Owning commercial real estate can be a smart way to diversify your investment portfolio and generate income. However, what if you don’t have the capacity or capital to go it alone? Partnerships are a great way to get in on deals, especially big deals without needing big bucks.
In my blog, “A Piece of the Pie”, I talked about how I first got into CRE investing. Such a great decision! In a blog series, I’ll explore the different aspects of CRE investment partnerships. We’ll start with…what are they?
1. When two or more investors combine capital and/or expertise to own income producing real estate, they form a partnership. What that looks like varies, and you can get somewhat creative when drafting an operating agreement. It’s best to have this agreement before partners decide to buy a building. During due diligence, a deal can get better or worse, so it’s important for the partners to be on the same page and make decisions together––from the start.
2. Some partnerships are based on active investments, while others take a more passive role. Active partnerships mean each member brings their expertise and work together to keep the cash flowing and the property in good shape. Passive partnerships could simply be a loan and/or profit sharing, but the investment is strictly a financial decision.
3. When a partnership buys a building, they follow how shares and roles are outlined in the operating agreement. An A-share partner is typically a managing partner (there can be more than one). They handle the day-to-day operations like finding the property, negotiating the deals, taking the lead arranging financials, heading up leasing, and organizing property management. They often make the decision when it’s time to sell. Their extra responsibility and potential liability means they may receive a larger share of the profits and maybe collect an acquisition fee when a property is purchased.
4. B-shares can be very involved and help the managing partner with securement, logistics, and ongoing tasks. In exchange, they receive an agreed upon share of ongoing revenue and profit when the property is sold. C-shares make strictly financial contributions––they may be a friend or investor who only wants a cash return. They provide a loan tied to the property––for example, interest only payments at 8% of $100,000 over five years. Sometimes a cash investor may also get a percentage upon sale to sweeten the deal, say 5-10% gain.
5. Most partnerships are structured as pass-through entities, so the money flows through a Limited Liability Company (LLC). Each partner reports profits and losses on their own tax returns, typically when a Schedule K-1 (a form that reports each member’s share of the partnership’s income, loss, and deductions) is issued. LLCs reduce the liability of each member. They separate other business and personal assets from the CRE investment partnership.
Conclusion
Partnerships allow investors to pool their resources and expertise. A complex or big deal would be out of reach for many, but partnerships allow you to get your foot in the door. In the next two blogs, we’ll discuss the pros and cons of partnerships as well as how to pick the right partner.
Jeff Salzbrun is the owner/broker of Commercial Equities Group (CEG). As a veteran-owned real estate brokerage, CEG has been involved in thousands of sale and lease transactions, ranging from single offices to 250,000+ square foot buildings. At CEG, we get your deal done. We know space, and we know the CRE business.
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