How to structure a real estate investment group?
Two friends and I are looking to start investing in cre together and splitting everything 3 ways. What’s the best approach to structure this as a business? I’ve read about LLC’s and Tenants in common partnerships but I just want to get some options and advice on what you think is the best way to go about this.
[{"id": "f1xl4g4", "text": "A partner and I just did this. We both have our own holding companies so we incorporated a third company and issued our personal holding companies 50 percent each.   This is for multi unit apartments. We actually have the building as the main asset for this corp so when we go to sell we can sell the company with the building as an asset,  enabling us to skip paying the land transfer tax.", "replies": [{"id": "f1xlhtd", "text": "Super helpful, thanks!", "replies": [{"id": "f1ybbne", "text": "I should have mentioned we split the cost of the investment equally, which is why we each took 50 percent. As another poster noted, buying a company could come with liabilities but with due diligence it can be an effective way to alleviate paying the transfer tax.", "replies": [], "depth": 3}], "depth": 2}, {"id": "f20pp3m", "text": "&gt;sell the company with the building as an asset,  enabling us to skip paying the land transfer tax.\n\nThis comes with some added risk to your eventual buyer. They're not just buying the property (and any liabilities it carries), they're buying the business and any liabilities. Tax liens, civil judgments, outstanding required distributions, etc. come into play.\n\nI've been the buyer in this kind of transaction and we required a guarantee from the seller attached to the parent entities with a minimum balance sheet requirement for a period of three years. Our ability to make the purchase in this structure was an advantage in our offer because of the added risk and the complexity of post-close indemnity (maybe not that complex, but still a pain-in-the-ass).\n\nSee below for how I described our structure in our investment committee memo (redacted to remove identifying information). \n\n\\-------\n\nOUR COMPANY. (\u201cOUR CO\u201d), through a wholly owned subsidiary, will be acquiring 100% of the common stock of HOLDING ENTITY I, Inc., a Delaware corporation, and HOLDING ENTITY II, Inc., a Delaware corporation (collectively, the \u201cCompanies\u201d), which, collectively, is the fee owner of the Project. \n\nThe Companies are single asset REITs, and accordingly each have common shares (100% of which are owned by the Seller) as well as 125 Series A preferred shares held by individuals. In the case of both Companies, OUR CO is acquiring 100% of the common stock of the Companies from the Seller at closing.\u00a0 \u00a0 As of the date of this Investment Memorandum, Seller is considering whether liquidation of the Companies can occur at any time post\u2010Closing (as opposed to requiring that the Companies remain REITs throughout the entire 2015 taxable year).\u00a0\u00a0If the Companies have not made distributions in 2015, Seller may allow OUR CO to liquidate the Companies immediately after closing, which would require a concurrent redemption of the Series A preferred shares.\u00a0\u00a0Any redemption of the Series A preferred shares done prior to December 31, 2015 will trigger a redemption premium of $100 per share, or $12,500, but such redemption is permitted in all events.\u00a0\u00a0Both OUR CO and Seller will be providing indemnities to each other for various tax\u2010related matters, including OUR CO's obligation to maintain proper REIT status until it can be properly liquidated under current REIT rules. \n\nEntity and tax representations will have a survival period of three years after the closing date (and longer for any claim which is pending). In the event that any claims arise for breaches of the entity and tax representations during the period of time starting with the closing date and running through the date that is six (6) months after closing (the \u201cSix\u2010Month Post\u2010 Closing Period\u201d), the aggregate liability cap will be equal to the purchase price ($65.00 million), exclusive of typical property\u2010related representations and warranties.\u00a0\u00a0For those claims for breaches of the entity and tax representations that arise during the thirty\u2010month period thereafter (the \u201cRemaining Thirty\u2010Month Post\u2010Closing Period\u201d), the aggregate liability cap will be $7,000,000.