Investing in real estate as a group July 9, 2008Posted by W. Keoki McCarthy in Invest, real estate, real estate investing, Uncategorized.
One of the things I advise investors that are going to partner up and purchase a property together to do is to put some rules about how to fairly deal with work done by one party on the property. Who has to do what and when and what do they get for doing it. Otherwise, both parties will wonder if the other person is pulling their fair share.
My first example:
Two investors purchase a property together. They put up 50% of the money each so they own the property equally. Investor A is very handy – he was a carpenter in a past life. Investor B is not handy at all – he is a CPA by day and a couch potato by night. Some work needs to be done to the property. What if A decides to do some of the work himself instead of hiring a contractor? As an owner, should he be expected to work for free for the good of the partnership? Or, should he track his hours and then expect that B will put in as many hours? What if B, being lazy, never puts in the same amount of hours? Isn’t that unfair to A? It can get even more complex. Picture this; A spends 14 hours doing yard work in a month. B did the books for the property at year end in about 4 hours. In this scenario, it appears that B did not work as hard as A. However, A and B could have hired out a yard person at $10/hour to do yard work costing $140. They could also have hired a CPA to do the books at $90 an hour costing $360. In this case it looks like B got the short end of the stick.
Here is another problem. What if both partners don’t have an equal share of ownership? If it is a 60/40 split do you want to count hours trying to figure out if A has done 60% of the work?
I also see investors saying, I’ll do all the work and run the show for a larger percentage of ownership. That can be dangerous to both sides. If A must do all of the work and they get an extra 10% ownership, the danger is that huge problems could arise and A will need to spend a lot of time and effort to mitigate them, but, when the time comes to sell the property, there is minimal gain. A will go uncompensated. Or, conversely, there is a huge gain and A is unjustifiably rewarded 2, 3, even 10 times more than their effort. This is one of the least effective methods as it is impossible to foresee the future value of a property. Therefore, someone is most likely going to lose with this method.
How do investors deal with these problems? The simple solution is to pay the investor that does the work the wage it would cost to hire a third party. If this is written into your operating agreement it will save you a lot of headaches in the long run.
A question I get frequently is this. Does the investor doing the work make the same hourly wage that a professional makes? Yes, if the investor is as good as a professional. If the investor is not, then pay the total cost saved by not hiring a pro. Example paying a rookie $90/hour to do plumbing because a plumber makes that amount is probably not fair. I may be able to fix a leak but it might take me all day whereas a plumber may take 15 minutes. Try to pay the partner the cost it should have been, not by the hour. Or, for bigger projects get bids and let the partner that wants to do the work be a bidder. If his/her bid is lower, they get the job, if higher go with the pro.
This is not the only way to go. You can be creative. However, this is the way that I’ve seen work the best. You still have to trust the other party as they are going to have to use their best judgment to determine how much they saved the partnership to know how much to get paid.
One last bit of advice. Don’t partner with investor B. While having a CPA around is nice, non handy couch potatoes tend to make bad real estate partners.