Should I be buying property with friends?
When it comes to buying property with friends, this question is very complex – not only from a structural and management level, but also from a people and psychological perspective. Friends are wonderful – I have some! Yet, there’s a big difference between friends and business associates.
My mom often says “don’t do business with friends and family” – as you risk losing the relationship. Having said that, I know of many people that have family businesses and businesses co-owned with friends.
This article looks at investment property, but it can apply to residential as well. Remember that property is a long term investment – and climbing out of a deal can be complicated!
If you’re lazy and have 15 minutes…
Buying property with friends can get VERY complicated. For this reason I did a video to expand on this article. Check it out HERE!
Reasons for buying together
Not everyone can afford property – and if someone wants to take advantage of tax breaks, leveraging rental property to pay off their bond or invest in a holiday home – it can be challenging. When buying together, you can lump your income together, so that you can afford a property together.
Another reason is diversification. Some people can easily buy a R 400 000 property cash – and that’s awesome. But for others, it would mean they have 100% exposure to a single property.
If there are multiple owners, there is generally also an even split of expenses and income.
Some people buy property with friends or family to tap into the diversified skills. For example, my wife is an interior architect. She understands renovations and the building process – I don’t speak “builder language”. Partnering with someone like that makes a good deal a great one!
Managing the risks
When managing risks of buying property together, you need to think about the terms beforehand, during and after. Consider how you will handle a crisis (financial or otherwise).
Managing risk is vital in any property deal. I know we don’t want to start a business with failure in mind, but the cliche rings true: “failing to plan is planning to fail”.
Before and during the investment period
Before you invest, you need to clarify the terms. Here are a few very broad examples:
- One person brings skill, another brings money and a third finds the excellent deal
- Everyone brings their share of the money
- One person brings a lump sum – a deposit, bond and transfer costs, whereas another will pay the shortfall and manage emergencies.
- All costs are split evenly among everyone.
Once you’ve pinned down what the terms are, you can then proceed with managing how the property, money, bond and emergencies will be managed, throughout the term of the property. Here are some examples (similar to the ones above):
- One person will do the maintenance (as they bring skill to the table)
- Split the running costs evenly
- Everyone will pay a bit more every month to save for a rainy day
I feel very serious about having a property emergency fund.
People are made redundant
They get retrenched.
Money dries up.
Have a property emergency fund in place!
Make sure that you talk about an exit strategy. This could happen at any time – including during the loan term, once the bond is paid off or when the property is on the market, but not getting sold.
As you can tell, this can become really, really complicated. When people want to exit immediately, many people opt to sell at a reduced rate – making their investment not worth that much any more.
Here are some examples I have seen for rules governing exiting a joint property investment:
- The investor needs to be invested for a certain number of years
- If the investor exits before this time due to unforeseen circumstances (retrenchment, etc.), there will be a penalty or ‘admin charge’ of a percentage of the amount.
- The other parties/shareholders have first right to buy out the exiting person
- The exiting person should find a replacement – this is more for stokvels
Practical risk mitigation
I suggest having a legal contract in place between all the parties drawn up by a professional lawyer – don’t do verbal agreements, as everyone remembers the terms differently. Cover all ends – before, during and after – and what happens to the profits and losses.
During your investment period, things might happen such as a burst geyser. Having a property emergency fund available for unforeseen, unplanned emergencies can make your life a lot easier – get that in place! I suggest having a separate bank account for the property – it just cuts out the possibility of foul play.
I don’t want to rewrite my article I did here for property investing and legal structures, but want to touch on the legal structures in this article, as it is VERY relevant and important.
As you might know, you have a trust, company or in this case a partnership for property investments. How you structure your deals depends on what you want to do with your property (your strategy), your exit plan and the people you’re dealing with.
I highly recommend again that you seek legal advice in this regard.
The best way to explain this would be through a couple of short case studies. Note these are not complete and perfect – they’re just to give you an idea about options.
I bought my first property with my sister and father with no contract in place. I was young and stupid – but it was well played and well managed because we valued relationships more than money. Here are the highlights:
- We split all the income and expenses 33.33% each
- The home loan was on all our names, though my sister and father’s income was put up for surety, as I didn’t qualify at the time
- We had to declare our tax individually and get all paperwork together, with letters explaining that it was a property jointly owned
- When we sold the property, everything was split 33.33%
- We didn’t have anyone that exited, and if they did it would’ve caused chaos on the extra bond costs, contracts, legal fees etc. etc.
If you have properties in a company, you are able to get some cool benefits – and it helps you to build more wealth:
- You need to lend the company money – so you can take out the borrowed money tax free. Remember to charge interest!
- If someone wants to exit, you can buy their shares without too much hassle. Make sure you check the legal ramifications on bonds, as banks often require people to sign surety for company debt – and they need to be notified if the shareholders change.
- The property portfolio can often grow at a reduced tax rate if you don’t cash out the profits – company tax is 28%, whereas many people are taxed at higher rates.
Funding – home loans and cash
One of the main reasons for buying property together is because of a cash flow shortage. To get a home loan as a group of people can be challenging to say the least. I would like to give the following suggestions on this:
- Take the top 3 earners and submit their details to the bank for getting the loan. The banks don’t like 40 people applying for a joint home loan
- Be careful who you allow signing surety. Make sure to declare all income and expenses!
- Consider using a mortgage originator to get the best rate. They will also be able to guide you on the proceedings.
- If you’re going the company route, you will need a lot of paperwork, so make sure you have everything in place from tax clearance to registration paperwork.
If you’re doing the deal cash, the initial process is a bit easier – you only have a transfer attorney to pay (incl. paying some fees upfront such as levies).
Buying property in a group can be complicated – and there are many things to consider, including legal structures such as trusts, companies or partnerships.
You also need to think about the terms – what does everyone bring to the table? You want to get your money’s worth!
Also consider an exit strategy – when, how and under which terms will you allow people to exit the business relationship?
Be careful out there – you don’t want to do business with just anyone!
- iGrow – Is buying investment property with friends a good idea?
- Private Property – What’s the deal when buying property with a friend?
Article reposted with permission from Frugal Local.