Best practices for buying an income property with a friend?
November 3, 2015 8:58 AM Subscribe
Two friends want to buy an investment property together. What should we consider?
I rented an apartment in Jim's small building for 5 years. He lives 1hr away so I got cheap rent in exchange for doing minor repairs and finding/managing all other tenants. Jim was amazing- generous and agreeable, collaborative, impeccably fair, kind and conscientious. I have skills in property management and sales, so over the years I've chosen 20 tenants who all rented above market value with 100% punctual payments, no conflict or damages. We were a great team.
Now I want to buy a house divided into apartments. I have no debt, perfect credit, I could put 20% down and still have some savings left as a cushion, and the market rental income would more than carry the mortgage. But the rental income can't be counted so I can't get a big enough mortgage. I'm also reasonably handy for renos and I have a lot of free time. I'd like to live in this property and fix it up for a few years, then I'm open to either being bought out so I can get my own place, or maybe keeping it as an investment; I'm pretty flexible as long as whatever happens is fair.
Jim also wants to buy a small building, but wants someone nearby/onsite to manage and upgrade it. He'd like to eventually own a number of income properties. He has cash, equity, and could get a decent mortgage. Maybe we'd be a perfect match?
We are talking about going 50-50 on a building. The market in our city (Toronto) is insane- house prices doubled over the past 8 years, and interest rates are pretty good (around 2.8%), so it seems like great timing for a proven partnership. What should we consider?
We will definitely each get lawyers and a thorough home inspection.
We'll probably each put 10% down, which means I don't have to clean out my savings.
I have a brilliant real estate agent who is in a similar arrangement with a friend (they bought a house together that one lives in and manages), and I have their co-written contract as a template, as well as a more standard real estate lawyer's contract for two owners. We'll mix and match to customize our contract, then get it looked at.
Contract will have a couple different options for buyouts / ending the agreement (ideas / concerns welcome).
Some other thoughts-
I have a cousin who can lend me some money; Jim has a brother who wants to partner financially as well. But I only want an agreement between Jim and me- no cousin, no brother on paper. I am going to suggest that the other two people are silent partners and make private agreements for the cash- but when it comes to the house, I only want me and Jim to have a vote on any decisions.
Jim has more money, equity, connections, and resources than I do. He was beyond fair with all previous dealings- he even bought a tenant a new laptop when hers got fried by a faulty outlet!! He has proven his integrity, he doesn't pinch pennies, and I trust him. But still, this is my life savings- what can I do to protect myself?
I will do labour on the house; Jim won't. How should we measure and track that labour? I was thinking of averaging a few contractor quotes for each job, and valuing my work at 75-80% of what getting a contractor would cost, and then Jim would contribute the same amount in cash, perhaps by buying materials, paying property taxes, paying other contractors, etc. That way we can keep our investment in the property "equal" (I'd pay in sweat and maybe some cash, he'd pay only in cash) and then we'd still be able to cash out as 50-50 partners.
I expect to be able to rent the other units above market value; I want my rent to be below market value. What's a fair way to make this happen? My thought is to pick a "target rent" that's a little higher than the mortgage payment. I'll rent the other units as high as possible, and then my own rent "tops up" to hit the target (hopefully this works out so I pay about 50-60% of market value). The monthly overage goes into a house account for contingencies.
Any other glaring issues I should consider?
Thanks!
I rented an apartment in Jim's small building for 5 years. He lives 1hr away so I got cheap rent in exchange for doing minor repairs and finding/managing all other tenants. Jim was amazing- generous and agreeable, collaborative, impeccably fair, kind and conscientious. I have skills in property management and sales, so over the years I've chosen 20 tenants who all rented above market value with 100% punctual payments, no conflict or damages. We were a great team.
Now I want to buy a house divided into apartments. I have no debt, perfect credit, I could put 20% down and still have some savings left as a cushion, and the market rental income would more than carry the mortgage. But the rental income can't be counted so I can't get a big enough mortgage. I'm also reasonably handy for renos and I have a lot of free time. I'd like to live in this property and fix it up for a few years, then I'm open to either being bought out so I can get my own place, or maybe keeping it as an investment; I'm pretty flexible as long as whatever happens is fair.
