How to Form a General Partnership in Commercial Real Estate Investing

A general partnership being formed

When two or more people create a profit-oriented business, even if there’s no written plan or even the intent to be a partnership, that’s what it is. It’s a partnership!

There is no registration requirement or formal filing that needs to be completed to form a partnership. It’s that easy.

But you still may be wondering how to form a general partnership in a more formal sense.

The formal definition of a general partnership is the association of two or more persons carrying on as co-owners of a business for profit, whether or not these persons intended to form a limited or general partnership.

Anyone who receives a share of the profits of a limited partnership or general partnership is presumed to be a partner in the business entity, except in cases where the profits were received as payment for debt, or in payment for services, wages or other employee type compensation, rent, annuity, retirement or health benefit.

All property acquired by the general partnership or limited partnership becomes partnership property and belongs to the partnership as a business entity, as in a marriage, rather than to the individual partners.

Types of Real Estate Partnership Agreements

The most common type of commercial real estate partnership business structure is where one investor brings in a few other investors, or one investor purchases an investment with another investor.

These are examples of how a partnership can be organized:

  1. A property management company, or a tenant, decides to purchase a property with an investor who only provides the money, for income and profit, wanting no part of daily operations and management.
  1. One partner provides the money while another partner, perhaps a real estate agent, provides the sweat equity of locating properties, making offers, and arranging financing.
  1. One partner may be an equity player, a secured lender seeking a return on investment, and often does not share liability with the general partner.
  1. Contractors and construction companies might also be involved as partners.

More specifically, one way a commercial real estate deal could work would be for one or two asset managers to round up limited partners. Together they do their due diligence and purchase some buildings. Each partner is assigned to certain tasks, responsibilities, and duties. Areas of expertise could include construction, government relations, marketing and tenant acquisition.

Risks to Manage When Buying Property With a Business Partner

If you’re considering taking the plunge of joint property ownership with someone other than your spouse, your decision making process should include forming a plan for managing risk.

In almost every business, there’s risk. A cafe business risks spilling hot coffee on the lap of a customer. A taxi service could have a fender bender. In real estate? A tenant’s dog could bite another tenant or visitor. A power outage could cause damage or a loss of data. These incidents could be blamed on you.

A properly organized and insured partnership provides a strong layer of protection when and if things go awry. A well planned commercial real estate partnership generates substantial tax benefits and profit, and is a win-win.

Property Ownership Risk #1: Liability Issues

There are hazards that affect your employees, clients and visitors, as well as problems that could affect your property.

For starters, you need to do due diligence on the financial aspects, your other partners, the title paperwork, the building itself, mitigate hazardous materials, and be aware of other environmental issues before forming a general partnership, limited partnership, or limited liability company.

Property Ownership Risk #2: Partner’s Exit

What will happen if the key partner, the one with the most expertise, decides to exit? This contingency should be planned for in advance.

Property Ownership Risk #3: Ongoing Expenses

Buildings eventually require repairs, updates, equipment replacements, safety modifications and more. Be realistic about expenses, and maintain cash reserves and proper insurance

How to Form a General Partnership: Draft a Partnership Agreement

A well-drafted partnership agreement will set the tone for a positive relationship between you and your partners. It should establish each partner’s responsibilities, duties and rights. This precaution will limit unexpected surprises and help disputes between partners from turning into litigation nightmares.

An advantage of most general partnerships is that each partner has an equal say in the managing of the business. Normally every general partner has one vote in all important partnership decisions, no matter their personal capital contribution. When an individual member acts on behalf of the partnership, the other members may be liable for intentional negligence, malpractice or unpaid debts.

A partnership agreement should define the legal and financial consequences for violating the spirit and the letter of the agreement.

8 Questions to Ask When Drafting a Partnership Agreement

Ask these questions, and make sure everyone in the partnership agrees on the answers.

  1. When is net profit distributed?
  2. How should a refinance of secured debt occur?
  3. Who is in charge of day to day maintenance and management?
  4. What is the term of the partnership?
  5. When is financial reporting going to occur to investors?
  6. If there is a dispute, can the partners mediate with a neutral third party?
  7. When and under what conditions do partners have the right to be bought out?
  8. What type of entity will hold partnership assets?

Depending on oral promises and representations can lead to misunderstandings. Get it in writing!

16 Issues to Consider When Organizing Your General Partnership

You also have to think about how the partnership will be organized. Discuss these questions with your associates.

  1. What are the purposes and goals of the business?
  2. What precise form of entity is best?
  3. What is the percentage of ownership for equitable interests/debt?
  4. What are the rights of limited or minority partners?
  5. What are the property management duties, fees and responsibilities?
  6. What are the duties of each general partner?
  7. Who will manage media and public communications?
  8. How will expenses, net profits and rights to reimbursement be dispersed?
  9. When and where will there be partner meetings?
  10. What method of accounting will be used?
  11. Who will be in charge of the partnership books and records?
  12. What are the conditions for termination by any of the partners, and what are their buyout and transfer rights?
  13. What happens upon the exit of a partner?
  14. What are the applicable state laws regarding mediation, arbitration and litigation
  15. What are the partner rights upon liquidation or dissolution?
  16. Under what situations and by what methods can the partnership agreement be amended or suspended?

10 General Tips for Partners in a Real Estate Joint Venture

  1. Understand the basic idea of fiduciary duty. Act in the interest of the partnership and not solely in your own self-interest.
  2. Draft a well-thought-out partnership agreement covering all aspects of the relationship.
  3. Have sufficient insurance for all possible risks.
  4. Stipulate real financial consequences for legal violations of the partnership agreement.
  5. Provide frequent accounting and financial disclosure between partners.
  6. Have scheduled meetings and conference calls.
  7. Be aware of necessary expenditures for improvement and maintenance of the property.
  8. Avoid conflicts of interest.
  9. Understand that partners have the right to independent legal counsel at all times.
  10. Place the title of assets in the names of all general partners, an LLC or a corporation, and not in the name of one partner, or a partner’s relative.

The Partnership Tax Return

The partnership’s accountant will typically file an annual information return, Form 1065.

The partnership is not required to pay income taxes, and each partner’s share of net rental income or loss on the property is taxed at ordinary income tax rates on his or her tax return.

The general partners have unlimited liability for the partnership’s acts and should insure against loss from those activities.

Read more to learn about partnership advantages and disadvantages, other business structures and entities such as LLCs, limited partnerships and sole proprietorships, estate planning for general partnerships, liability issues, and examples of general partnerships.

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