How Can I Structure a Real Estate Partnership?

Going into a real estate deal with a partner can have many benefits. But the fine print in the partnership agreement should contain all of the right language for when things go wrong or not as expected. Creating the right partnership structure is key to its survival and longevity. Let’s go through what you need to be aware of when structuring a real estate partnership.

Why Form a Real Estate Partnership?

Before we look at ways to structure a real estate partnership, why would someone want to form one in the first place? After all, can’t you make more money as a single operator?

There are a few reasons to bring in a partner(s). One of the more common reasons is the primary investor doesn’t have enough money to put down on the property. So, they find a partner who can add the remaining amount.

The two partners might split their ownership 50/50. This means each partner owns 50% of the equity and receives 50% of any distributions.

The arrangement can be worked out in a number of ways. If one person adds 100% of the down payment and the other does all of the work, including management, the split might be 25/75, where the cash investor is getting 25%.

Distributions don’t have to be paid out every month. They can be paid at the end of the year. This way, if there are higher expenses during the year, the partnership has cash on hand to pay them.

Another reason for bringing in a partner is experience. For those with less experience, giving up equity can have its advantages if your partner has real estate investment experience. This arrangement can be a great learning opportunity.

In some cases, one partner might not be enough. If the target acquisition is a large property, multiple partners may be needed to meet the down payment requirement. This is obviously a more complex partnership. The more people involved, the more complex the deal since there can be competing goals, disagreements, and more things that can generally go wrong amongst the partners.

Last but not least, a partnership is a way to disperse risks. In a single-person deal, the single investor takes 100% of the risk. In a partnership, risks are shared by all partners involved. Although not necessarily proportionately.

In the next section, we’ll get more into the weeds on how to structure a partnership.

Structuring The Partnership

There are several ways to structure a partnership. From a legal perspective, it can be a GP (general partnership) or an LP (limited partnership). Some might even use an LLC.

In a GP, all partners are equal and share in liabilities and responsibilities. All partners must agree when there is a decision to be made. If one partner passes away, the partnership dissolves. For tax purposes, GPs are taxed as active investors. A major drawback of being in a GP is that each partner is responsible for the liabilities of the GP. 

For example, one of three partners takes out a $250,000 line of credit. Then one partner decides to leave the country. The remaining two partners are personally responsible for the line of credit, putting their personal assets at risk.

In an LP, one person is the GP (also called a sponsor or managing partner). The GP is an active investor and is delegated all decision-making. Other investors in the partnership are LPs (limited partners/investors) and have no control. They are passive investors. However, their liabilities are limited only to what they put into the partnership. If one LP passes away, the partnership does not dissolve.

LPs are often used in syndications, crowdfunding, and joint ventures.

Depending on the legal partnership structure chosen, responsibilities might be split across partners. For example, responsibilities across a four-person GP might look like this:

P1- Capital infusion

P2 - Financing (i.e., loan)

P3 - Management

P4 - Deal flow

If two people are involved and one is providing capital for the down payment, the legal structure will likely be an LP. The general manager accepts all liability and management of the property. The LP is a passive investor. Because the general manager has no money in the deal, they could end up with the highest returns, depending on how equity and cash flows are split.

When looking for a partner, getting involved with someone you know is generally better. Expectations should be outlined in the partnership agreement. It will also state the responsibilities of each person.

The partnership agreement should describe what happens in the case of disagreements. How do they get resolved? Will arbitrage be used?

Other considerations: If more cash is needed (i.e., capital call), who comes up with it? Is everyone diluted? How is someone removed from the partnership for whatever reason? What happens if a partner passes away or wants out?

Be explicit in the partnership agreement and spell everything out. Also, keep in mind that some months may not generate any income. Therefore, partners should not expect cash flows every month.

Creating a partnership can be complex. Deciding on the right legal structure, tax considerations, and partnership agreement is best worked out with a real estate attorney.