January 2014

COMMERCIAL REAL ESTATE PARTNERSHIPS – WHAT’S THE PROBLEM

Many investors form a partnership to acquire commercial real estate. Most of these joint venture purchases mistakenly have not been legally established as partnerships prior to the close of escrow. Two or more partners may sign personally for financing at the time of the purchase and after escrow form a legal partnership.

This scenario referenced above is common but can be very dangerous. Zig Zigler the late motivational speaker has a phrase called “stinkin thinkin.” The lack of a written partnership document at the close of escrow is a perfect example of this phrase.

The Lawyer who is hired to draft the partnership must take considerable care in interviewing the partners and determining their goals, duties, and financial interests in the property. Let’s presume the lawyer has a good financial background or confers with other counsel to determine the best partnership entity that works well for the individuals for tax purposes. Should the partnership be taxed as an LLC, C Corp, S Corp, or a Tenant in Common?

The type of partnership depends on many factors or goals of the individual partners.
Samples of these partnership goals are listed below:

1. Will the property be sold quickly or held for long term
2. Will one of the partners utilize the property for their own use
3. What is the price in mind as to a subsequent sale price or lease price
4. Can the partners subsequently sell part of the property and hold on to a portion of it

More issues to be considered are “duties” of each partner. Some of the duty issues that should be written into an agreement prior to its acquisition are below:

1. Who will be the accountant for the partnership and who will sign the checks
2. Who shall be the property manager
3. Who will the broker be and what are the fees if one is needed
4. Do they have a budget if construction is needed and who will be in charge
5. Who will handle the day to day business of the partnership

The financial issues must be carefully documented. Below are some financial matters to be considered:

1. How much does each partner invest and what is his percentage share
2. Does each partner pay in accordance with their interest if cost estimates are exceeded
3. What if one partner wants to hold the property and another wants to sell
4. How much money will be retained for reserves
5. Does each partner have enough personal assets to secure the success of the property
6. How will the profits be distributed after all the expenses are paid

My approach to the matter of how much reserves are really needed after all expenses are paid is to carefully calculate the operating costs of the building for one full year if the building becomes vacant. The partners should be able to distribute all excess reserves if there are adequate reserves for one year after the property becomes vacant. In addition, it should be considered that if the property may need refurbishment those expenses must be added to the reserves. One caveat is that we are in a normal sales and leasing market.

I could go on about partnerships since I have worked with hundreds of clients over the course of my career. Most people wish they never had gone into the partnership with the other person. The reason many people go into partnerships is because of a lack of skill or money to conduct the venture themselves.

In conclusion, walk very carefully when considering a partnership. The friend you have today may be your worst enemy in the future. Also, make sure your legal counsel is well selected and has some years of experience in partnership matters to legally establish a contract before the transaction is completed.

“Lee has a tremendous breadth of knowledge in the real estate field. He assisted me with a case which involved combing through a great deal of information, and he was very thorough in navigating his way through the sea of documents with a good understanding of the facts. He was always mindful of trying to be as efficient as possible by focusing on the most relevant information rather than delving into every single document. I would absolutely work with Lee again in the future.”  
Eugene Kim, Attorney, Gresham Savage Nolan & Tilden, PC