As real estate prices have increased across the country on a historical basis, affordability has become a concern for some people. One solution is joint venture investments, which provide an affordable option to enter the market, but also require diplomacy since you’re working with partners. The key to avoiding hassle and protecting your asset is to understand the legal aspects and keep your emotions intact.
Joint venture partnerships are becoming an increasingly popular solution for investors who want to increase their cash flow and watch their property portfolio grow.
“There is a lot of this happening in the case of women, or young investors,” says Ilona Bronson, regional manager at Invis Inc., Vancouver. “Property partnerships have become very popular because it’s so hard to get into the real estate market.”
Some investors are still wary because they fear being left in a financial crisis in the event their partner bails. However, by fully understanding the legal aspects and with a signed agreement, a joint venture partnership can be successful.
Before you take the plunge as an investor, make sure you have your facts straight. Joint ventures are a good idea for those who want to share the risk and profit. Not only do they make investing more affordable, but they can also speed up the process of entering the real estate market.
There are a few considerations, however. If you don’t find a partner who shares your goals, your arrangement could quickly become complicated, and your asset could become a liability.
“Each person has to fill out a formal mortgage application,” says Bronson. “If one defaults, there’s no way around it and the other will be held accountable.”
Bronson notes that it’s vital to consider everything such as shifts in the market or a change in personal income. Also, investors will often partner with a family member or friend, and this can also be trouble. It’s imperative to keep emotions out of the partnership equation.
After finding a suitable candidate who they think is trustworthy, there are a few options in terms of agreements. Both parties should be sure to get everything in writing, no matter how well they think they know each other.
“The different agreements depend on what the parties are trying to accomplish,” says Joseph N. De Sommer, barrister and solicitor at Joseph N. De Sommer, Toronto. “You can do a corporate arrangement or a partnership arrangement or a host of other possibilities.”
According to De Sommer, a partnership agreement can cost anywhere from $1,000 to $10,000, depending on the complexity of the arrangement and number of partners. It can also be affected by the value of the property.
“The purchase of the property would be subject to the normal purchase fees, and if one has to incorporate, there can be other fees involved in that, depending on the terms of the incorporation,” he says. “A basic incorporation costs about $1,100, but it can be far more complex depending on what the parties want to do.”
There are many different mortgages available when applying for a loan, but there are a few that are specific to joint ventures.
A split loan is the most commonly accepted. There is a single application and both partners have to be approved and are held responsible for the payments as personal guarantees. Generally, a split loan can be fixed, variable, a line of credit or a combination of two or three, says Bronson. (Learn more by going to our compare home loans page)
If the property is a mixed-use commercial or multi-residential unit, then it might be entitled to a different kind of mortgage, which will allow more financial freedom since an investor is less dependent on their partner.
“Under these applications we do require the property to have a debt coverage ratio of 1.2 so that we are not dependent on the guarantors’ income, and the property basically carries itself,” says Marcello Infante, AMP at AVP Mortgage Services, Laurentian Bank, Toronto.
Whether to choose a fixed or variable rate is up to the partners. If both partners are new investors, says Bronson, then applying for a five-year fixed rate might be best. More sophisticated investors could opt for a variable rate, which might save money in the long run.
“In a partnership, choose the mortgage that best suits the individual,” she says. “It all depends on their stamina for risk.”
Mortgages aside, the most important part of being involved in a joint venture is the legalities. It’s vital to remember that signing on that dotted line means that both parties are entitled to it. Make the agreement as detailed as possible in order to protect yourself legally and financially.
“There should be a partnership agreement outlining the terms of the partnership clearly so that everyone understands what their rights and obligations are,” says De Sommer. “If one partner bails, that does not alleviate the obligations to any third parties.”
Under a co-tenant agreement, regardless of who the majority owner is, both parties are held equally liable to the lender for the loan. The lender has the right to sue and claim the full amount owing if one party defaults, and the other is unable to pay in full.
According to Jim Hilton, partner at Blake, Cassels & Graydon LLP, Toronto, there is a way for investors to protect themselves against this. It must be negotiated and agreed upon beforehand by the lender that the lender will look to each owner for their proportional share of the liability. This has to be stated in the loan terms.
Occasionally, one party might want to buy the other out and this can be a viable option if the partnership sours.
In a co-tenancy agreement, there is typically a provision called buy-sell or shotgun notice, which allows one party or the other to break the loan.
“It boils down to something similar to a divorce,” says Hilton. “Either I buy you out, or you buy me out, but at what price?”
The party that is initiating the process picks a price as both a buyer and seller, but should carefully analyze both outcomes because they won’t know what their partner will accept.
“There could be some restrictions with this,” says Hilton. “Sometimes you can have a total unfettered shotgun notice, sometimes it can only be if there’s a dispute, and sometimes it can only be after the first five years of the investment. It depends on what the parties agree to at the time.”
Hilton warns that if there is no buy-sell provision in the original agreement, then there’s a right to go to court, and a judge will divide up the assets. However, this can be messy and costly, and therefore it’s advised to have this stated in the agreement ahead of time.
Another option is a default buy-out where one party defaults the loan and this gives the other the right to purchase the property. Unlike a shotgun notice, this is solely up to the investor who is stuck paying both shares to take over the property. The defaulted partner doesn’t get a choice.
The question, again, becomes at what price? According to Hilton, a smart idea is to pay the defaulted party their share of the interest minus the amount that you’ve already paid on the loan on their behalf.
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