortgage much, but it was more about the principle since the place was just sitting on the market.
We agreed to pay $470,000 . The mortgage was in Chad’s name and we did a quick claim deed to transfer the property’s ownership to our partnership’s limited liability corporation (LLC). Our partners received commission for the sale.
We were ready to start raking in the money.
We made this a really sweet deal for our partners as we took on all the risk by putting up the cash and taking on the mortgage. We should have:
- Activated equity for our partners AFTER we got our down payment repaid
- Negotiated an even lower price since the property was listed for so long
- Asked more questions about the deal with previous buyers falling through
Regardless of your skill with investing, it’s critical to ask questions and expect answers. While there are many unknowns when it comes to purchasing real estate regarding the actual property itself, it is an real estate agent’s job to help inform you about the process and answer any questions you have whether it be about the agent’s understanding of a seller’s motivation, thoughts on the suggested price and negotiation tactics . The most important thing is that YOU have to ask.
What would you do differently if you were in our situation? Share your thoughts below or e-mail [email protected]