What You Need To Know Before Buying An Investment Home With Friends
Of course, like all reality television, home improvement and home flipping shows don’t tell the whole story. And savvy would-be investors realize this, which is why a new and growing trend has been emerging in the real estate market: Aspiring or existing homeowners who want to team up with friends to buy an investment property, either to fix up and flip or to rent out, sometimes spanning several states.
If this concept has crossed your mind and you’re intrigued enough to learn more, then keep reading — there’s a lot you need to know about investing with a friend before you take the plunge and actually do it.
Real estate investing with friends can be done, if you approach it the right way
Some experts might tell you not to even consider investing with a friend. It’s too risky, you could destroy the relationship, investing alone is challenging enough … pick your argument, and someone is making it.
But those experts are ignoring one important fact: There are people right now who are investing in properties with their buddies and making it work, and work well, for everyone. The level of participation to date is too low to really call it a trend, but there are plenty of people who work in markets where the income is relatively high, yet they’re not aspiring to own a home for themselves because homes are simply out of their reach.
San Francisco is an excellent example. Wages in the market are higher than almost anywhere else in the country, but when home prices are in the seven digits for a basic starter home (and they are), then that high income really doesn’t help you unless it’s at the very top level and you’re able to pay for a down payment, property taxes (remember, the deduction for mortgage interest just went down significantly for properties in this value range), and other basics, let alone fixing the place up until it shines.
As a result, groups of friends in areas like San Francisco are pooling their money and buying up homes in areas with lower home prices, such as in the Midwest or the Southeast. Of course, not everybody is following the same path, but there’s enough interest in this kind of deal to make it very appealing to certain types of people.
So beware of the advice coming from experts in your neck of the woods if they’ve never heard of this kind of arrangement. It might not be all that common, and maybe they haven’t encountered it before, but it’s definitely happening — and there’s no reason why you can’t participate, too, with the right mindset and a good friend or group of friends to help.
Do you have the same goals for the investment home?
To make a deal like this work, everyone involved needs to be on the same page when it comes to goals and expectations. Perhaps you’d make more money sooner on a fix-and-flip deal, but if you don’t have a solid point person in the area who can manage the contractors and permits for you, then it’s probably much wiser to think about a buy-and-hold strategy, where you purchase a home, make a few tweaks to get it rental-market-ready, then rent it out.
Of course, deciding on your strategy is just one piece of a vast puzzle. How long will you keep the home if you’re renting it out? Will you consider lease options for renters, where you offer them the chance to buy the house from you after a period of time has passed, or are you only interested in monthly rentals? What about a vacation rental — will you list the house on Airbnb or VRBO and achieve your return on investment that way?
There is no one perfect answer for any individual, and that lack of a perfect answer can increase exponentially when you add additional borrowers to the mortgage. It’s really not enough to say “We want to rent this place out.” You need to think about what kind of rental you’re creating and behave accordingly.
Your partners’ finances matter — a lot
To set an interest rate for a mortgage loan, lenders spend a lot of time parsing a borrower’s ability to pay back a loan; they look at everything from current and past bank statements to tax returns to itemized lists of assets and debts in order to assess each borrower and set the interest rate.
Do you know if your buddy has overdrawn his account recently? How much money is your potential partner paying in alimony or child support every month? If your investment colleague already owns a home, do you happen to know whether she is current on her payments or whether the loan is “underwater”?
The terms of the mortgage, including the mortgage rate, are going to best using information from every single borrower involved. You may trust your friend beyond all reason and are perfectly happy to let them watch your dog or even babysit your kids, but if you don’t have a good answer about whether or not they’re responsible financially — at least as responsible as you are — then you’ll want to get one before you apply for a mortgage loan together.
How will you split the profits?
Maybe everyone involved is putting an equal amount toward the down payment and any repairs that need to be done. And maybe everyone involved is also putting an equal amount of money effort toward fixing and flipping the home, or toward managing the renters, so it’s possible that an equal split of both equity and profits are a simple solution to the issue of “who gets what.”
But that’s pretty rare in most group deals, where one borrower might be providing the bulk of the down payment while another plans on pitching in with their time and energy more thoroughly. Have a serious discussion about what the expectations are for rental return, what you plan to do with the profits accrued, and how you plan to split them up.
For example, perhaps it makes sense to open a joint bank account where you can park the profits from your rental investment, which you can also use to pay the mortgage or accommodate any expenses from your fix-and-flip or rental project. Contractors who are fixing up the house will need to be paid — who’s responsible for that, and to what extent? What if a pipe bursts in the rental or you need to replace a water main? Keeping some of the profits in a joint account can make a lot of sense, especially if you expect ongoing expenses from the project.
