Investing in real estate is a goal for many Americans, and that goal has become more
pronounced since reality television became a thing and HGTV jumped on the
bandwagon. How many times have you watched a fix-and-flip or home investment
show on television and thought to yourself,” Doesn’t look too hard — I bet I could do
that!”
Of course, like all reality television, home improvement and home flipping shows don't
tell the whole story. And savvy would-be investors realize this, which is why a new and
growing trend has been emerging in the real estate market: Aspiring or existing
homeowners who want to team up with friends to buy an investment property, either to
fix up and flip or to rent out, sometimes spanning several states.
If this concept has crossed your mind and you’re intrigued enough to learn more, then
keep reading — there’s a lot you need to know about investing with a friend before you
take the plunge and actually do it.
Real estate investing with friends can be done if you approach it the right way
Some experts might tell you not to even consider investing with a friend. It’s too risky,
you could destroy the relationship, investing alone is challenging enough … pick your
argument, and someone is making it.
But those experts are ignoring one important fact: There are people right now who are
investing in properties with their buddies and making it work and work well, for
everyone. The level of participation to date is too low to really call it a trend, but there
are plenty of people who work in markets where the income is relatively high, yet
they’re not aspiring to own a home for themselves because homes are simply out of
their reach.
San Francisco is an excellent example. Wages in the market are higher than almost
anywhere else in the country, but when home prices are in the seven digits for a basic
starter home (and they are), then that high income really doesn’t help you unless it’s at
the very top level and you’re able to pay for a down payment, property taxes
(remember, the deduction for mortgage interest just went down significantly for
properties in this value range), and other basics, let alone fixing the place up until it
shines.
As a result, groups of friends in areas like San Francisco are pooling their money and
buying up homes in areas with lower home prices, such as in the Midwest or the
Southeast. Of course, not everybody is following the same path, but there’s enough
interest in this kind of deal to make it very appealing to certain types of people.
So beware of the advice coming from experts in your neck of the woods if they’ve never
heard of this kind of arrangement. It might not be all that common, and maybe they
haven’t encountered it before, but it’s definitely happening — and there’s no reason
why you can’t participate, too, with the right mindset and a good friend or group of
friends to help.
Do you have the same goals for the investment home?
To make a deal like this work, everyone involved needs to be on the same page when it
comes to goals and expectations. Perhaps you’d make more money sooner on a fix-
and-flip deal, but if you don’t have a solid point person in the area who can manage the
contractors and permits for you, then it’s probably much wiser to think about a buy-
and-hold strategy, where you purchase a home, make a few tweaks to get it rental-
market-ready, then rent it out.
Of course, deciding on your strategy is just one piece of a vast puzzle. How long will
you keep the home if you’re renting it out? Will you consider lease options for renters,
where you offer them the chance to buy the house from you after a period of time has
passed, or are you only interested in monthly rentals? What about a vacation rental —
will you list the house on Airbnb or VRBO and achieve your return on investment that
way?
There is no one perfect answer for any individual, and that lack of a perfect answer can
increase exponentially when you add additional borrowers to the mortgage. It’s really
not enough to say “We want to rent this place out.” You need to think about what kind
of rental you’re creating and behave accordingly.
Your partners’ finances matter — a lot
To set an interest rate for a mortgage loan, lenders spend a lot of time parsing a
borrower’s ability to pay back a loan; they look at everything from current and past
bank statements to tax returns to itemized lists of assets and debts in order to assess
each borrower and set the interest rate.
Do you know if your buddy has overdrawn his account recently? How much money is
your potential partner paying in alimony or child support every month? If your
investment colleague already owns a home, do you happen to know whether she is
current on her payments or whether the loan is “underwater”
The terms of the mortgage, including the mortgage rate, are going to best using
information from every single borrower involved. You may trust your friend beyond all
reason and are perfectly happy to let them watch your dog or even babysit your kids,
but if you don’t have a good answer about whether or not they’re responsible financially
— at least as responsible as you are — then you’ll want to get one before you apply for
a mortgage loan together.
How will you split the profits?
Maybe everyone involved is putting an equal amount toward the down payment and
any repairs that need to be done. And maybe everyone involved is also putting an equal
amount of money effort toward fixing and flipping the home, or toward managing the
renters, so it’s possible that an equal split of both equity and profits are a simple
solution to the issue of “who gets what”
But that’s pretty rare in most group deals, where one borrower might be providing the
bulk of the down payment while another plans on pitching in with their time and energy
more thoroughly. Have a serious discussion about what the expectations are for rental
return, what you plan to do with the profits accrued, and how you plan to split them up.
For example, perhaps it makes sense to open a joint bank account where you can park
the profits from your rental investment, which you can also use to pay the mortgage or
accommodate any expenses from your fix-and-flip or rental project. Contractors who
are fixing up the house will need to be paid — who’s responsible for that, and to what
extent? What if a pipe bursts in the rental or you need to replace a water main?
Keeping some of the profits in a joint account can make a lot of sense, especially if you
expect ongoing expenses from the project.
