Legal Implications of Real Estate Partnerships and How to Protect Your Investments
Real estate partnerships can be a lucrative and strategic way to invest in the real estate market. By joining forces with other investors, you gain access to additional resources, expertise, and opportunities that may not be available to you as an individual investor.
But it’s crucial to approach real estate partnerships cautiously and ensure you are legally protected. You don’t want some swindler pulling the wool over your eyes.
While a lot goes into partnerships, don’t feel intimidated. We’ll guide you through some of the most important legal considerations and steps you need to take to safeguard your investments.
Pro tip: Bookmark this page as a glossary of terms and considerations you can quickly reference when speaking with your attorney or exploring a new partnership.
What Is A Real Estate Partnership?
A real estate partnership is a business structure that involves two or more investors who pool their resources and expertise to invest in and manage a real estate project or portfolio. These partnerships allow investors to combine their resources, share financial risks and rewards, and leverage each other’s expertise.
Different types of real estate partnerships exist, including general, limited, and limited liability partnerships (LLPs). In a general partnership, all partners share equal responsibility for the partnership’s management and profits or losses.
Limited partnerships consist of general partners who manage the partnership and limited partners who have limited liability and involvement in management decisions.
LLPs provide each partner with limited liability protection, similar to that of a limited partner in a limited partnership.
Partnerships may form limited liability companies (LLCs), limited liability partnerships (LLPs), or S-corporations. These entities offer the partners tax advantages and legal protection, as they are not subject to corporate income tax or entity-related tax.
Instead, the income and losses of the partnership are passed through to the individual partners, who report them on their personal tax returns.
As exciting as all that was, it’s a key piece of the puzzle when you’re looking to create a business partnership. Thinking about the best possible options for you and your investment is the guiding principle for your attorney.
What Are The Legal Implications Of Real Estate Partnerships?
While getting into the metaphorical business bed partners can be daunting, there are some benefits.
- Access to more capital and financing options
- Ability to leverage each partner’s skills and network
- Diversification of risk and exposure to different markets
- Potential for higher returns and cash flow
- Flexibility in allocating profits and losses
Just like, well, everything in life, real estate partnerships also come with some legal implications and risks to keep top-of-mind.
- Fiduciary duty: General partners have a fiduciary duty to act in the best interest of the partnership and the limited partners. This means they must disclose any conflicts of interest, avoid self-dealing or fraud, and exercise due diligence and care in managing the partnership’s affairs.
- Joint and several liability: General partners are jointly and severally liable for the debts and obligations of the partnership. This means that each general partner can be held responsible for all the partnership’s liabilities, regardless of their contribution or share. If one general partner defaults or becomes insolvent, the other general partners may have to cover their share.
- Dissolution: Real estate partnerships can be dissolved by mutual agreement, by operation of law, or by court order. Dissolution can be triggered by various events, such as death, bankruptcy, retirement, or breach of contract by one or more partners. Dissolution can also result in tax consequences, such as capital gains or losses, depreciation recapture, or cancellation of debt income.
- Disputes: Real estate partnerships can be prone to disputes among partners over various issues, such as management decisions, financial performance, profit distribution, or exit strategies. Disputes can lead to litigation, arbitration, mediation, or settlement agreements. Disputes can also damage the reputation and relationships of the partners.
How To Protect Your Investments In A Real Estate Partnership
Do Your Due Diligence: Get the Nitty Gritty on Your Potential Partner
We all want to believe people are made of sugar and spice, but, unfortunately, that’s typically not the case. That’s not to say there aren’t amazing humans out there who you can do great work with, but due diligence is a crucial first step.
Research the potential partner’s background, experience, reputation, financial situation, and track record. Verify their credentials, references, licenses, and insurance. Check their credit history, criminal record, and litigation history. Ask for proof of funds and financial statements.
Establish Clear Roles and Responsibilities: Everyone Pick a Lane
One of the key factors in a successful real estate partnership is establishing clear roles and responsibilities for each partner. This step helps avoid conflicts and ensures everyone understands their obligations and contributions to the partnership. By defining roles, you can prevent misunderstandings and allocate tasks based on each partner’s strengths and expertise.
Everyone stays in their lane!
Consider factors such as deal sourcing, financing, property management, legal compliance, and marketing when determining roles. Be transparent about who will handle each partnership aspect and document these responsibilities in a written agreement.
Create a Comprehensive Partnership Agreement: We Both Know Our Roles
A partnership agreement is a legal document that outlines the partnership’s terms and conditions, protects your investments, and ensures all parties are on the same page.
Seeking legal counsel to customize the agreement based on your specific needs and jurisdiction is definitely the best course to take.
The partnership agreement should cover at least the following:
- Profit and Loss Allocation: Specify how profits and losses will be distributed among partners. This can be based on the percentage of capital contributed or other agreed-upon terms.