\u00a0 \u00a0 Because the buildings being acquired were new construction and not yet fully occupied when acquired by the Seller, net income at the Project for the period from REIT establishment (12/1/2013) through closing (estimated to occur by the end of June 2015) is estimated to be $X.X million.\u00a0\u00a0Assuming a conservative 50% collective state and federal income tax rate, the maximum potential tax liability in this case is $X.X million. \n\nThe value of such representations, warranties, and indemnifications beyond what we see in a typical real estate transaction will, in this case, be secured by a indemnification agreement from PARENT CO (\u201cSuper REIT\u201d), a parent company to the Seller, with net assets of approximately $250 million as of 12/31/2014.\u00a0 \u00a0Additionally, during the Six\u2010Month Post\u2010Closing Period, SUPER REIT will covenant and agree to maintain a minimum net worth of $15,000,000.\u00a0\u00a0Further, commencing as of the closing date and continuing through the thirty\u2010six (36) month period following the closing date (the \u201cPost\u2010Closing Period\u201d), Seller shall acquire and maintain, at its sole cost and expense, a representation and warranty insurance policy for breaches of the entity and tax representations (the \u201cCovered Claims\u201d) in an amount equal to $7,000,000 from an insurance carrier with an A.M. Best Rating from A to A+ and in a form approved by Buyer in its sole discretion (the \u201cInsurance Policy\u201d), and as to any such Covered Claims, OUR CO may seek recovery of its losses up to $7,000,000 under the Insurance Policy.\u00a0\u00a0To the extent that OUR CO suffers any indemnified losses that are not  Covered Claims under the Insurance Policy, OUR CO may pursue its losses against the Seller and Super REIT during the Post\u2010 Closing Period. \n\n\\------\n\nIf this was a smaller deal I doubt we'd have gone through with the headache of purchasing in this format. Beware.", "replies": [{"id": "f20uawx", "text": "appreciate the response, all very valid.  You did in the end, end up buying the Company though correct?  If everyone is covered and nothing is misleading, it can be a way to reduce the transfer tax.", "replies": [{"id": "f211orl", "text": "We did, but it was costly for both sides and we made the seller carry most of the burden of those costs. It also hurt their marketing process, further depressing their sale price. I'm not sure that they came out ahead and we unwound the entities as soon as possible and moved them into new SPEs. I've been involved a couple billion in transactions and only two have had this kind of structure, and both times it was seen as hair on the deal and required concessions from the seller to offset. Just my experience.\n\nEspecially for a smaller player I'd suggest that this is a tough approach - not many groups are going to trust that you've got your affairs 100% in order (you're non-institutional) and you'll therefore be putting up a lengthy and substantial guarantee. Essentially personally guaranteeing the transaction up to the sale price for years after the sale is a risk that most people shouldn't feel comfortable taking on - just to avoid a transfer tax.", "replies": [], "depth": 4}], "depth": 3}], "depth": 2}], "depth": 1}, {"id": "f1xphe7", "text": "What sort of CRE and what will you be doing (development, straight rental, some sort of business)?  Will each of you contribute an equal amount and will do an equal amount of the work?  Or will there be a manager owner and two silent money investors?  Does anyone want to 1031 their separate ownership?  \n\nMost investment rental real estate with multiple owners (excluding husband wife combos) that I've seen, is done via LLCs taxed as a partnership.  However, there are a ton of factors at play (and things can be structured a ton of different ways for different circumstances), and I would highly suggest you consider what you want to do, and then go to a good securities/corporate lawyer with what you want to do, and have them tell you if it is possible or not and the potential downsides.", "replies": [], "depth": 1}, {"id": "f1xzvv8", "text": "While it's not related to real estate, check out [Founders' Dilemmas](https://www.amazon.com/Founders-Dilemmas-Anticipating-Foundation-Entrepreneurship/dp/0691158304) by Noam Wasserman.  