At some point in your journey as a commercial real estate investor, you’ll find a great property, with wonderful potential. But, you’ll be short on financing. Fortunately, if you have some experience under your belt and are willing to do a bit of work, you can finance that property by taking on a partner. Building a commercial real estate partnership is great for the short-term benefit of being able to raise private money. And it is also great for the long-term since a good partner will help you scale your investments to a higher level.
Finding a great partner is a lot like finding a life partner. It’s not a relationship you’ll want to rush into. Instead, taking the time to make sure you both share the same values and mission is a surer recipe for success. In the same vein, once you’ve found a potential partner, it’s a good idea to spend some time working together first before you seal the deal. Sometimes you’ll discover that despite the seeming “perfectness” of the match, the personality mix or skill mix don’t complement each other.
If you do find yourself in the lucky position of having found a great deal and a potential partner, the next step is to decide exactly what type of commercial real estate partnership fits your investment goals.
Below are several common types of partnerships to consider.
Debt commercial real estate partnership is when debt partners receive interest on their investment (usually between 5%-7%). It is secured by a mortgage (as a bank would offer), a promissory note, or property insurance. They do not receive any percentage of the NOI or equity; they are merely interested in getting back interest along with their capital by the promised date. And although the interest rate may be higher with debt partners, they maintain absolutely no participation in any part of the running of the property or receive future payouts.
Debt partners might be a good choice for you if you just need a smaller amount of money in order to help you close a deal, or if you plan on buying the property, fixing it up, and selling it again within a short period of time. Over the long term, they are less expensive since they don’t receive any equity in the property. The only disadvantage of using a debt partner is that you absolutely must make sure to repay a debt partner on time. Otherwise, they have the right to repossess the property.
Equity partners differ from debt partners in that they are lending you money to finance the property in exchange for an ownership percentage of the property. In addition to owning a percentage of the property, they are entitled to participate in any decisions that need to be made about the property. They also receive a portion of the cash flow, as well as any appreciation or depreciation that accrues on the property.
Equity partners are used when a debt partner offers too high of an interest rate, or when the investment is long-term. While equity partners may be individuals, they may also be private firms and are often more willing to lend money in areas where other lenders might not, such as when a buyer has weak credit.
One advantage of using equity partners is that they are also able to move faster than banks or even debt partners, allowing you to close a time-sensitive deal quickly. Also, when using equity partners instead of debt partners you have no obligation to pay them back for funds borrowed. Since equity partners receive their payment in the form of a percentage of ownership, they will be involved in increasing the cash flow, which can act as an advantage.
Sweat Equity Partners
Sweat equity partners are a form of equity partner. Basically, it means that one partner invests capital, while the other partner invests “sweat,” or does the work necessary to make the property successful. Although profit-sharing partnerships vary in terms of how each side is reimbursed, generally the working partner will receive a regular salary, with a share of the ownership of the property. The percentage of ownership the working partner receives will depend on how critical his role is to the success of the property, and can sometimes increase from year to year based on his success.
Whatever type of commercial real estate partnership you choose, the exact terms of how each partner will be compensated are entirely up to you.
As long as each partner:
- feels the distribution is fair, and,
- is clear about what their responsibilities are,
then you have the basis for a good working relationship.
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