Jim also wants to buy a small building, but wants someone nearby/onsite to manage and upgrade it. He'd like to eventually own a number of income properties. He has cash, equity, and could get a decent mortgage. Maybe we'd be a perfect match?
We are talking about going 50-50 on a building. The market in our city (Toronto) is insane- house prices doubled over the past 8 years, and interest rates are pretty good (around 2.8%), so it seems like great timing for a proven partnership. What should we consider?
We will definitely each get lawyers and a thorough home inspection.
We'll probably each put 10% down, which means I don't have to clean out my savings.
I have a brilliant real estate agent who is in a similar arrangement with a friend (they bought a house together that one lives in and manages), and I have their co-written contract as a template, as well as a more standard real estate lawyer's contract for two owners. We'll mix and match to customize our contract, then get it looked at.
Contract will have a couple different options for buyouts / ending the agreement (ideas / concerns welcome).
Some other thoughts-
I have a cousin who can lend me some money; Jim has a brother who wants to partner financially as well. But I only want an agreement between Jim and me- no cousin, no brother on paper. I am going to suggest that the other two people are silent partners and make private agreements for the cash- but when it comes to the house, I only want me and Jim to have a vote on any decisions.
Jim has more money, equity, connections, and resources than I do. He was beyond fair with all previous dealings- he even bought a tenant a new laptop when hers got fried by a faulty outlet!! He has proven his integrity, he doesn't pinch pennies, and I trust him. But still, this is my life savings- what can I do to protect myself?
I will do labour on the house; Jim won't. How should we measure and track that labour? I was thinking of averaging a few contractor quotes for each job, and valuing my work at 75-80% of what getting a contractor would cost, and then Jim would contribute the same amount in cash, perhaps by buying materials, paying property taxes, paying other contractors, etc. That way we can keep our investment in the property "equal" (I'd pay in sweat and maybe some cash, he'd pay only in cash) and then we'd still be able to cash out as 50-50 partners.
I expect to be able to rent the other units above market value; I want my rent to be below market value. What's a fair way to make this happen? My thought is to pick a "target rent" that's a little higher than the mortgage payment. I'll rent the other units as high as possible, and then my own rent "tops up" to hit the target (hopefully this works out so I pay about 50-60% of market value). The monthly overage goes into a house account for contingencies.
Any other glaring issues I should consider?
Thanks!
I am not an expert but depending on the size/value of the property have you at least considered owning it through some sort of liability-limiting entity like an LLC or LLP rather than just as joint tenancy or tenancy-in-common?
posted by Wretch729 at 10:34 AM on November 3, 2015 [6 favorites]
posted by Wretch729 at 10:34 AM on November 3, 2015 [6 favorites]
You should be very clear at the beginning as to what each of you expect your exit strategy to be. What happens if one or the other of you need cash immediately, gets married and wants to move away, the market suddenly skyrockets and one of you wants to sell but the other doesn't, the distribution of the assets should one of you die suddenly, etc. These are questions your lawyers should be posing and helping you sort out.
posted by vignettist at 11:00 AM on November 3, 2015 [2 favorites]
posted by vignettist at 11:00 AM on November 3, 2015 [2 favorites]
If you and Jim are both happy with your current rent deduction, go back to how you calculated that. How many hours does that assume, how many tenants is that looking after, etc? Pretend Jim owned the building you're looking at and you were renting it, how much rent deduction ($N) would you look for under those same metrics at the new site? If you both own it, you each owe half the mortgage and he's willing to pay you $N/month to be the manager, which you will use to pay your half the mortgage. That's not the same as him paying more of the mortgage than you do.
Then there's the question of improvements to the building beyond just what the tenants require, i.e. upgrades that you wouldn't do if it weren't an investment. Get quotes from outside contractors, write up your own quote (materials needed, hours worked at a lower-than-professional rate) and split that remodeling bill 50/50. Then he's paying you 50% of the bill which will probably cover a bit more than materials because it includes your time. You take virtual cash out of your account, hand it to yourself to make up your half the bill, and put the total back into your account; again, this is not the same as him paying more than half.
Or honestly, do what works for the two of you. Agreeing that something feels fair is much more important than it actually being mathematically 50/50, in terms of health of the partnership.
