House Flip Partnerships: Things NOT to Do

Private lenders believe that the borrower’s financial contribution to the fix-and-flip transaction makes their loan less risky. By contributing their own funds, borrowers demonstrate their financial discipline: their ability to save and manage money. They also show their faith in the transaction and its profitability. Having “skin in the game” motivates borrowers to move fast, work hard, and make responsible decisions.

At New Funding Resources, we fund the lion’s share of what’s needed to buy and rehab a property. We call it financial leverage. Financial leverage is using borrowed money (debt) to increase the potential return on investment. It allows investors or businesses to control larger assets with less capital, magnifying their potential gains. Essentially, leverage enables an investor to invest more than they could by relying solely on their own funds.

However, even with the financial leverage, it’s not uncommon for new investors to struggle to come up with enough of their own funds. Some have little capital and need to save more before becoming real estate investors. Others have some funds, but these funds might be not enough to purchase a property within their desired price range. For that group, bringing in partners who can contribute additional capital might be the right solution. However, consider these three mistakes before you run out to find such partners. These mistakes will complicate your foray into real estate investing and renovation business and cause havoc in your relationships with your partners.

HAVING MULTIPLE PARTNERS FOR A SINGLE FIX-AND-FLIP

The right partner can propel you forward both financially and professionally. He or she can help you qualify for a loan by contributing additional funds and that additional personal guarantee your lender might need. They can save you time and hassle by taking on a part of the renovation project. If they have more experience than you, they can

share their wisdom, helping you accurately evaluate an investment opportunity that comes your way, efficiently manage your contractors, and accurately price your newly renovated property.

Despite all the benefits of having partners, underwriters are often concerned when they see more than two partners in the deal. Why? The more partners you have, the higher the chances of misunderstandings, inefficiency, and conflicts.

Lack of funds is the most common reason for real estate partnerships. Imagine a brand new real estate investor with $20K in capital. Now imagine four brand new investors with a combined $80K working together for the first time. Talking about herding the cats! One of the partners might not have as much time to contribute as others, creating a feeling that he is “slacking off.” Another partner might not have enough experience and require too much hand-holding. The third partner wants receipts for every dime spent, and the fourth makes critical decisions without consulting anyone.

Perhaps more importantly, having multiple partners reduces profits for everyone. If you were planning to make $50K in profits and split them equally, each partner in a two-person partnership would anticipate taking home $25K. The payday will be more modest in a partnership with three people, and each of them would take home only $16K.

Let’s say you’ve run into unexpected expenses that reduce the profitability of your flip down to $35,000. With two partners, you still get a respectable $17,500 profit per share. However, with three partners, your house flip profit dips below $12K each.

An important question to consider is how your partners would react to this reduction. Some might become aggressive and combative, and others might feel unmotivated and disengage from the process. You have a problem in both cases.

For all these reasons, our recommendation is to keep the number of your partners to a minimum, preferably one. This will make your life easier, your fix-and-flip process smoother, and your renovation project more lucrative.

NOT DEFINING EACH PARTNER’S CONTRIBUTION AND RESPONSIBILITIES

Regardless of the number of partners you work with, the straightest path to conflict is not setting expectations. To avoid problems, define each partner’s contribution, including where it begins and where it ends. Also, make each partner’s responsibilities clear. If one partner contributes more money than the other, does it mean the second partner contributes more in time and labor? Is the money partner expected to pay for any additional costs? Who makes major decisions regarding the renovation? Who is paying the carrying costs of your rehab? Unless you discuss these questions in advance and preferrably in writing, you are running a risk of imploding relationships and dwindling profits for everyone involved.

NOT DOING BUSINESS AS AN LLC

Doing business in your personal name opens you up to all types of risk and liability. This risk is multiplied when you work with a partner. When you and your business partner buy a property in your personal names, your interest in the property will likely be affected by your partner’s liabilities. For example, if someone sues your partner personally – even if it’s on issues unrelated to your renovation business – they might go after the property you own together. If your partner has IRS liens or judgments, they might attach to the property you co-own. While we always advise against doing business in personal names, not creating an LLC while working with partners is truly asking for major problems down the road. If you don’t have an LLC, here are the quick steps to create it quickly and easily. A quick note: whether you are borrowing in personal names or an LLC, all your official partners need to personally guarantee the funds you borrowed to purchase and renovate the property.

New Funding Resources is a private mortgage lender financing rehab projects in Washington DC, Maryland, and Virginia.