Is the best number of partners to have equal to 0?
Is there a difference between a partner and an investor?
Is a partner someone who wants a say in the business or joint venture while an investor is simply looking for a ROI, return on investment?
L to R: Robin Chahal, Prof Bruce, Armin Eshtabli
Here’s a take on this by a former student of mine, Robin Chahal, who is not only a successful tech executive but also a savvy real estate as well as stock-market investor–
1234 Any Street Joint Venture Lessons Learned
In 2015, there was a unique opportunity in residential real estate in Ottawa. The city had legalized adding a secondary dwelling unit to single family homes, and Ontario Renovates Grants were being liberally awarded, offering up to $25,000 to put towards home renovations.
At the time, I had cash to invest and experience with renovations, but no free time. Another investor, Shelly (not her real name), had time but didn’t have a lot of cash or credit. We formed a joint venture and purchased 1234 Any Street (address changed).
I provided the majority of the capital and put the mortgage in my name. Shelly managed the renovations, rented and lived in the basement unit, and provided property management for the upstairs unit as well.
With this joint venture model, the big benefit for me was I got on-site property management with a property manager who took care of the property like she owned the place, because she did, at least in part.
The big benefit for Shelly with this model was it allowed her to get started investing in real estate years before she’d be otherwise able to. The compounding effect of those extra years is enormous.
The end deal was, Shelly put in $10,000 in return for 30% equity. I put in $23,333.33 for the remaining 70% equity. The additional cash required came from me in the form of a second mortgage to the joint venture at 8% interest. Our initial estimates predicted this loan would be $45,000. In the end, the loan was $115,000.
Lessons Learned or re-learned in this joint venture:
· Apply for credit before you need it. A year before buying an investment property or starting any kind of renovation project, set up a non-secured line of credit that you don’t plan on using. Set up a HELOC (home equity line of credit) against your primary residence.
· Consider doing a “Reverse Smith Maneuver” where you pay off a portion the mortgage of your primary residence, and then pull that money back out via a HELOC. You can’t write off the interest on your mortgage. But the interest on a HELOC can be written off, if you use that money for an investment.
· When doing a home inspection on any house, do a load test on the sewer connection. Fill every sink and bath tub with water. Then, with the water running on every faucet, pull every plug, and flush every toilet in the house. Find the floor drain in the basement, if there is one, and watch the water level.
· If you have a city sewer connection back-up, call the city before doing anything else. I learned this lesson the hard way on 1234 Any Street, but that lesson came in handy when the sewer connection in my primary residence backed-up last spring.
· Some realtors are looking to get you a deal. Some realtors are looking to make a deal. If you don’t know what kind of realtor you are working with, assume they are looking to make a deal. Be careful what information you share with your realtor regarding your negotiation strategy. We bought 1234 Any Street for $328,000. We found some problems with the building. I wasn’t concerned but I wanted the seller to believe I was concerned. I think my current realtor could have gotten this property for $315,000.
· When a solid, knowledgeable mortgage broker gives you advice on how to finance your project, follow that advice. Thinking I knew better cost several thousand dollars in refinancing fees and ultimately resulted in $20,000 less financing.
· Do not ask someone, who has never managed a renovation before, to manage a renovation with your money. If you are too busy to manage the renovation, you are too busy for this type of investment. Initially we had Shelly manage the renovation. This was a mistake. Later, I made an even worse mistake. Shelly and I started sharing the management responsibilities, creating opportunities for things to slip between the cracks.
· I had never managed a renovation like this before either. Hiring a general contractor who had done this kind of project before should have been a base requirement.
· We had problems with our general contractor, Steve (not his real name). The time line stretched out way too long. The renovation costs kept spiraling out of control. The carrying costs for a property that isn’t generating income magnified the problem. Steve had never added a secondary dwelling unit to a building before. I had used Steve on the home renovation at my house and everything worked out great, but I was managing that renovation and Steve had a crew of four guys on site every day. On this project, it was just Steve most of the time. And there was definitely scope creep. There were last-minute design changes that impacted the schedule and price. I feel that if we had gone with a more experienced contractor, this wouldn’t have happened. In part, I feel a more experienced contractor would have gotten the job done so fast there wouldn’t be opportunities for scope creep and last-minute changes and budget increases.
· For any long project, make sure to keep detailed notes. If possible, constantly revise your contract. In many cases, Steve and I, or Steve and Shelly would verbally come to an agreement, but months later, when the project was still dragging on, no-one could remember accurately what was agreed to.
· Never spend more than $6 per square foot on tile. Tile that costs $30 per square foot today will be on sale at Home Depot next year for $1 per square foot. I justified spending more money on finishes, thinking that I wanted Shelly to really like living there. This was a mistake.
