When you know what you're doing and follow a proven strategy, investing in real estate offers an incredible opportunity to grow your wealth and set yourself up for a comfortable financial future. The problem is that most forms of real estate investing require a substantial amount of money. And this often makes it very difficult for individuals to get started. Also, if you're not sitting on a pile of liquid funds, you may be wondering if it makes sense buying a house with a friend as an investment.
The short answer is that it depends. It can work out well, but there are a lot of important factors to consider before jumping in.
The Pros and Cons of Investing in Real Estate With Partner
Investing with a partner can combine complementary skills and boost your capital and borrowing capacity. But it also complicates the real estate investing journey significantly. It can even strain family and friendship relationships beyond repair.
Real estate is a long-term investment. Keep this foremost in mind when you're considering investing in real estate with a friend or relative. You're entering into a long-term relationship with whomever your partner. So, there must be trust, commitment, shared vision, open communication, and a big helping of perseverance. Make sure everyone involved shares the same mindset of being in it for the long haul.
Assuming you're on the same page with your friend or relative, let's look at the pros and cons of buying real estate with someone.
- Access to capital. Partnering with someone allows you to take advantage of an opportunity sooner, rather than waiting and saving until you can fund a deal yourself. And having more capital opens up the number of deals you can consider.
- Ability to ramp up faster. Combining money can give each of you a head start in buying a larger property or several properties much sooner than you could have done individually.
- Familiarity can reduce partnership risk. You know whom you're dealing with. At some level, you have familiarity and trust with a friend or family member. This offers an advantage over investing with a stranger.
- Harnessing the advantages of shared knowledge and expertise. Let's say your uncle is a licensed contractor who also has landlord experience. And let's say you have access to great deals and a pot of money to invest. You can work together to have a competitive market advantage to purchase and manage a rental property. These types of partnerships can also be beneficial in shortening both of your learning curves.
- Relationship risk. Friendships and family relationships are complicated. Adding an investment partnership with all the things that can go wrong creates additional stress and complications. You could lose a relationship if expectations aren't met, and the experience ends poorly.
- Slower decision-making capability. With two or more people, you could lose the ability to make quick decisions. Differing opinions and expertise can lead to an impasse on crucial and timely decisions. More stakeholders slow down decision making and sometimes close it down, which can cost money and missed opportunities.
- People change. Goals change. Investments go south. Life changes bring new complications over the course of the investment partnership. These include marriages, divorces, financial hardships, job changes, and relocations. All these things must be successfully negotiated and dealt with to maintain a good working relationship. In reality, there are more reasons for it not to work than for it to work out well.
- Missed tax and first-time homebuyer benefits. In my state of Maryland, there are grants and other benefits available to first-time homebuyers. For example, there's a one-time opportunity to save recordation taxes. When two people purchase a property together, they both use up that first-time homebuyer chance rather than each of them having the chance to use the benefit individually.
- Money and friends/relatives are a dangerous mix. One of the pros is that you know whom you're dealing with. But do you really know them? When money is involved, the relationship crosses a line that could bring out the worst in otherwise very nice people!
- You'll likely incur legal fees and additional hurdles. When you go it alone, you don't need to draw up partnership agreements. And you might not even need to consult with or pay for an attorney.
How to Minimize Risk When Investing in Real Estate With a Friend or Relative
Have you decided that the pros outweigh the cons? You can do some things to minimize the chances of things going wrong and reduce disputes and disagreements.
1. Clearly Define — and Agree on — the Investment Strategy and Goal
There are many real estate investing strategies. You can combine funds to invest in crowdfunding projects, a buy-and-hold rental property, or a fix-and-flip property. Or invest in some other strategy.
When investing in tangible property, the two main strategies are:
- A shorter-term strategy of buying a distressed property, fixing it up, and selling (flipping) it for a profit.
- A longer-term plan to buy and hold a rental property with positive cash flow.
I've personally bought distressed homes and weren't sure whether the property would become a buy-and-hold or fix-and-flip in the initial phase. The choice depends on a lot of unknown factors until you get into the actual renovation. However, when combining funds with another investor, it's more important to agree on the strategy in advance and move forward in unison.