- Decision-Making Authority: Outline how decisions will be made within the partnership. Consider whether decisions will require unanimous consent or if certain partners will have voting rights based on their ownership percentage.
- Capital Contributions: Clearly define each partner’s financial obligations and the consequences of failing to fulfill these obligations.
- Dispute Resolution: Include provisions for resolving disputes, such as mediation or arbitration, to avoid costly and time-consuming litigation.
- Transfer of Partnership Interests: Address the process for transferring or selling partnership interests, including any restrictions or rights of first refusal.
An iron-clad partnership agreement can prevent potential conflicts, protect your investments, and provide a roadmap for resolving disputes.
Consult a Lawyer: Hello, There
An attorney can help you review the agreement, advise you on the legal implications and risks involved, negotiate on your behalf, draft any amendments or addendums, and ensure compliance with local laws and regulations.
As you can probably tell, a lot goes into building a partnership. While you’re sharp, ambitious, and motivated, it’s always advisable to have an expert on hand who can make sure all your t’s are crossed and your i’s are dotted.
Consult an Accountant: Look at the Numbers
An accountant can help you evaluate the financial feasibility and profitability of the partnership. They can also help you prepare tax returns, financial statements, bookkeeping records, and audits.
They’ll crunch the numbers so you don’t have to.
Consider Forming a Legal Entity: Keep the Personal Out
While not mandatory, forming a legal entity, such as a limited liability company (LLC), can provide additional protection for your real estate investments. By creating a separate legal entity, you can shield your personal assets from potential liabilities associated with the partnership.
Transferring the ownership of properties to an LLC can limit your personal liability if any lawsuits arise.
For example, if a tenant sues the property owner, your assets, such as your home or other investments, will be protected if an LLC owns the property.
When you chat with your attorney, decide if this is the best course of action.
Obtain Adequate Insurance Coverage: Protect Yourself!
Insurance is critical to protecting your real estate investments. This includes general liability insurance, property insurance, and possibly additional coverage for specific risks or hazards.
Consult with an insurance professional specializing in real estate to assess your insurance needs and obtain appropriate coverage. Regularly review and update your insurance policies to align with your properties’ current risks and value.
Comply with Legal and Regulatory Requirements: The Red Tape Compliance
Real estate investments are subject to various legal and regulatory requirements. When you don’t play ball, it can lead to penalties, fines, and legal disputes.
An attorney can help you understand any common legal and regulatory considerations. These could include the following:
- Property Zoning and Land Use: Ensure that your properties comply with local zoning regulations and land use restrictions.
- Tenant and Fair Housing Laws: Familiarize yourself with tenant rights and fair housing laws to avoid discrimination and legal issues.
- Environmental Regulations: Understand and comply with environmental regulations, especially if your properties involve hazardous materials or environmentally sensitive areas.
- Tax Compliance: Stay current with tax laws and regulations related to real estate investments, including property taxes and reporting requirements.
Maintain Proper Recordkeeping and Accounting: Paper Trails Are Your Friend
Accurate recordkeeping and accounting help maintain transparency, track financial performance, and comply with tax obligations.
Keep detailed records of property acquisitions, expenses, rental income, repairs, and other financial transactions. Use accounting software or consult a professional accountant to track income and expenses, prepare financial statements, and ensure accurate tax reporting.
Basically, keep all of your financial ducks in a row so you can see how awesome your investment is doing.
Regularly Review and Update Legal Documents: Are We Still Getting Along?
As your real estate partnership evolves, regularly review and update your legal documents to reflect any changes or new agreements. This includes updating partnership agreements, lease agreements, and other legal documents related to your investments.
Changes in ownership, new investment opportunities, or adjustments to partnership roles and responsibilities should be properly documented and reflected in the relevant legal documents. Reviewing and updating your legal documents periodically helps ensure that they accurately reflect the current state of your partnership and protect your investments.
Communicate Regularly: The Golden Rule
Communication is key to maintaining a healthy and successful partnership. You should communicate regularly with your partner, share information, provide feedback, address issues, and resolve conflicts. You should also document all communications and transactions in writing (paper trail, baby!).
Establishing open lines of communication and trust can help prevent misunderstandings, resolve conflicts amicably, and foster a positive working relationship. Regularly schedule partner meetings to discuss the partnership’s progress, goals, and any necessary adjustments.
While this was a fun (exhausting?) ride, it wasn’t the whole shebang. There are always mitigating factors, nuances, or other considerations that are unique to you, your partnership, and your investments that must be considered.
Seasoned real estate attorneys (👋) are key to helping you navigate those waters. If you’re looking for representation and counsel for your burgeoning partnership, contact us today.