It's not a page turner, but it definitely addresses a ton of the issues that come up in starting a new business that a founder faces.  Noam looked at data from 10,000 startups and compared that to outcomes so it's not just stories (although it has that).  One of my favorite take aways is that companies where the founders equally split equity failed at a higher rate than those with unequal splits.  I won't spoil the explanation of why, but it's definitely worth a read!", "replies": [{"id": "f1ypash", "text": "Yeah if you can\u2019t agree who gets the 51% up front it\u2019s better that you don\u2019t partner.  I am fortunate I had a lawyer explain this to me in the beginning or I would be in a world of hurt. \n\nYou know who you can trust to be fair? You.", "replies": [], "depth": 2}], "depth": 1}, {"id": "f1y768t", "text": "Cre and finance lawyer here. An LLC with a good operating agreement will do it. The key is to find a good lawyer to draft the OA. Pm me with your state and I can probably make a referral.", "replies": [], "depth": 1}, {"id": "f1y9bh9", "text": "If I were in your shoes I would setup an LLC. Which is what I did when I bought my light industrial property. We have a 4 member LLC with equal ownership. I hired a real estate and business attorney to draft a very specific operating agreement with all roles/ responsibilities defined. Also included buy out provisions and setup myself as the managing member, and the rights assigned to that role.\n\nAlso, I have a CPA that I used to work with in my banking days that the attorney worked with during the setup of the entity. Doing it right upfront is key. As well as including your exit strategy upfront. How do your partners get out? How do you determine the value of the asset?\n\nSounds like you live in CA? I also don\u2019t know why someone would buy an existing LLC, unless it saves them on the transfer tax. Buying someone else\u2019s company can expose you to liability, as I understand it.\n\nIANAL.", "replies": [], "depth": 1}, {"id": "f1zs4z3", "text": "Don\u2019t take this the wrong way, but it kinda scares me that you\u2019re asking this question.\n\nIf the property is an investment that none of the owners/members are using then an LLC is the obvious choice. Your operating agreement is key and you will eventually disagree with your partners, even if they\u2019re friends. Requiring a democratic process to make every single business decision can become cumbersome and in some cases hamper your ability to operate. \n\nGenerally deciding when and how to disperse cash is a major point of contention. Additionally, a process for making capital calls is a problematic aspect of a partnership like this. If you plan on personally guaranteeing any debt on the property as \u201cjoint and several\u201d guarantors then disparity in your personal net worth should be considered.", "replies": [], "depth": 1}, {"id": "f242jjp", "text": "Form an LLC and get an attorney to construct an internal agreement between you guys.", "replies": [], "depth": 1}, {"id": "f3nbcvj", "text": "Hi guys,\n\nI\u2019m new to Reddit so I apologize if I\u2019m not in the correct forum. Recently I\u2019ve managed to pay down my student loans (thank you lord) and now I\u2019m interested in Real estate investing. I have come across a builder that has been doing high end real estate ($1.2 mill + homes) for over 10+ yrs. He is a really cool guy and I know others that know of him as well. I told him that I\u2019m interested in investing and he offered me the following. I\u2019m wondering if you guys can chime in and let me know what you think?\n\nDeal: \n-I buy the land $700K (20% down and the rest loan)\n\n-He builds the house ($450-500K) BUT I take the entire loan for the land and building it out myself\n\n-We put the house on the market for $1.7-1.9 mill\n\n-total cash investment is $400K and the rest bank loan\n-total investment overall $1.3 Mill\n\nNow obviously at first I said that doesn\u2019t make any sense because you have no skin in the game. \n\nHe then offered to co-sign on the loan then we split the profit after we sell\n\nThe lot is in a very desirable area in Houston TX. Typically a home lasts 67 day on the market in that area with price ranges from $1.3-2.3 million\n\nI don\u2019t have any other loans, no bills, no wife, no kids and I\u2019m a physician so I typically make $200-250K a year.\n\nLet me know what you guys think. Thank you in advance!", "replies": [], "depth": 1}]