2. Define Participation Roles and Timelines
Decide what roles each partner will take. Detail what's involved and attach a projected completion date. Documenting a projected timeline is crucial. Time is money, and delays can quickly derail profitability. If it takes twelve instead of three months to complete a rehab and you're using borrowed money to finance the project, your costs just increased dramatically, and your profits just decreased.
3. Document All Agreements in Writing
Create a legally binding document once everyone involved has agreed on the roles, responsibilities, and investment partnership goals. If you're taking on debt to finance the investment, get an attorney to draw up a co-borrowing agreement to protect each person's interests and rights.
Without legally binding agreements in place, the things that go wrong are sure to cause disagreements. The documents should eliminate confusion about the percentage of funding to be provided by each party and how profits and rental income will be distributed among partners. Make sure all agreements are in writing, and each participant signs off on all the terms.
4. Plan for Changing Circumstances
Life happens to all of us, and circumstances can change dramatically for one or both of you. Your financial situation a year from now could look totally different from today. So make sure everyone agrees on what will happen if the situation changes.
What happens if your uncle loses his job and can't fund his part of the deal? Will the home now go into foreclosure, or do you have a plan B? While it's difficult to plan an uncertain future, it's important to project some situations that may occur and agree on what will happen to the partnership and investment should the financial situation of either partner change.
5. Communicate Regularly
Schedule a meeting or Zoom call at least every three months, or even more frequently. Ensure everyone knows what's going on with the investment at all times. Problems that go unaddressed get larger over time. So make a plan to meet about the investment status regularly. If everything is on target, you can use the meeting to celebrate your success.
6. Discuss and Agree on Your Exit Strategy
Have an exit plan and set up contingencies should one of you want to leave the partnership. If it's a rental property, for example, answer the following:
- How long will you hold it?
- What are the terms if one person wants out of the partnership or wants to sell the investment early?
- What are the terms if you're successful and other family members want to join?
When investing with a partner, choose a strategy that makes the most sense. In general, the simpler the deal, the easier it's going to be to keep everything moving smoothly.
Case Study For Buying an Investment Property with A Friend
Let's say you're planning to buy a property to rehab and flip. There's a high level of complexity and a lot of things that can go wrong. Perhaps the goal is that your brother-in-law is going to do all the rehab work. You put up all the investment funds. And the two of you split the profit 50/50 when it sells.
But what happens when he takes too long to do the rehab work leaving your money tied up for more than a year? Or he underestimates the rehab costs, and all of a sudden, you need to come up with another $30,000 to get the job done? Not only are you facing financial difficulty, but you're likely also experiencing a fractured relationship with both your brother-in-law and your sister.
A simpler investment might be joining together to combine finances to invest in a crowdfunding deal where you each put in 50% of the funds needed and decide to share the profits 50/50 when it closes. Let's say, for example, you have $12,500 cash, but the minimum investment in a great deal at Arbor Crowd is $25,000. There's no real complexity. You each put in the same amount. All the financial accounting is done for you by the crowdfunding platform management. And when it closes, you each take 50% of the profits.
But again, it all depends on what you want. With some partnerships, shorter is better as it lessens the time in which disagreements can develop. When all parties have a clear and documented understanding of all the aspects of a fix-and-flip deal, avoiding a long-term relationship can be a plus.
Our Recommended Crowdfunding Services:
Should You Invest in Real Estate With Someone You Know?
In general, my conclusion is that it's not a good idea to invest in real estate with a friend or relative. With 40% to 50% of marriages ending in divorce, you're taking a big chance that you'll be able to maintain a favorable and committed investment relationship with a friend or relative for the next 10–20 years.
A small disagreement about how responsibilities are being shared can quickly turn into a major fight. Keeping everyone happy is never as easy as everyone thinks it should be. Money always brings out the worst in people, or so the saying goes. While there are no absolutes, it does seem likely that investing with friends and relatives will cause relationship stress.
That being said, the goal of real estate investing is to make money. If a working relationship can be forged that has a high likelihood of making money for everyone involved, it could make sense to move forward despite the added stress of managing money matters with your family or friends.