When considering buying rental property with friends, remember that even couples married a long time won’t agree on everything.
After several decades living in the same house, my wife and I purchased another home that was much more peaceful and has a view. Just after we moved in, it became apparent that her ideas on how we would use the rooms in our new place were vastly different from mine. We are working through our differences one at a time.
Getting started in real estate can be much easier buying a rental property with friends than on your own. You will be able to buy a better property, and managing tenants will be much easier.
But there are many issues that you must consider to get this type of partnership to work. By coming to agreements on most of the terms before you start there will be fewer surprises once you have invested your hard earned cash.
Why buy a rental property with a friend?
You know owning rental real estate is your path to passive income, or can one day lead to ending your need for a full time job. But buying rental property on your own has many drawbacks. Can you afford it? Do you know what you are doing? Can you get the funds needed to buy a property that will be profitable?
Getting together with a friend as your partner can help make your dreams a reality. There are several specific things buying an investment property with a friend will accomplish:
- Purchase a better property – By combining financial resources with a friend, you can purchase a much larger, better quality and more profitable rental than you could on your own. Any additional money that your friend offers for a down payment and expenses will allow you to acquire a much larger mortgage and give you a much bigger inventory of rentals to consider.
- Easier to get a mortgage – When you combine forces with a friend, that person’s added income can make it much easier for you to get financing. Lenders look at debt to income ratio before handing out any money. If your friend has a reasonable income with low to moderate debt, it can smooth the way to getting a loan.
- Split responsibilities (different skills) – It would be unusual for one person to be good at making home repairs, a financial wiz and dealing with all kinds of personalities. Just a few of the skills you will need to become a landlord. Successful partnerships divide responsibilities by their skills. One friend deals with the tenant issues while the other makes repairs.
- Build credit – If you don’t have established credit, it may be difficult to get funding for an investment property. When you partner with a friend, it can help you to secure a mortgage as well as build your credit.
21 issues friends often don’t think about when considering purchasing investment property together
- Exiting the relationship – You are probably so excited to discuss how you will divide the income from your new rental property but one of the first things to consider is what will happen if you or your friend want to end the relationship. This may happen due to marriage, divorce, loss of job, relocation, child, or just change of life plans. Before you move forward buying a rental property with a friend, you must discuss an exist strategy.
- Equity split – What percentage will you and your friend own of the property. Will it be 50/50 or something else. Will one of you live there? Manage the property? Be a passive investor? When deciding percentage of ownership, you should consider all of these situations. Otherwise you may discover later that one person got a better deal.
- Income split – Even though you determined how to divide the equity, you now need to determine how to divide the income as well. If one of you lives in the rental will that person pay rent? Will that person receive payment for any onsite management duties. Will you use income to pay back a larger down payment.
- One friend does not have an established credit score (a low score can impact mortgage rate) – This happens often with younger investors. If you have not had time to establish good credit, it can be harder to get a loan. Check and discuss your credit scores. If one is low, work on improving it and monitor regularly.
- Choosing a rental property – It is important that both you and your friend agree on the rental selected for an investment. You’re not buying something from Amazon that is easily returnable. Discuss the pros and cons for each of you and use this to come to a mutual decision.
- Method for finding tenants – There are many ways to find tenants from free online listing services to very expensive rental agencies. Friends who own a rental together will have to decide how much to spend on advertising, what to include in any ads, and who will take photos. Once somebody responds to your ad, you will likely need to show them the property. This can take a lot of time.
- Screening and selecting tenants – A tenant background check contains a lot of information. Partners should agree ahead of time on which criteria to use when selecting tenants. You may also want to obtain a credit report to make sure the tenant is able to pay the rent.
- Handling tenant issues – Even after choosing well-qualified tenants with excellent references, there are bound to be regular issues. The more details you discuss with your investment partner ahead of time, the better. Then, including all of these topics in a lease will help simplify all tenant communications. Topics such as “can we paint”, “can we have a dog”, or the “will you fix the shower” will all be easy to resolve.
- Who collects rent – Many landlords still collect rent by check. If you and your friend decide to use this method there are several things to work out. Will your tenants mail checks to you or will you pick them up? What exactly do you do if the rent is late or not the correct amount? Who will deposit paper checks? Many banks have mobile APs that make this easy.
