Equity Sharing Joint Venture Partnerships
by Richard Hamlin, Realtor®, C.B.A.®, e-PRO®
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In 1986, while a broker at William Pitt Real Estate, I designed three versions of my Equity Sharing Program that turned out to be outstanding in satisfying the needs of the two types of would-be buyers who were consistently being frustrated in their search for affordable homes. Those two types of potential buyers were:
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1. The Investor, who was constantly looking for good investment properties to rent out wherein the "numbers would work". This usually meant where the rental income would carry the property's expenses, preferably with some positive cash flow. But, sellers were not naively underpricing their properties, and the bargains these Investors sought simply did not exist.
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| The Medina family partnered with the builder of this brand new townhouse. |
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2. The Individual or the Couple, with little or no cash to put down, but with creditworthiness and income that would otherwise be adequate only if they had the cash necessary.
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Equity Sharing, as we apply it to a real estate purchase, is a joint purchase of property by two or more parties.
One party, called the Co-Investor, occupies the property. The other party, called the Investor, provides whatever part of a down payment, most often 20%, plus closing costs and adjustments the Co-Investor lacks. Together, they make a financially whole buyer with tremendous benefits and protections for each partner.
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| The Molloy family, shown here with John DeLucia (R) of Century 21 Gold Coast. |
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The Co-Investor has exclusive occupancy rights and assumes all the obligations of property ownership, just as though he had used his own funds. Depending upon the agreement, either the Investor or the Co-Investor (or both together) obtain a mortgage for the property. The Investor’s preference to be either an active or a passive investor may determine whether or not the Investor co-applies for the mortgage. The objective is to require not more than an 80% first mortgage, so as to avoid private mortgage insurance.
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The Co-Investor, as the owner-occupant party, makes all the payments on the mortgage, as well as all property tax payments, insurance, maintenance and repairs, fix-ups, and staging for the eventual resale when a mutually agreed resale is preferred over a Co-Investor buy-out at the end of the partnership.
Both parties agree to a termination date for the equity share. The usual termination date is projected from five to ten years, with some flexibility built in at the end so as not to force a sale in a bad selling market. Before the termination date, the parties either sell the property and share the profit as agreed, or the Co-Investor exercises his right to refinance the property and buy out the Investor's interest.
When the Co-Investor wants to buy out the Investor, a professional appraisal of the property is used to establish the buy-out price. From sale proceeds, each party first gets reimbursed dollar for dollar for any cash invested upon the original purchase, including closing costs and adjustments, and the Co-Investor gets credit for any cash spent refurbishing and upgrading the property, providing he did the upgrades with the partner’s knowledge and permission. Keeping detailed records is important for each party. Repair expenses incurred by the Co-Investor, other than initial repairs made by the partners to make their purchase reasonably habitable, are considered routine maintenance and repairs of the Co-Investor Owner-Occupant, and are not reimbursable.
Any remaining gain or loss in equity upon resale is shared between the Co-Investor and the Investor according to their agreement . . . usually 50/50, but can be whatever the parties have agreed.
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| Daisy and Greg, shown here on their closing day . . . the day before their wedding! |
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| A Win/Win: Everyone benefits
As with a joint venture, both parties benefit. The Co-Investor becomes a home owner without needing any cash or, in many cases, without needing very good credit. And the Investor makes a superior return on the investment, without the typical investor headaches of vacancy, evictions, maintenance and repairs, renting agent fees, or the fear that an occupant might trash the property. Each party is protected from the other by the way we design the agreement. Just as with joint ventures, you'll need to find an Investor — such as family, friends, or an outside source. Often, tax preparers are sources for investor referrals, particularly toward the end of the year.
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A motivated seller may also agree to sell on an equity share agreement, especially in a slow-moving market. The seller would become the Investor and retain the opportunity to share in any future appreciation in the property.
Both parties share the tax benefits
In an equity share, both the Investor and the Co-Investor are entitled to the tax benefits of real estate ownership. However, in order to comply with IRS regulations, the equity share agreement must be drafted with special care so the Investor is not seen as a lender under the tax laws. A lender does not receive the tax and tax deferral benefits of ownership, and if certain provisions are not worded properly, the Investor could lose those benefits.
Likewise, a renter is not entitled to the tax benefits of ownership. Therefore, the agreement must be written so the IRS does not see the Co-Investor as a renter or mere tenant.
Use a real estate attorney for safety
An equity share can be an excellent way to acquire real estate with little or no money. However, unless you are an attorney and understand tax law, do not draft your own equity share agreement. This is a specialized area where even very experienced investors should use a real estate attorney who understands equity share agreements.
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There are two transactions involved, only one of which is the real estate transaction. The first transaction is the creation of the Equity Sharing Joint Venture Partnership. The partnership must be created before the real estate transaction is attempted in order for it to work. Without the partnership, you don’t yet have a financially whole buyer. Remember, a financially whole buyer is a combination of cash, income, and credit-worthiness. Once we have created the partnership, we have actually created a buyer that did not exist before.
Here is the sequence that works:
1. Binder the partnership,
2. Binder a property,
3. Contract the partnership,
4. Contract the property purchase.
The partnership must be bindered before the property is bindered. Ideally, each partner has his own attorney. Safeguards are written into the partnership so that neither party can exploit the other without penalty. Since every partnership will end some day, all the various ways a partnership can end must be taken into account up front so that the dissolution does not become adversarial.
Partnerships can be 50/50 even when the up-front contributions are not equal. The parties’ contributions can even be 100/0 in terms of funds advanced, but the partnership can still be 50/50 as long as each partner meets his obligations to the partnership.
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