Real estate partnership structure: Key steps and challenges

The IRS succinctly defines a partnership as “A relationship between two or more people to do trade or business where each person contributes money, property, labor, or skill and shares in the profits and losses of the business.” While this is an excellent start to understanding partnerships, there are many distinctions that must be made, particularly with real estate partnerships.

In this article, we’ll look at real estate partnerships in detail: the different structures, their benefits, key considerations in establishing a real estate partnership, their challenges and how to overcome them, and more. Let’s begin with a look at the different real estate partnership structures.

Understanding different real estate partnership structures

Just as there are different structures for corporations (Benefit Corp, C Corp, S Corp, Professional Corp, etc.), there are also five primary real estate partnership structures: general partnerships, limited partnerships, limited liability partnerships, limited liability companies, and real estate investment trusts. To choose the right structure, you first need to understand the differences.

General Partnership vs. Limited Partnership

While liability is of paramount importance to all parties when deciding on a general or limited partnership, many other factors need to be considered. These are the significant differences between the two:

Aspect	General Partnership	Limited Partnership
Liability	Unlimited liability for all partners	Limited liability for limited partners, general partners have unlimited liability
Management	All partners participate in management	Limited partners have no management authority, general partners manage the business
Decision-making	All partners have equal decision-making power	General partners have more decision-making power than limited partners
Contributions	All partners contribute equally as agreed	Limited partners contribute capital but have limited involvement in operations
Liability for losses	All partners share losses equally	Limited partners’ liability is limited to their investment
Partnership agreement	Not legally required, but advisable	Legally required to have a written partnership agreement
Duration	May dissolve upon the withdrawal of a partner	Can have a fixed duration or continue indefinitely
Taxation	Partners report income and losses on their personal tax returns	Similar to a general partnership, but limited partners may have certain tax benefits
Adding partners	All partners must agree to add new partners	General partners can add new limited partners without unanimous consent

It’s important to note that partnership laws and regulations may vary depending on where the corporation is domiciled or business is conducted. It’s always recommended to consult with a legal professional or refer to the laws applicable in your state.

Limited Liability Partnership (LLP) vs. Limited Liability Company (LLC)

Confusion abounds when the subject of LLPs and LLCs arises. These are their primary differences:

Aspect	Limited Liability Partnership (LLP)	Limited Liability Company (LLC)
Liability	Limited liability for all partners and owners	Limited liability for all members and owners
Legal entity	Partnerships with some characteristics of a corporation	Hybrid entity with features of both a partnership and a corporation
Management	Partners typically have management authority	Can be managed by members or appointed members
Decision-making	Partners have decision-making power based on partnership agreement	Decision-making power is determined by operating agreement
Ownership	Partners have ownership interest in the partnership	Members have ownership interest in the company
Formalities	Fewer formalities and less paperwork required	More formalities and paperwork involved
Taxation	Partners report income and losses on their personal tax returns	Can choose to be taxed as a partnership, corporation, or disregarded entity
Transfer of ownership	Ownership interests are generally not transferable	Ownership interests can be freely transferred or assigned
Formation	Typically formed by filing a partnership agreement with the appropriate state	Typically formed by filing articles of organization with the state

Research the regulations and requirements or consult a professional concerning the most appropriate business structure for your needs.

Real Estate Investment Trust (REIT)

A Real Estate Investment Trust (REIT) is a type of company that primarily invests in Income-generating real estate properties. It allows individuals to invest in real estate assets without directly owning or managing them. Investors can buy shares of publicly traded REITS on major stock exchanges; private REITs are also available.

REITS generate income through rental income from their properties, capital appreciation of real estate assets, and sometimes through mortgage interest. In addition, they are legally required to distribute a significant portion of their income to shareholders as dividends.

REITs usually specialize in a specific type of asset class. For instance, one REIT may focus on apartment communities while another may focus on retail, office, residential, healthcare, or industrial properties. Unlike other real estate companies, REITs are obligated to primarily hold and operate the properties they develop rather than resell them for profit.

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Choosing the right partnership structure for your goals

Without a specific goal or objective in mind, your chances of selecting the best structure for your needs are diminished. Decide what matters most to you – control, defined exit strategy, ease of reporting, tax advantages, etc. Consulting with your financial advisors and your attorney can also provide clarity.

