Real estate is a common and attractive investment for many. From a financial standpoint, you build equity in a property that appreciates over time and there are tax benefits. From a personal perspective, you own your own home that you can live in, rent out, or flip to sell. It seems like a win win, but when investing in property with friends, there are five things you should keep in mind:
1. Get to know your friends personally and financially
It seems obvious, but investing together is different from brunching together, so you’ll want to make sure you trust the person you’re investing with and set up ground rules (we’ll talk about this later), so that you’re both protected. From a financial perspective, when you invest in a property with a friend, the mortgage will be in both names, which means both of your credit reports will be pulled. If one of you has bad credit, that means you may not qualify for a low interest rate or qualify at all for the loan you were hoping to receive. This also means if someone misses a payment, your credit score could be affected. Make sure you know your friend’s financial situation before going into business with them.
2. Form an agreement or LLC
Outlining an agreement or forming a limited liability company (LLC) are great ways to identify responsibilities, roles, and risks for your investment. When forming an LLC, you’ll have to draft an operating agreement (tips to do that here), so that it’s clear how your allocations, ownership, and roles are outlined. This also will provide you with a certain layer of legal protection as a business that a personal engagement would not. If you’re curious about starting an LLC and business bank account, check out Tribevest.
In your personal agreement or LLC operating agreement, you’ll want to make sure you both know and agree on what happens in the event of:
- Selling of the property and proceeds
- Sharing of loss and exit strategy
- Marriage or death
- Ownership arrangement changes
- Market fluctuations
- Tax implications and insurance
- Repairs and upgrades
3. Be clear on roles and responsibilities
Again, this is what an Operating Agreement for an LLC can help with, but in the meantime, make sure you consider and document the following:
- Budgeting & Bill Payment
- Financial Transactions & Accounting
- Repairs & Improvements
- Renter Agreements & Tenant Relations
- Contact Tracking & Relationship Management
4. Define ownership
There are two types of ownership to consider: Joint Tenants or Tenants in Common. In this case, “tenants” refers to the type of ownership and not the individual renting. Please note each of these legal arrangements have various implications, so you’ll want to consult a legal advisor, as needed.
- Joint Tenants: Each owner has an equal share in the property that you own together. When you’re married, this 50/50 ownership ensures that if a spouse passes away, the ownership passes directly to the other owner without going into probate. However, if you’re investing with a friend, this means the entire property value is included in the deceased friend’s estate, meaning this is not a great choice for friends who invest together in real estate.
- Joint Tenants with Right of Survivorship: In this scenario, if one owner dies, the value of the property goes in full to the other owner. This may seem like a great plan if you are investing with a friend, but if your friend wanted their portion to go towards their spouse or children upon death, you’ll want to consider Tenants in Common.
- Tenants in Common: In this option, you and your friend own an undivided share in the property. This means you determine if the ownership proportion is 50/50, 60/40, 75/25, etc. If you have more money to put down than your friend, this makes things clean and simple as your ownership matches your contribution. If one of you dies, the property will pass to that individual’s beneficiaries, so make sure you each have a will or an asset allocation document.
5. Pooling your money
Real estate properties come with a variety of expenses from taxes, insurance, maintenance, homeowner’s association fees (HOA), repairs, appliances, and more. You’ll want to assume that 1-3% of your property value should be set aside for these expenditures. While you can create separate bank accounts for investments, brokerage accounts, or do a joint account, we’d recommend going the business banking route. When you form an LLC, you can set up a business banking account. This allows you and your friends to schedule contributions to one account and ensure all business transactions are handled through one account under the protection of your LLC status.
If you’re nervous about investing with friends and family, you don’t have to be. With Tribevest, we make it easy for you to start an LLC, open a business banking account, pool money, and invest in property in no time at all.