Using Joint Venture Partnerships for Financing

Joint venture partnerships can be an excellent way to finance a real estate transaction, and they can be handled in a variety of ways. The most common is where one partner puts up cash and the other puts up his or her interest in the deal and/or his services in managing the property. The joint venture agreement will spell out how the money is contributed and how it is disbursed. Title to the property is generally held in the name of the joint venture, although title can be taken in the name of one or both of the partners.

Using a partner to finance deals can be very effective on a deal-by-deal transaction. Sometimes a joint venture partnership looks more like a general partnership because it is not specific to any one particular property. For example, an investor, or group of investors, may “pool” money together for the purchase of properties at a foreclosure auction. This type of arrangement should be approached with extreme caution because it looks more like a general partnership than a joint venture. It also may cross over into securities regulations, particularly if you are the one soliciting money from other investors.

Legal Issues

Owning real estate jointly with other parties is an effective financing tool, but it can also be a liability. Under the Uniform Partnership Act, the law holds all partners liable for each other’s actions. Thus, if you are a “silent” partner, you could be held liable as the “deep pocket.” Consider setting up a limited liability company (LLC) or limited partnership for joint venture projects. The owners of an LLC are shielded from liability for activities of the company and the activities of each other. Limited partners (but not general partners) of a limited partnership are similarly shielded from personal liability. For more information on LLCs and limited partnerships, visit my Web site at <www.legalwiz.com/LLC>.

Alternative Arrangement for Partnership

Rather than having a partnership own the property, partners can realize the same profit goals by using a note and security instrument. One partner will hold title to the property and sign a note to the other partner for the amount of the other partner’s cash investment. The note is secured by a mortgage on the property. A second note and mortgage is also executed, which will be a shared equity mortgage. A shared equity mortgage has a payoff that is based on a formula that relates to the increase in value of the property.

Shared equity mortgages (AKA shared appreciation mortgages or participation mortgages) were popular when interest rates were so high that commercial borrowers could not maintain positive cash f low. The lender thus dropped the interest rate in return for a share of the future profits in the borrower’s property. Today, shared equity mortgages are not as popular, but they are still an effective tool for financing properties with people who are open-minded.

Case Study: Shared Equity Mortgage with Seller

A viable option for seller financing is to make the seller your partner with a shared appreciation mortgage. In this case, the seller/ lender shares in the future appreciation of the property. A seller may be willing to accept little or nothing down in exchange for principal and interest payments, lack of management, and future appreciation. Essentially, the note and mortgage documents read the same as a standard note and mortgage, except that the payoff amount increases over time in proportion to the value of the property. The shared appreciation can be written a number of ways and need not necessarily be a 50/50 split of future appreciation.

When Does a Partnership Not Make Sense?

Real estate partnerships, like any business partnership, should be approached with profit in mind. Buying property jointly with a friend makes no sense just because you want to limit your exposure to half the loss. Likewise buying property with a partner should be avoided if the partner’s share of the profit is less than you could pay for a loan. Even at 18 percent interest and with 10 points origination fee, you might still end up with more profit by borrowing hard money.

Use your common sense and a calculator, not your emotions and fears. An equity partner should be used when conventional, hardmoney, seller-carryback, and creative financing means are out of the question. In my experience, if you need a partner to finance the deal, it may not be all that good a deal; if you buy at the right price, borrowing the necessary money is easy. However, there is one exception to this rule: If your partner has a great deal more experience than you, giving up part of the profit for a good education may be worthwhile. And, suffice it to say, make sure you know who you are partnering with by checking out his or her background and references.

Key Points

• Equity sharing and joint ventures can be effective financing alternatives.

• Approach general partnerships with extreme caution.

• Consider alternatives to partnerships whenever possible.