By Don R. Campbell
Cutting Edge Research Inc.
Knowledge will be your capital… Integrity be your magnet… Relationships will be your fuel
There will come a time when most real estate investors will be looking for secondary sources of cash to build their portfolios. Some will use additional leveraged monies, such as Lines of Credit, or equity in the rest of their portfolio, or even private money. However, one of the most common solutions is bringing a ‘Money Partner’ into the mix – someone who can provide working capital to fund the portfolio growth and who is looking to get a return on their available cash.
Although this type of relationship is commonly called a Joint Venture, in many cases it is not technically such. Many times it could be a shareholder relationship, where the investor and the cash provider own shares of a corporation which they use to invest. In other cases, the money investor just wants a simple, annual percentage return on their investment – this would be a lender relationship.
A true joint venture occurs when two or more parties get together, pool their money, knowledge, and leverage to build a portfolio. No shares are owned, it is just two or more parties deciding that the best course of action for both is to work together. They agree to terms on money, dividing of duties, and setting of goals. From that comes a Joint Venture Agreement (or as some people call it a Business Prenup agreement). This agreement must be detailed and must be completed before any money passes hands because once real money enters the equation, new emotions enter, making the written agreement much more volatile to create. When an agreement such as this is created, it becomes the basis of the relationship moving forward and deals with all potentialities (taxes, income, expenses, death, divorce, duties and disputes).
The majority of these Joint Venture deals are structured where one partner finds and negotiates the real estate deal to the absolute best of their ability, while the other partner or partners puts up all or part of the cash in return for participating in the ultimate profits or losses in the deal. They are full partners, each with their own risks in the deal. One is contributing their vast expertise, experience and contacts to maximize the profits in the deal by choosing the property wisely, arranging a good price, and then managing the day-to-day operations of the property. The other is often a silent partner providing just the initial investment capital. Risks are shared, as are the rewards, mostly on a 50% each party basis (after the money partner is paid back their capital first.).
As a very simplified example (that does not take taxes into the equation):
PURCHASE & OPERATION:
- Property is valued at $350,000 when purchased, but real estate expert partner negotiates the deal and buys it at $300,000.
- The money partner puts up $65,000 (for down payment and closing costs),
- A mortgage is arranged for the remaining $240,000.
- Property is overseen by the real estate expert partner
- Money partner receives monthly or quarterly updates
SALE & PROFIT SPLIT
A few years later, the property is sold for $420,000. Here’s what happens:
- Bank gets paid back the remaining mortgage of $210,000
- Money partner is paid back their initial $65,000
- Closing costs are paid (lawyer, realtor commissions) $5,000
- Leaving $140,000 pre-tax profit which is divided equally between the two partners
This simplified math scenario above is very typical where the money partner, with very little effort, receives a strong return on their initial investment. The real estate expert puts in all of the effort of maximizing the profit for the partnership, spending countless hours so the money partner does not need to.
There is one component that is missing from this equation and that is the positive cash flow that is created from the property (usually beginning in year 2 of ownership). This cash flow, in most cases, is split 50/50 on an annual basis, not monthly or quarterly due to the fluctuating and seasonal operating expense waves.
Bringing other people’s money into your real estate deals can be a huge win for both parties involved, but I must warn you, it is critical that you look after the other partner’s money better than you would even protect your own. In order to make this structure successful and repeatable, you must give extra attention to your due diligence, making sure you’re buying into the “right deal.” Never, ever put someone else’s money into a deal that you wouldn’t put your own (or your grandmother’s) money into.
Never tolerate risks that you or your investor wouldn’t normally accept. Explain the risks to the money partner in advance and keep in close contact with them. If there is bad news, don’t hide it. If there is great news, tell them early and often. This is critical because a successful deal is the best way to attract even more funds to your investment business!
Leverage in real estate comes in many forms including leveraging of money, leveraging of time, leveraging of knowledge, as well as leveraging of expertise. All four take time to create, all four are equally as important in a deal and all four must be in balance for the deal to be profitable. That is why business relationships between people with different assets and skill-sets work much better than those with matching skills.
Never, ever put someone else’s money into a deal that you would not be willing to put your own or your favorite friend or family’s money into.
A colleague of mine, Peter Kinch, has written a book titled “The Canadian Real Estate Action Plan”. In it he shares the story of a couple who is building their portfolio and need to attract Joint Venture Capital in order to achieve their financial goals. He has a unique way of sharing the importance of planning for inevitable Joint Venture attraction. He uses a car as an analogy:
“I want you to picture your real estate goal as a thousand-mile automobile journey and your biggest obstacle is simply a lack of gas. All you need to do to reach your goal is to plot out how and where to find the gas stations along the road map. Now the problem is, if you don’t have a map and you’re simply looking out the front window hoping you’ll stumble across a gas station along the way, the odds of you running across a gas station at the exact same time you are about to hit empty, is remote.”