· We refinanced the property after completing renovations. The loan required from me at this point was significantly larger than originally predicted. At this point, I should have renegotiated that Shelly’s fees for property management fees would be re-invested into the joint venture as equity instead of being paid out every month. This way, she would share in the extra financial burden as well.
· After refinancing, we were looking at a paper loss on the investment. As a mental exercise, as a group, we should have run through what an early exit from the investment would look like if we sold the property that day.
· Before forming the joint venture, as a mental exercise, as a group, run through where the money will come from if there is negative cashflow one month, or over many months.
· Don’t use MS Excel for your bookkeeping. Use Quickbooks or some other bookkeeping software.
· To make bookkeeping even easier, I should have set up a separate bank account in my name, for the joint venture’s income and expenses. Then set up one credit card in my name, for joint venture expenses. After that, have Shelly set up one credit card in her name, for joint venture expenses. Quickbooks can automatically import the transactions from these accounts.
· Send monthly cashflow statements to all parties involved. On a set day every month, make sure bookkeeping is up to date and let everyone know how much money the joint venture made or lost. Having bookkeeping information available to all parties, at all times is helpful, but this needs to be easily digestible information. Having all the bookkeeping up to date on a set day every month is difficult but important.
· Send monthly balance sheet statements to all parties involved, explicitly stating the value of the joint venture based on the last appraised value of the property minus current liabilities.
· When hiring a property manager, assess how handy they are. For the past two years, I’ve been going to the property fairly often to do things like change light bulbs in trickier light fixtures, reset the router, attach curtains rods, teach Shelly’s partner how to start a lawnmower (!), teach Shelly’s partner how to start a snowblower, clean out eaves troughs, change locks. I just found out last week that the batteries in the smoke detectors haven’t been changed since I changed them when we first bought the property.
· For this joint venture, less than two years after buying the property and a little over one year after moving into the property, Shelly decided she wanted to live out of the country, but still manage properties in Ottawa. Fortunately, the last 5 months haven’t been all that busy for me because I’ve had to go to the property a lot for things as small as finding the TV remote control in the couch. Out of city property management doesn’t work.
- Keep It Simple Stupid. If it takes more than 30 seconds to explain the partner structure to your spouse, it’s too complicated. There are many ways we could have structured this partnership in a simpler fashion.
I think the Property Manager joint venture business model works best when the mortgage for the property is in the property manager’s name. It binds the property manager to the property and makes them acutely aware of any cashflow issues. It also insulates the investor’s credit.
I don’t know if this is going to be a problem, but I’m expecting this to come up.
The next time I’m applying for credit, the lending company will look at my tax returns. My tax returns will show rental income and also show the property address and ownership percentage 70%. I’m anticipating a conversation with the lending company where explaining less than a 100% ownership is going to be a challenge – especially if I have to explain the 2nd mortgage part of the deal.
Lending companies do not seem to handle complexity well.
I should also let you know that with Shelly and her partner in another city, I negotiated their exit by paying them $14,000 for their 30% interest in the property. It was worth (probably) $3,500 so (again) I overpaid.
However, owning it 100% in my name was worth the extra costs. No I’ll keep the building my personal portfolio for the next 50 years (I hope) and then transfer its ownership to one (or more) of my children so let’s it’s in my family for 3 generations or about 100 years, which means I overpaid by ($14,000 – $3,500)/100 = $105 per annum, a negligible amount, especially in a market like Ottawa’s where there is vast demand for rentals, real estate inflation has shot up from 1.5%-2.5% per year to 3, 5 or 7% for well-located property (which this is) and my tenants pay down around $8,000 to $10,000 in principal on my mortgage every year.
Which is to say, I’ll get back my over-payment in about 4 months time (taking into account real estate inflation and principal paydown). Not bad, huh?
Robin Chahal, technologist, real estate investor
postscript by Bruce M Firestone:
By the way, from the above story, you should be able to deduce why most partnerships don’t work.
a) unequal financial contributions going in or on-going lead to problems
b) unequal sweat equity (work and effort put into the joint venture) leads to one partner (or more) feeling that their contributions are being under-valued or unappreciated
c) this leads to arguments, which if not resolved, result in the project becoming an orphan–no one is in charge, no one cares and pretty soon the property is in serious jeopardy
d) there is an old quote, “There are still two chairs in heaven waiting for the first two partners to get there and still like each other”
e) So, beware joint ventures and partnerships
f) Human psychology works like this–if you own 100% of something, you know the buck starts and ends with you/you pay attention & don’t mind putting in extra work or money (at least not as much)
Last point: What’s the difference between a partner or an investor?
An investor is just looking for a ROI while a partner wants a say in the business. Investors I like, partners, not so much.
Bruce M Firestone, B Eng (civil), M Eng-Sci, PhD
Century 21 Explorer Realty Inc broker
Ottawa Senators founder
Real Estate Investment and Business coach
MAKING IMPOSSIBLE POSSIBLE