For several reasons (diversification, help with financing, etc), I’ve decided that I will open up my real estate investments to friends and family who are potentially interested in having an equity stake in my investments. When the situation arises that I have equity partners in a deal, I will certainly spend some time with my CPA and my attorney to ensure that all my T’s are crossed and I’s are dotted.
In the meantime, I’ve outlined some high-level parameters for how I plan to deal with equity partners, and have added that to my business plan:
LISH PROPERTIES BUSINESS PLAN
Leveraging Outside Investments
In order to provide greater flexibility to meet its investment goals of asset accrual, cash flow, asset exchanges, and diversification, the company will look to outside investors to provide additional capital on top of that of the primary owners. A percentage of each property acquired by the company will be opened up to equity partners, and each investment vehicle will operate under a separate partnership agreement specific to the investment needs and the desires of the partners.
Ownership
To ensure the alignment of goals between the company owners and outside investors, the company will generally retain a minimum 33% ownership in each investment. The company may, under certain circumstances, choose to hold an investment on behalf of outside investors where the company has not stake; in these cases, the company will ensure that the overhead associated with these investments poses no tax on other investments or investors.
Partnership Agreements
Each individual investment vehicle will have an associated partnership agreement that lays out the rights and responsibilities of the partners for that investment. The company will attempt to maintain consistency in partnership agreements for the sake of simplicity and overhead reduction, but also recognizes that in certain circumstances, specific terms will be required to satisfy investors within a particular investment. Because each property will have a separate partnership agreement, and because some investors may have a material interest in multiple properties, it is important to note that at no time will the company implement a partnership agreement that poses a conflict of interest towards other agreements or investors, without agreement among all affected investors.
Management of Investments
The company will be responsible for the day-to-day management of the investment properties, and will retain the right to make decisions affecting day-to-day management issues. This includes – but is not limited to – the following types of decisions:
- Whether to use a property management company
- Tenant screening and acceptance criteria/determination
- Property maintenance and repair decisions
- Rent increases/decreases
- Etc.
The company has authority to make all day-to-day operating decisions, it will do everything possible to optimize both for long-term appreciation and short-term cash-flow for its investors.
Entry Strategy
Prior to purchasing any property, a short-term strategy for transitioning the property to new management will be identified. Entry strategies may include rezoning efforts, improvements to the property, adjustments to rental rates, implementation of marketing plans, sub-metering of the utilities, etc.
Exit Strategy
Prior to purchasing any property, an ideal exit strategy for the investment will be identified. This exit strategy will be agreed upon by the investor partners, and will be documented in the partnership agreement. Typical exit strategies may include (but are certainly not limited to):
- Short-Term Sale (especially for Rehab and Value Plays)
- Refinance to Regain Investment (especially for Value Plays)
- Long-term hold for cash flow
- Mid-term hold for 1031 exchange
During the hold period, investors will have the opportunity to reevaluate the exit strategy for the property; the partnership agreement will clearly identify the rules for determining and executing on the exit strategy for the property.
Conflicts of Interest
While the company may consider adding partner owners at some point who have voting rights towards corporate decisions, it should be clear that investors into specific investment vehicles will have no operating control over the corporate entity as a whole. Instead, investors will have clearly defined rights and responsibilities towards their investment vehicles as defined in the specific partnership agreement that governs the investment. Additionally, the company will ensure through contractual agreement that at no time will it undertake a business strategy that presents a conflict of interest with investment partners without agreement from affected partners.
Might be worth laying out in the Partnership Agreements section (or elsewhere) the potential structures of partnership agreements from a tax & legal perspective. I know nothing about this, so I’d be intrigued to know how such partnerships are structured. Things like:
1) Would there be separate companies created that are part-owned by Lish and part-owned by outside investors?
2) If so, what type of companies are ideal for this? Does the ideal structure vary based on how many parties there are, whether the parties have more than one investment together, etc?
3) What are the tax implications for an outside investor of the partnership structure?
Or maybe those are all things that are handled on a one-off basis by the lawyers/CPAs involved at time of investment.
Certainly good questions, Caleb!
And you do make a good point that I should be more specific about this issue. My intent is that the property would be held in an LLC, with the partners each owning a percentage of the LLC proportionate with their equity stake. I would hold my share through Lish Properties, and the other partners could choose to own their share through their own holding company or in their own name.
In terms of the tax implications, assuming the partners didn’t object, I’d file to have the LLC taxed as an S-Corporation, and therefore the taxes would flow through to the individual owners (or their company), and their specific tax circumstances would be an issue between them and their advisors.
In other words, I would expect my partners to have their own CPA and attorney to advise them on how to hold and manage their portion of the investment. Of course, if my partner, my advisors, or their advisors recommended another way to hold the investments, I would certainly consider alternative methods.
Thanks for the questions…I’ll update my plan accordingly…