Partnerships in real estate

Historically low interest rates in the euro area, the strongest Dutch inflation in about 20 years and negative interest rates on savings accounts mean that many wealthy individuals are looking for a safe haven for their money.

Investing in real estate is generally seen as an attractive option. On the one hand, there is the possibility of investing in real estate indirectly, for example by buying shares in a real estate fund. On the other hand, one can invest in real estate directly, by buying investment properties oneself and operating them (or having them operated).

A lack of time or knowledge of the real estate market regularly leads a wealthy party to enter into a partnership with an associate - usually someone without substantial equity, but with a nose for opportunities - with the goal of building a solid real estate portfolio in a short period of time. One party brings in the money, the other performs the work required to actually buy and operate (or have operated) investment properties.

Such cooperation can be structured in several ways.

Option 1: Legal entity

A first option is for the parties to set up a legal entity that will own the property. A limited partnership or limited liability company is the obvious choice. However, setting up such legal entities entails legal obligations and restrictions. Moreover, this construction can be fiscally unattractive, especially when parties do not wish to develop entrepreneurial activities, but only want to realize a passive cash flow by buying and operating real estate.

Option 2: Wealthy party as bank

A second option is that the wealthy party lends money to the other party - whether or not securitized with a mortgage right. The wealthy party thus effectively acts as a bank and does not acquire ownership of the property. An advantage of this option is its simplicity. A major disadvantage is the fact that the wealthy party, in the absence of ownership, will not usually reap the benefits that make investing in real estate such an attractive option: the positive cash flow benefits the borrower, as well as any increase in the value of the real estate. Moreover, the high net worth party does not benefit from any leveraging (or leveraging) of the property.

Option 3: Cooperation agreement

A third option is for parties to purchase real estate jointly and operate (or have operated) this real estate jointly. The law automatically provides that parties to a joint purchase also each become owner of the real estate for the undivided half. Nevertheless, it is highly recommendable - if not necessary - to conclude a cooperation agreement with each other, with agreements on the method of cooperation, the distribution of profits and costs and the possible exit of one of the parties.

A first important part of the cooperation concerns the distribution of the money, prior to the purchase of the real estate. It is undesirable for the wealthy party to pay 100% of the required equity without a clear basis for doing so. This party then pays 100% in exchange for 50% of the property. The notary on duty will undoubtedly sound the alarm and ask whether the wealthy party is making a gift to the partner or granting a loan to the partner. In other words, the parties should make clear arrangements on the front end about the deposit of the required capital (usually the purchase price and buyer's costs). The parties can do this through a so-called "credit agreement," an agreement under which one party is entitled to borrow up to a certain amount from the other party on certain terms.

Suppose that the wealthy party wishes to invest € 1 million in real estate, together with the other party. The parties conclude a credit agreement for this purpose, under which the wealthy party will lend amounts to the other party on first request, until a total amount of € 500,000 has been lent. The loans can only be used for real estate to be purchased jointly and have one and the same end date. At the time the parties wish to purchase a particular investment property, such a loan is claimed, so that both parties can each pay their share of the required capital. Parties may choose to agree on a low interest rate for these loans to compensate for the efforts of the non-wealthy party.

The parties then arrange the cooperation in a cooperation agreement. Points of interest in this agreement are as follows:

• Parties include a specific goal, for example, to jointly purchase €1 m of investment properties within one year.
• The parties shall include a clear terms of reference, broadly stating that the non-wealthy party shall propose investment properties, with an operating budget and a maximum purchase price to be paid, upon which the wealthy party shall indicate whether or not it agrees to purchase the intended property. After the conclusion of the intended purchase agreement, the non-wealthy party arranges the bank financing - whether or not based on parameters included in the cooperation agreement regarding the Loan-to-value, the fixed-interest period and the term. The wealthy party is obliged to provide all documents requested by the bank. Finally, the non-wealthy party arranges the leasing and management of the investment property in question, whether or not by engaging third parties specialized for this purpose.
• The parties will include a clear profit and cost allocation, which will generally include a 50% share of cash flow, increase or decrease in value and costs by both parties.
• The parties make agreements on the possible exit. Prior to entering into the cooperation agreement, the parties should consider scenarios in which one of the parties wishes to sell the joint property, in which one of the parties wishes to split off (and thus become full owner of half of the portfolio) or in which the parties die. Such arrangements are always customized and depend on the relationship between the parties (and any heirs).

Finally, another point of interest regarding security for the wealthy party. In the setup described above, the wealthy party is always co-owner of the accumulated real estate portfolio. If the wealthy party wishes additional security, parties may choose to establish a mortgage right in favor of the wealthy party. If parties wish to leverage (or "leverage") the property to be purchased with bank financing, the wealthy party will never be able to obtain more than a second mortgage right. Moreover, the bank will have to agree to this second mortgage right. Experience shows that banks are not immediately sympathetic to this, but are willing to cooperate to make a second mortgage right possible. After all, a fruitful cooperation can lead to a flywheel for both the wealthy party and the non-wealthy party, which also benefits the bank.