When there are profits to be paid out and you don’t need to worry about expenses for whatever reason, then think about what kind of split seems fair. If one party contributed to most of the down payment for the home, then maybe they should get more than 50% of the profits until their down payment is paid back. Or maybe they’ll be happy taking additional equity in the home and will reap a bigger share of profit when the place is eventually sold. Every group is different, so find a profit-splitting strategy that works best for yours.
Getting out of the deal could be a problem
Nothing lasts forever, and that includes a real estate investment deal. One of you may be ready to bounce before the others are, so you need to make an exit strategy for what will happen if you lose a partner or the rest of the group wants to exit gracefully before you’re really ready to call it quits.
Have another chat with your partners and talk about what kind of timeframe seems reasonable for the investment. If they only want to be involved in this kind of deal for 12 months or fewer, then perhaps a fix-and-flip strategy is going to work best for your group — that way there will be no question about what the profit is or could be, and a year is enough time in most markets to get everything fixed up and sold without a significant time or budgetary crunch.
But if your group is in it for the long haul, and a rental home seems like a better investment to you, then you’ll need to talk about what to do if someone wants to take their money and run. Will the rest of the partners buy them out, or will the house need to be sold? If the other partners are going to buy out the exiting partner, how will you determine the buyout amount? Will it be based on the purchase price or the current value of the house, and how will you figure out what the current value is? How long will partners have to make a decision about the buyout, and how long will they have to exchange those funds?
Yes, it’s a little disheartening to talk about how you’re going to break up a partnership before it even starts … but if you don’t, you could find yourself facing this situation without a plan at all, and if anything has the potential to kill a relationship, it’s a lack of a plan when someone wants out.
You might disagree over who’s responsible for what…
Buying the house is never the end of the list of expenses. There are almost always things you’ll want to do to the house before you sell it again or rent it out, and that’s especially true if it’s a flip. How far do you want to go to make the house ready to sell again, and who’s going to pay for what when it comes to fixing it up?
In some ways, a flip can be easier than a buy-and-hold strategy for dividing up responsibilities. Anyone who owns a rental property can tell you that it’s almost impossible to anticipate the expenses that emerge, often with no warning. The plumbing and electrical emergencies can be more expensive than you thought — especially if the home is occupied; you need to make sure it’s consistently habitable.
But sometimes you might get a special request from a renter, and there are also the expenses that emerge when the place is empty. If the departing tenant didn’t do a great job cleaning up, you’ll need to hire a cleaner; you may need a landscaper or someone to mow the lawn while the house goes back on the rental market; finding and vetting renters in and of itself can be expensive and time-consuming, too. Are you going to do credit checks on potential renters? Will you require references from previous landlords? Will you allow smoking or pets in the house? Even if you forbid those things, if someone breaks your rules, what’s your plan (beyond leveraging a security deposit) for cleaning up after them?
All of these problems become your problem and your partners’ problem after you decide to invest in property together. Try to hash out who’s responsible for what as early as possible, and make sure your profit-sharing plan reflects what you’ve decided.
… So it might make sense to hire an experienced flipper or property manager
If none of the group of partners lives in the area where the property is located, then it’s probably smart to talk about who’s going to manage the place for you in a very boots-on-the-ground sense. Even if you’re planning on turning it into a full-time vacation rental, you shouldn’t ignore the local aspect. What will you do if there’s a late-night emergency with one of your tenants? Or if someone arrives at the vacation rental and it’s been burglarized in between visitors? Do you really want to try to handle that from miles or even states away?
Both fix-and-flip and buy-and-hold investors are going to want to think about finding and appointing a local to help them manage the deal. You really don’t want to be chasing down contractors from afar, so a local flipper with experience who’s willing to manage the flip for you — for a fee, of course — can be a lifesaver and end up saving you both time and money on your flip. A good property manager, too, can be worth his or her weight in gold, even for vacation rentals, so talk about whether you’re going to hire one and how you’ll pay for it before you start shopping.
An attorney can solve a lot of these problems for you
We know: Thinking about teaming up on a real estate investment property sounds like a lot of work. It is! But it can also be hugely rewarding. To make sure that you’re maximizing the reward and minimizing the headaches, it’s a very wise idea to loop in an experienced attorney who has helped other real estate investors navigate the maze.
An attorney can help you create legal documents that will carefully outline the responsibilities, profits, exit strategies, and other issues that could arise, giving everyone involved confidence that they know what’s happening and how to handle any unforeseen events (because they will have been foreseen and managed by the attorney).
And an attorney can also help you find your blind spots, if any, either with one deal in particular or with the partnership in general. Most attorneys experienced in real estate investment have seen just about every way a partnership can sour, and they can help you erect parameters that prevent that from ever happening to your partnership — or your relationship.
If you don’t know any attorneys who specialize in this area of law, talk to your real estate agent. They can likely refer you to someone or ask their own network for a solid recommendation.