Being a passive investor is a great way to gain experience and knowledge in real estate investing. But before you drop that dollar, here are some things you need to know about partnering and investing in real estate.
A Joint Venture (JV) agreement is a contract between two or more parties that clearly outlines the specifics of a real estate transaction. The complexity of the JV agreement can be simple or quite complex depending on the number of partners involved, the type of transaction, and knowledge of each person. When in doubt, you should always have your attorney review the JV Agreement to make sure your investment is protected.
A JV Agreement should include the following elements:
- Purpose of agreement and parties involved
- Term of agreement — A start and end date with the term for the specific project. I would not recommend a JV agreement that goes longer than 12 months.
- Roles of the members of the JV Agreement
- How profit and losses will be shared
- Worse case scenarios covered — If a member dies or gets divorced, who would take over their role in the JV agreement?
- Signatures of all parties — If you do have to enforce the terms of the agreement and you don’t have a signed “contract,” it will be a cumbersome process if you end up in court.
But JV agreements are more that just the legalities of the agreement itself. Most new investors get excited about just getting a deal and think partnering is a perfect way to “scale” their business, but they fail to do some investigative steps prior to entering into a JV Agreement.
Let’s talk beyond vetting the deal and doing your due diligence. What about vetting your potential partner? Some key questions you should ask:
- Do you personally know this person, and have you seen their prior projects (flips, rehabs, etc.)? How experienced is the person you are loaning money to? Who will manage the project? Consider the financial “health” of other partners — have they had properties foreclosed on? Filed bankruptcy? Do they have references from other investors they have worked with? This is business, not personal; however, personalities are often overlooked. If you end up in a JV Agreement with someone who has a hard time talking about money and things go wrong, it will be hard to take out the personalities in a financial transaction.In the beginning all is rosy; it is when something happens (and it usually does) that problems arise.
- Are you in first lien position? If something happens and the project goes sideways, you could find yourself at the bottom of getting paid back, or not paid at all. If you are new to private money lending, always make sure you are in first lien position to cover yourself.
- What is the final outcome of the project? Is it a flip or a buy and hold, and what is the solution should the property not sell?How will the lender get their investment out of the property?
- Where is the property? Can you drive by it? How will you determine if this is a good deal for your investment? How will you determine ARV, repair budget, and sales price?
Be sure to have a negotiated strategy for who is going to do what for the real estate transaction. For example, one person brings and negotiates the deal, another person brings money, and even a third person is overseeing a renovation project. Parties to a JV Agreement will be best served if all parties write their roles and responsibilities and percentages of profit for each partner.
Also, protect the parties from disagreements about how money is spent and type of contractors to use. Be prepared to discuss shortcomings or financial pitfalls if the project goes south. For example, if you have a partner that likes to take shortcuts on rehabbing a property, and you don’t want to take shortcuts like failing to pull permits, then you are not on the same page to complete a project.
Imagine your partner hires contractors for a job but doesn’t get written bids for work. You find yourself overbudget quickly. Prior to entering into a JV Agreement, each partner needs to discuss:
- What exact work will be performed on the property
- Who is going to make the decision on what vendor to hire
- The cost of a project
- How to handle a disagreement on the quality of work performed
- Who will oversee that the work meets expectations
- How to handle overages on budget and timeframe for work to be completed.
Partnering in a real estate transaction is a great way to scale your business. Partnering offers you more time for more deals, more money for deals, and more expertise on deals. However, use caution when entering into a JV Agreement as it is a binding contract. When things go wrong, which can quickly happen, that is not the time to find out your JV Agreement is not written in a way to protect the project, your time, or your money.
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