Another route is to set up automated rent payments that withdraw funds from your tenants account each month
- Paying mortgage – Most lenders will automatically deduct a mortgage payment from your account each month. But there are a few decisions you will need to make. What type of mortgage you use could depend on how long you intend to keep the property. For example, a 30-year mortgage would be ideal for a long term investment to maximize income. You may also want to discuss if money will go towards prepaying the principal.
- Agreeing on emergency funding (unforeseen expenses) – Having money set aside for unforeseen expenses is critical. I have experienced water main breaks, sudden infestations, water pipes burst, roof issues and much more. These repairs cost thousands of dollars. You and the friend you are investing with will need to agree on an amount that will be set aside to cover emergencies. It is also a good idea to discuss what to do if required repairs go beyond that amount.
- Dealing with prolonged vacancies – A landlord nightmare is to have a rental property with no tenants. The lack of income does not mean you can forego paying the mortgage and other expenses. Someone has to come up with that money. Investment partners must discuss this in advance.
- Who handles property maintenance – Someone will need to complete regular lawncare, snow removal, painting and so forth. This may include inspections, purchasing and maintaining equipment, or calling contractors.
- Who will handle property maintenance – If either you or your friend agree to handle maintenance, are you qualified? How much are you authorized to spend if a contractor is needed? Before buying rental property with friends, consider who will complete ongoing maintenance.
- Who will handle property repairs – Same goes for repairs which can happen more suddenly. If you agree to handle repairs, do you have the skill and equipment to deal with most issues?
- Professional vs DIY repairs – Sometimes repairs can be major or beyond your skill level. If a DIY repair is done incorrectly, further problems may occur. When you’re not available, are tenants authorized to call someone to make an emergency repair.
- Who will select contractors (is it your friend’s buddy?) – Does your friend have another “friend” who knows how to do repairs and maintenance. Will you pay the lowest price service or pay for the best quality to keep your property in tip top condition?
- Who will manage city inspections – Most cities and towns will require you to register a rental property. One of the owners should attend the regular inspections completed by the municipality. One of you may be required to appear at an occasional court appearance.
- Who will collect tax preparation documents – Friends who buy a rental together will need to file separate tax returns (unless you form a business entity). You will need to collect information on income received, and expenses paid.
- Active vs passive investors (one of you just puts up cash) – Buying a rental property with a friend does not always mean you divide the work equally. Sometimes, one of the partners is a passive investor who pays money into the investment, but does little of the work while the other does all or most of the property management.
This type of relationship could affect equity and income splits and income tax filing.
- Insurance / liability – Maintaining proper insurance for your rental is critical. When investing with a friend you may have different requirements. You may be liable if someone gets injured on your property. It is best to discuss this thoroughly with an insurance specialist.
How to co-own a rental property and keep your friendship
When you buy a rental home with a friend as an investment, you want it to be successful and keep your friendship. Here are a few thoughts that will help you achieve these goals.
- Choose the right type of ownership – There are a few ways to prepare a title on your rental property. It could be Tenants in Common where if one partner dies, their share of ownership goes to beneficiaries, or Joint Tenants With Right of Survivorship where the owner’s share would pass to the surviving owner.
- Form a business entity – There are many risks with owning a rental property. Owners can protect themselves personally from a lawsuit or damages by forming a business entity such as an LLC.
- Real Estate Investment Partnership Agreement – You need to have a co-owner agreement that details as much as possible about how your rental property will operate and the responsibilities of each owner. It should include percentage of ownership, payment of expenses, operating responsibilities and exit strategy.
- Create an exit strategy – You want to make it easy for either party to leave the partnership. This may mean one friend buying out the other, putting the property up for sale or finding another investor. It is important to have your agreement well documented. Keep in mind that when you sell a rental property there may be huge tax consequences. Talk with your accountant about completing a 1031 Exchange for a different rental.
- Review and refine your operating strategy – have regular formal meetings with your friend to discuss and refine strategy. Are the tenants working? Is there enough money in the emergency fund? Are repairs getting out of hand? Do both friends have equal responsibilities? Will someone need to paint the apartment soon? You may have more conversations when just getting started but it is important to have them regularly and document everything. The less surprises there are the smoother your investment will operate.
Hopefully this guide helps make the process of real estate investing with one or more friends a lot easier. Proper planning and lots of discussions will minimize the issues of buying rental property with friends to a minimum.