Benefits of real estate partnerships

There are four primary benefits of real estate partnerships:

Enhanced access to capital and resources: Partnering with others provides you with capital to benefit from opportunities you wouldn’t have been able to pursue on your own because of financial limitations.

Risk mitigation and liability protection: The shared risk provided by a real estate partnership is often the best protection against financial loss and liability.

Pooling expertise and specializations: When it comes to real estate investing, partnering with others who have different strengths than you is a prudent move that dramatically improves your chances for success.

Flexibility in decision-making and governance: Aspects of real estate partnership agreements concerning decision-making and governance can be customized to suit the specific needs and preferences of the partners.

Key considerations in establishing a real estate partnership

No one enters into a partnership expecting it to fail. For a real estate partnership to flourish, there are numerous key considerations you must address and steps you must take before executing a formal agreement. They are:

Identify compatible partners

Ask yourself these three questions when you’re considering entering into a partnership: Do I trust my potential partner(s)? Are our goals and expectations aligned? And are our values similar? If you can’t answer in the affirmative to all three, take it as a red flag that must be addressed before pen and paper meet.

Define roles and responsibilities

Any team, sports or business, won’t succeed if people don’t know and agree to their roles and responsibilities. Partners can appear unmotivated and disinterested when they don’t clearly understand what’s expected of them.

Structure capital contributions and profit sharing

This is an area where many partnerships struggle. Expectations of what a partner will contribute financially, what their percentage of the profits will be, and when they’ll receive those profits are where the wheels can come off. Discussions and commitments concerning these issues must be attended to before operations begin.

Outline decision-making processes

Knowing in advance how decisions will be made is a defining characteristic of successful partnerships. Those who wait to delineate decision-making power and protocols clearly can open themselves up to dissension and disagreements when critical decisions need to be made.

Create an effective partnership agreement

An effective partnership agreement provides clarity, addresses potential issues, and establishes a framework for the smooth operation of the partnership. It should be clear, concise, and comprehensive. You should have arrived at it through the collaboration and consensus of all the partners. Naturally, the plan must be legally compliant for the jurisdiction in which it operates. Finally, it should be flexible and adaptable, while also being realistic and fair.

Real estate partnership challenges and how to overcome them

Every partnership, personal or professional, will experience challenges that must be overcome for the partnership to continue in a healthy and functional manner. There are several key considerations concerning real estate partnership challenges.

Communication and conflict resolutions

Effective communication and conflict resolution require ongoing effort and a commitment to collaboration. Real estate partners can foster a positive and productive working relationship by prioritizing communication, actively working through conflicts, and implementing resolution strategies.

Managing expectations and aligning goals

Expectations and goals should be agreed upon before individuals commit to a partnership. If a conflict arises, partners should come together to discuss and reassess the partnership’s goals, objectives, and strategies. Managing expectations and goals in a real estate partnership requires continuous communication, active participation, and a shared commitment to the partnership’s success.

Exit strategies and dissolution planning

One of Steven Covey’s 7 Habits of Highly Effective People was “Begin with the end in mind.” This is certainly true for real estate partnerships. Discussions should be held before the partnership is formed concerning goals and what happens when those goals are, or aren’t, reached, and one or more of the partners would like to exit the partnership. There should be no surprises concerning the dissolution of a partnership.

The future of real estate partnerships

The future of real estate partnerships is being shaped today by various factors, including market trends, technological advancements, and evolving investor preferences. While these factors offer insights into potential developments, the future of real estate partnerships will also be influenced by broader economic conditions, regulatory changes, and investor preference. Adapting to changing market dynamics will remain essential for real estate partnerships to thrive in the future.

Conclusion

Real estate partnerships have long been a prominent vehicle for investors to collaborate, pool resources, and pursue promising real estate opportunities. As the real estate landscape continues to evolve in a post-pandemic world, real estate partnerships will very likely remain a cornerstone of the real estate industry as they seize opportunities and shape the future of real estate investment.

 

Modified Date & Time : 22 Apr 2024, 06:26 am