Partnership Paradigm: Part 3 – Where It Ended Up
The Year 2020 brought mayhem to the world and touched every aspect of life from supply chains to real estate to employment. With the concern of COVID impacting renters, many short-term rental activities ground to a halt. New cleaning protocols, masks, hand sanitizer and toilet paper mania rocked everyday life.
Our partners approached us about ending our partnership early in 2020. The results of our investment were becoming clearer as time passed. Our partners’ projections for revenue were off by nearly 30 percent. Projected expenses were on par from a cost perspective, but ate about 67 percent of our revenues, instead of the projected 50 percent.
It mean a smaller share of profits to split in our 70/30 arrangement. Our partners were not making a lot of money from this investment for the time they were putting in. We understood why they wanted out.
Per our operating agreement, the guidelines and responsibilities of our partnership, they had to request the dissolution as only Chad and I had the power to trigger it.
The operating agreement stipulated that upon ending our partnership, the loan on the property had to be paid off first, and then the remainder would be divided 70% to us and 30% to our partners. They were also our real estate agent and could earn a commission on the sale.
Road to Sale
The first step toward selling our investment was converting it from a short-term rental to a medium-term rental. The short-term rental demand halted with the COVID lockdown and our partners were able to rent the properties to traveling professionals. This helped keep our finances in the black, or close to it.
Then it was time to look at the numbers. In 2018, we purchased the property for $470,000. The new valuation was anticipated to be around $520,000. Chad started plugging in costs for taxes, realtor fees, closing costs, loan payoff etc. We worked backward to see what sale price we needed to cover what we and our partners hoped to gain from divesting the property.
After the loan was paid, then we could look at how to divide whatever was left. Our partners wanted their initial investment paid back: $14,000. We also wanted our initial investment back – the down payment of $123,000.
If our partners received their $14K back from the sale AND received a commission, they would make more than 100% return on their investment, in addition to profits earned from our two years of ownership.
|Closing Costs||$ 12,000|
|Real Estate Agents’ Fees (split between buyer and seller agents)||$ 32,000|
|Partner Investment||$ 14,000|
|MINIMUM SALE PRICE||$528,500|
Given the shaky conditions of the economy, Chad and I worried what the sale of this rental would yield. The property was unique in that it was zoned as an R-2. It was legally two homes on one property. The main house had two bedrooms and one bathroom. The unit above the detached garage was two bedrooms and two baths. It did not have the appeal for typical first-time home buyers given the price point and the size of the buildings. This fact narrowed the pool of potential buyers. We also worried that investors may be too scared to take on our property with COVID’s uncertain impacts still looming.
Was $528,500 a tall order? Homes were selling at crazy prices and we weren’t sure we could realize 13 percent appreciation given the property’s unique features.
Our plans to sell the property and dissolve our partnership needed to be memorialized in a dissolution agreement. This would be an amendment to our contract that would make it no longer binding once certain terms were met. The negotiations began and the lawyers were cued.
The first item was our partners’ commission. They wanted out of the property so we felt they should drop their commission fee. They would keep the furniture (or sell it) as they wished.
Our partners agreed and asked to include a provision that if the furniture was sold with the property, that a separate bill of sale would be paid directly to them. We approved and countered with including that we would be reimbursed for any legal fees required to create the dissolution agreement. The cost for this item was a few thousand dollars.
Lastly, Chad’s accounting audit found that our partners owed about $5,000 to the business, which would be deducted from any profits they would receive after the above items listed were paid off. Then any funds left in the company bank account would also be split 70/30.
Our dissolution agreement included a minimum price we could agree to sell the property: $528,000. Taxes would be paid by each side of the partnership and outside of profits.
|Buyer agent Fee||-$15,840|
The order of disbursement was as follows:
|Profit from Sale||$189,840|
|Our Investment Pay Back||-$123,000|
|Profits Remaining to Split||$66,840|
The profit would allow both sides of our partnership to get their investment back and additional earnings on top of it.
The rental was put on the market in the Fall of 2020 and we had several offers prior to the open house. Our property actually sold for $540,000, with the difference ($12,000) going to our partners for the separate bill of sale for the furniture currently in the rentals. We received our investment back and earned additional profit, thanks to the rampant appreciation.
After the closing, the last items were to 1) reconcile and divide the remainder of the business funds and 2) file our last year of taxes. It took almost another six months to wrap up the dissolution.
From the sale alone, we received 100% of our investment back, plus the profit from appreciation. The return on investment on each side looked something like this:
ROI= [ ($123,000 + $46,788) / $123,000] x 100% = 138%
Our Partners’ Returns
ROI = [ ($14,000 + $12,000 + $15,052) / $14,000] x 100% = 293%
This calculation does not include any profits made during the operation of the property, but as you can see, we all made money. On the one hand, I feel that we were very lucky, given the uncertainty of COVID and the unfolding pandemic. The rising appreciation rates were one of the only benefits to the long list of horrors caused by COVID.
Real estate operates in a market, which means it’s subject to ups and downs. If COVID caused a recession, the results of our sale would have been very different (think 2008) or perhaps we would still be in the partnership, waiting for the market to change. In real estate investing, timing is a large piece of the puzzle to making or losing money.
We also chose a market (Colorado Springs) that continues to grow, appreciate and show resilience in times of economic uncertainty. If you want to learn more about how to pick a real estate market, check out the post on why we picked Oklahoma City. I’ll talk more about how to choose where to invest in a future post.
We created and now ended a partnership. If we ever do another, we have a lot of lessons learned to look back on.
- Learn all you can about your partners and how they perform work planned on their side of responsibilities
- Make sure the agreement divides up the risk equally
- As mentioned in Part 1, we should have activated equity AFTER we got our down payment back (whether from the sale or from profits earned) or let it happen more on a graduated scale.
- Know what motivates your partners, which will help keep them on task. This can be tricky, but it never hurts to ask.
- One item that may have helped was to publicly document the progress on a local real estate group or on forums. This could have inspired our partners to better respond to our questions about accounting since they are active and their other real estate business depends on their reputation.
While we don’t plan on doing a partnership again, we have our “lessons learned” physically filed with our business documents. If it makes sense in the future, we will have a stronger checklist to vet our partners, better stipulations for creating an operating agreement and standards for bookkeeping.
Would you do a partnership? Share your thoughts below or e-mail [email protected]