“I’ve got the brains. You’ve got the looks. Let’s make lots of money.”
Ah, the Pet Shop Boys said it first, right? But it’s got an undeniable application here, in the field of real estate and investments. Think about it this way: if you’re a real estate “bird dog” looking for someone with a bag of “kibble” to invest, the pitch might sound along the lines of, “I’ve got the deal. You’ve got coin. Let’s buy some property!” But how do you build your nest securely, so no one ends up being kicked out and making an ignominious landing, like some relative of a Red Footed Booby*?
Begin with a Solid Equity Sharing Agreement.
Okay, fair enough. So what is an Equity Sharing Agreement? It’s a written agreement between two investors—one with know-how, the other with cash—who agree to purchase real estate together and split the profits. But notice the phrasing here: a written agreement.
There’s a Reason You Want to WRITE THIS DOWN.
Written agreements protect you against the phenomenon of being on either the giving or receiving end of a bad case of “Can’t Remember Sh*t,” NOT a good place to be. Keeping yourself out of there involves putting some pesky, but important, details in black and white. Here are just 10 of them:
Price and Spending Limits
One of the only things certain in any kind of commerce is that prices can change. So protect yourself, and set limits on not only the price of the property but any amounts you’re investing for rehab work. One common cause of conflict in agreements like this is a difference of opinion on what kind, and how much, work should be invested in making the property “ready for prime time.” You cure this by making a budget and STICKING TO IT, with any deviations requiring unanimous consent. And make sure there are consequences for non-performance: if one party fails to meet its obligations, that party should be subject to also forfeiting profits.
If the Property Doesn’t Sell
It happens, you know. No matter how spiffy you think the property is, how well-connected your contacts and market may be, sometimes…a property doesn’t move. So now, you have a separate set of decisions to make about managing the property. Who will do it? Make a Plan B and know what it is!
Over time, I’ve come to decide that utilizing a third-party property manager is the best way to ensure that everyone’s interests are protected. That’s a result of hearing one too many horror stories about one party keeping all the income and “forgetting” to pay insurance, taxes, or utility bills…with predictable (and unpleasant) results. If the investor with the cash is out of state and has no direct involvement with the tenants, the results can be even more unpleasant. Make sure you have a way to prevent that unhappy ending.
Paying for Time
Like any other working canine, a “bird dog” wants a “bone” if he’s going to rehab a property. There needs to be some incentive; that’s understandable. What’s not is that often this demand doesn’t even come up until the property’s been bought—but when no work’s yet been done on it. Then, the “bird dog” asks for money and the investor’s unwilling to ante up. (“Explain to me again why you’re entitled to 50 percent of the profits if I’m paying for everything and you’ve done nothing?”)
If your rehabber walks, you’ve got to start from Square One, and again, that’s a place you don’t want to be. Nail this issue from the get-go, then, by coming to an agreement about how much work the “bird dog” will perform free of charge. In addition, whatever he IS paid needs to come off the top…BEFORE the profit split.
Handling Unforeseen Costs
When Murphy’s Law kicks in, and an unforeseen or unexpected expense occurs, who’ll pick it up? Will you split the costs, or will the investor be the one who has to reach deeper into his pocket? You can’t finish a project without fixing everything that breaks, so don’t go into the project without knowing who’s going to cover the occasional “oops.” If you don’t, mutual expectations can blow up in your faces—which is a great premise for A&E’s next reality show, maybe, but really bites if it’s your LIFE or finances they’re showing in meltdown!
How much homeowner’s insurance are you going to carry? Be sure both parties agree on the amount and type coverage needed to protect the property, who will purchase it, and how the insurance agreement will be worded to protect both of you.
Allocating Tax Benefits
Federal tax laws have plenty to say about equity-sharing arrangements, so apprise yourself of those details. It pays—literally—to know the rules you need to follow in order to reap the maximum tax benefit from this form of investment.
When and How to Rent
This is a two-part decision: first of all, you’ll need to come to a fair division of rent, should you decide to split it, until the property sells. And part of THAT decision is agreeing on how long a period of time will be considered “reasonable” to wait for a sale BEFORE you put it up for rent.
If the “Love” Dies
It’s a sad fact: business partners divorce faster than one-night stands in Vegas, even the ones who were sure they’d found “true love,” blessed by Pastor Elvis! Think ahead to cover this just-in-case scenario, and have a method set up by which one party can buy out the other if either wants out. You can arrive at this provision either as a set figure or use a sliding scale, based on the amount of work completed.
An offshoot of this can occur when the property doesn’t sell in 120 days, yet there’s financing already in place. How long can and will the investor carry the project? If bird dog can’t pay, then what happens? Answers to these kinds of contingencies can keep the “love alive” a lot longer!
How will you settle disputes between the parties? (And even in the best of “marriages,” these things happen!) Make sure your agreement covers how you want to handle these—whether through mediation or arbitration.
Divvying Up the Proceeds
Once the mortgage balance is paid off, the value above and beyond that is the equity in the property—which is the whole reason for these partnerships in the first place! A key factor in what happens at the “end of the road” is feasting on proceeds—and deciding who gets what share. Lots of factors go into determining who gets the lobster, and who gets the chicken: amount of work each party puts in, investment amounts, and degree of risk. Make sure your agreement spells out clearly HOW these feasts will be served.
And…That’s Not All
These are just a handful (or two, if you think about ten fingers) of the provisions a quality equity-sharing agreement must contain. To make sure all your bases are covered, it’s best not to try to DIY this paperwork: let an attorney and/or real estate investment pro guide you in putting these packages together…lest your song quote the Pet Shop Boys again: “If you lack the inclination, I’ve got the crime.”
*(Yes, there is such an animal. Look it up.)