(but yes, vignettist, exit plan!!)
posted by aimedwander at 1:42 PM on November 3, 2015
Then there's the question of improvements to the building beyond just what the tenants require, i.e. upgrades that you wouldn't do if it weren't an investment. Get quotes from outside contractors, write up your own quote (materials needed, hours worked at a lower-than-professional rate) and split that remodeling bill 50/50. Then he's paying you 50% of the bill which will probably cover a bit more than materials because it includes your time. You take virtual cash out of your account, hand it to yourself to make up your half the bill, and put the total back into your account; again, this is not the same as him paying more than half.
Or honestly, do what works for the two of you. Agreeing that something feels fair is much more important than it actually being mathematically 50/50, in terms of health of the partnership.
(but yes, vignettist, exit plan!!)
posted by aimedwander at 1:42 PM on November 3, 2015
The contract is a good starting place.
Since you're talking about having multiple other renters, to do this and be comfortable, I would want to have an LLC and treat repair work as work done as an employee of or contractor to the LLC. Profits/overages go into the business, the business pays salaries to it's employees in accord with an employment contract.
Also, charge a reasonable rate. 100% of market for your labor. If you can only do the work 70-80% well, then don't do it -- if you can do it 100% then charge 100%. You might like to also see about getting bonded and insured for certain types of work just in case you mess up. You're ultimately talking about the long term viability of your investment when you talk about repairs and so on -- don't let your property slip into disrepair and don't half-ass repairs.
Something to keep in mind is that you don't want to be held personally liable if at all possible and no matter how well things are going with your business partner now you don't want to leave yourself totally vulnerable in the event he does a 180, or dies and has a person who for whatever reason wants to shaft you take on the estate.
Incorporating as an LLC and treating yourself as a regular owner/employee can really take some of the sharp edges off. It makes it a bit clearer if a partner wants to be bought out later. It makes things a lot clearer if a tenant files suit against the LLC.
In short, I would take measures to avoid personal liability (incorporation as an LLC, appropriate bonding as a contractor) and avoid any organizational structure which will hinge strongly on good faith of all participants.
posted by Matt Oneiros at 4:14 PM on November 3, 2015
Since you're talking about having multiple other renters, to do this and be comfortable, I would want to have an LLC and treat repair work as work done as an employee of or contractor to the LLC. Profits/overages go into the business, the business pays salaries to it's employees in accord with an employment contract.
Also, charge a reasonable rate. 100% of market for your labor. If you can only do the work 70-80% well, then don't do it -- if you can do it 100% then charge 100%. You might like to also see about getting bonded and insured for certain types of work just in case you mess up. You're ultimately talking about the long term viability of your investment when you talk about repairs and so on -- don't let your property slip into disrepair and don't half-ass repairs.
Something to keep in mind is that you don't want to be held personally liable if at all possible and no matter how well things are going with your business partner now you don't want to leave yourself totally vulnerable in the event he does a 180, or dies and has a person who for whatever reason wants to shaft you take on the estate.
Incorporating as an LLC and treating yourself as a regular owner/employee can really take some of the sharp edges off. It makes it a bit clearer if a partner wants to be bought out later. It makes things a lot clearer if a tenant files suit against the LLC.
In short, I would take measures to avoid personal liability (incorporation as an LLC, appropriate bonding as a contractor) and avoid any organizational structure which will hinge strongly on good faith of all participants.
posted by Matt Oneiros at 4:14 PM on November 3, 2015
This thread is closed to new comments.
I will do labour on the house; Jim won't. How should we measure and track that labour?
Good question, and this is something you should also work out very explicitly with your business partner. Frankly nothing we recommend is as important as your mutual agreement on this point. Also I wouldn't insist that the two of you remain "equal" at all times but rather that you agree how to track and value the relative contributions because they probably won't just wash out naturally. (E.g., what if there is a repair that requires a quart of drywall putty and 2 gallons of paint but like 40 hours of labor?) Keep track of all these contributions and update a spreadsheet monthly or quarterly so you always know your relative equity in case, again, someone wants out unexpectedly.
posted by Joey Buttafoucault at 9:42 AM on November 3, 2015 [1 favorite]