“…this is exactly how most real estate investors approach using JV partners. They wait until they run out of money or options and then turn to it as a “last resort,” with little or no preparation.”
Put this way, it becomes quite obvious that from the very beginning of your real estate investing journey, you should be positioning yourself to be a good ‘stopping place’ for other people’s cash so you can fill up your tank and keep moving. The best way to do this is really rather simple when you think about it. Peter continues:
“What if instead of focusing only on what kind of real estate you are going to buy over the next 18 months, you shifted your focus to thinking about what a potential JV partner would want to see in you? Who would I need to be in order for someone to believe enough in me to trust me with their money? Are you that person today? Is there anything you need to change in order to become that person? What if, in the process of spending your seed capital, instead of concentrating on what you are buying, you focus on becoming the person you need to be in order to attract JV capital in the future?
It is important to understand that you don’t need to be that person today—you need to become that person. When you start thinking this way, it will change the role and purpose of your seed capital. Seed capital is now no longer simply cash for a down payment. It’s the tuition fee that allows you to develop into a sophisticated real estate investor who is well positioned to be able to attract JV capital in the future. In order to understand this, they, and you, need to learn about CCI—confidence, credibility and integrity.
CCI—THE SECRET TO ATTRACTING JV CAPITAL
The key points of Peter’s CCI philosophy:
- You get confidence by doing.
- You get credibility by having some results—some fruit on the tree.
- You get integrity by using your own money to earn your stripes and not by using someone else’s money as your tuition fee.
Peter asks a very powerful question that we all need to keep asking ourselves as we progress as investors “What can you do over the next 18 months, with your current knowledge and capital, to develop CCI and position yourself to make it easy to attract Joint Venture capital?”
In other words, when thinking honestly, are you the type of investor that others should and will feel comfortable in as an investment partner? Or do you have some obvious work to do to become that person who others gladly, and safely, write $50,000 cheques to knowing it will be well taken care of.
Once you are ready to accept investment capital, and you have all of the appropriate paperwork ready, then the next obvious question is:
But Where Do I Find Willing Investors?
First step is to begin with people you know. First and foremost, never underestimate those around you when it comes to available investment capital. Many will surprise you if you approach with the right deal that fits their needs and risk tolerances.
These potential investors can be anyone from parents, friends, relatives, professionals (doctors & dentists) right to those who hang out at the same club or gym as you. The biggest mistake that can be made is pre-judging someone as ‘not having any money.’ I have seen this back-fire on many beginners, only for them to discover a year later that the person they dismissed ended up investing in something else with someone else.
This is a business and you must prospect for potential partners. It all starts with basic conversation – making sure that everyone knows you are a real estate investor and that you work with others as partners. Once you have casually started this conversation you will quickly be able to determine whether they are interested or not by their body language and the direction they take the conversation. If they are obviously not interested, DO NOT PUSH IT! There is a whole system that we have designed just for this critical piece and it is outlined in the Joint Venture Secrets Program you can find at www.reincanada.com .
Once you find someone who wants to work with you, the next step is to immediately begin treating it like the business that it is. This is especially important for friends and family, as these relationships are often taken more casually when they in fact should be taken even more seriously.
Your job is to make sure that the deal is a winner for them first, then you second.
Whether you are attracting a money partner or you are providing the money for the partnership, it is critical that you complete a background check on the other party. Yes, this can be a bit uncomfortable at first, especially with family or friends. However, it is MUCH MORE uncomfortable later on down the road if something goes wrong. Whether family, friends or business associates, it is very important to him to know who he is really going into business with.
Once again it goes back to treating the partnership like a business. You must ensure that legal agreements are written and you have designed the divorce in advance. The Joint Venture agreement is like a pre-nuptial agreement for your real estate business and is MUCH easier to discuss and agree to during the early honeymoon phase of the relationship. Along the way, you should hold regular meetings to discuss the money and the property, but not on family or friend time – keep these separate.
Last but not least, before you buy your first property with your new partner, create an agreed-upon spreadsheet that will be used to divide the profits. Use your accountant to ensure that all of the tax, dividend, and expenses are included in the calculation. Both partners agree that this will be the template so there are no disputes in the future. This spreadsheet becomes an integral part of your Joint Venture Agreement.
Keep Your Advisors Informed
In all cases, structure your deals in advance. Have the detailed conversations before the deal is signed and then work very, very hard to ensure the other party wins, because when they win, so do you.
For a much more detailed look at the potential of Joint Ventures in real estate, visit
http://www.realestateinvestingincanada.com/product/tabid/59/p-114-jv-secrets-e-book.aspx for a special e-book and audio.