When there are profits to be paid out and you don’t need to worry about expenses for
whatever reason, then think about what kind of split seems fair. If one party
contributed to most of the down payment for the home, then maybe they should get
more than 50% of the profits until their down payment is paid back. Or maybe they’ll
be happy taking additional equity in the home and will reap a bigger share of profit
when the place is eventually sold. Every group is different, so find a profit-splitting
strategy that works best for yours.
Getting out of the deal could be a problem
Nothing lasts forever and that includes a real estate investment deal. One of you may
be ready to bounce before the others are, so you need to make an exit strategy for
what will happen if you lose a partner or the rest of the group wants to exit gracefully
before you’re really ready to call it quits.
Have another chat with your partners and talk about what kind of timeframe seems
reasonable for the investment. If they only want to be involved in this kind of deal for
12 months or fewer, then perhaps a fix-and-flip strategy is going to work best for your
group — that way there will be no question about what the profit is or could be, and a
year is enough time in most markets to get everything fixed up and sold without a
significant time or budgetary crunch.
But if your group is in it for the long haul, and a rental home seems like a better
investment to you, then you’ll need to talk about what to do if someone wants to take
their money and run. Will the rest of the partners buy them out, or will the house need
to be sold? If the other partners are going to buy out the exiting partner, how will you
determine the buyout amount? Will it be based on the purchase price or the current
value of the house, and how will you figure out what the current value is? How long will
partners have to make a decision about the buyout, and how long will they have to
exchange those funds?
Yes, it’s a little disheartening to talk about how you’re going to break up a partnership
before it even starts … but if you don’t, you could find yourself facing this situation
without a plan at all, and if anything has the potential to kill a relationship, it’s a lack of
a plan when someone wants out.
You might disagree over who’s responsible for what…
Buying the house is never the end of the list of expenses. There are almost always
things you’ll want to go to the house before you sell it again or rent it out, and that’s
especially true if it’s a flip. How far do you want to go to make the house ready to sell
again, and who’s going to pay for what when it comes to fixing it up?
In some ways, a flip can be easier than a buy-and-hold strategy for dividing up
responsibilities. Anyone who owns a rental property can tell you that it’s almost
impossible to anticipate the expenses that emerge, often with no warning. The
plumbing and electrical emergencies can be more expensive than you thought —
especially if the home is occupied; you need to make sure it’s consistently habitable.
But sometimes you might get a special request from a renter, and there are also the
expenses that emerge when the place is empty. If the departing tenant didn’t do a
great job cleaning up, you’ll need to hire a cleaner; you may need a landscaper or
someone to mow the lawn while the house goes back on the rental market; finding and
vetting renters in and of itself can be expensive and time-consuming, too. Are you
going to do credit checks on potential renters? Will you require references from
previous landlords? Will you allow smoking or pets in the house? Even if you forbid
those things, if someone breaks your rules, what's your plan (beyond leveraging a
security deposit) for cleaning up after them?
All of these problems become your problem and your partners’ problem after you
decide to invest in property together. Try to hash out who's responsible for what as
early as possible, and make sure your profit-sharing plan reflects what you’ve decided.
… So it might make sense to hire an experienced flipper or property manager
If none of the group of partners lives in the area where the property is located, then it’s
probably smart to talk about who’s going to manage the place for you in a very boots-
on-the-ground sense. Even if you’re planning on turning it into a full-time vacation
rental, you shouldn’t ignore the local aspect. What will you do if there’s a late-night
emergency with one of your tenants? Or if someone arrives at the vacation rental and
it’s been burglarized in between visitors? Do you really want to try to handle that from
miles or even states away?
Both fix-and-flip and buy-and-hold investors are going to want to think about finding
and appointing a local to help them manage the deal. You really don’t want to be
chasing down contractors from afar, so a local flipper with experience who’s willing to
manage the flip for you — for a fee, of course — can be a lifesaver and end up saving
you both time and money on your flip. A good property manager, too, can be worth his
or her weight in gold, even for vacation rentals, so talk about whether you’re going to
hire one and how you’ll pay for it before you start shopping.
An attorney can solve a lot of these problems for you
We know: Thinking about teaming up on a real estate investment property sounds like
a lot of work. It is! But it can also be hugely rewarding. To make sure that you’re
maximizing the reward and minimizing the headaches, it’s a very wise idea to loop in
an experienced attorney who has helped other real estate investors navigate the maze.
An attorney can help you create legal documents that will carefully outline the
responsibilities, profits, exit strategies, and other issues that could arise, giving
everyone involved confidence that they know what’s happening and how to handle any
unforeseen events (because they will have been foreseen and managed by the
attorney).
And an attorney can also help you find your blind spots, if any, either with one deal in
particular or with the partnership in general. Most attorneys experienced in real estate
investment have seen just about every way a partnership can sour, and they can help
you erect parameters that prevent that from ever happening to your partnership — or
your relationship.
If you don’t know any attorneys who specialize in this area of law, talk to your real
estate agent. They can likely refer you to someone or ask their own network for a solid
recommendation.
