S.E.C. Real Estate Observer

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Happy Partners

Our number one goal of a real estate investment with outside investors is LIABILITY – to make certain that the partners are not in trouble because of the deal. All of our investors go into the deal knowing that we could lose some or all of our equity. But what they do not want is something that can take them out of their own day to day businesses. Many of the S.E.C.’s use partnerships or limited liability companies for the development vehicle in syndications. The liability reasons are multiple; mainly we do not want personal liability in case some deadbeat decides to stage a fall on a banana peeling in front of your retail center. But there are other reasons for using a vehicle other than tenants in common or joint ventures. Each state has its own set of rules and the tax laws vary significantly. For instance, in Texas we use limited partnerships for ownership and limited liability companies as the general partner. The GP has all the liability and Texas, with no state income tax (as of right now), does not tax the limited partnership shares. The GP is subject to what we call a state franchise tax; in effect an income tax on corporations and the partners are protected from losing anything except the partnership interest.

The second rule we have is REPORT, REPORT, REPORT. It is one of those little quirks of life that if someone gives you money for something, be it a real estate investment or a charitable donation, they want to know what you did with the money. In our case, we report quarterly. The fact that we are usually doing land development makes monthly reports redundant and most of our investors do not want that many reports anyway. Wilson & Stonaker has found that reporting four times per year is adequate and keeps everyone up to date. If there is big news – good or bad – we send out a detailed email to the partners so that they know what is going on. Until about two years ago, we were reporting using snail mail. We would send the balance sheet, P&L, a pro forma and a written summary of the events particular to the investment along with copies of any important news articles to each partner. Since then, we are posting our reports quarterly on our website. We use a two part posting. We post a public side that includes our thoughts on what is happening nationally, regionally and in each of the submarkets we are active in. Anyone accessing the Internet and our website can read these reports and view our site plans, etc. Then there is a private side for each deal. This requires a password to access it and contains all the important data for each deal such as balance sheet, P&L and the pro forma projections.

Email and website postings are wonderful but can be impersonal and sometimes confusing. So we make it a point to pick up the phone or schedule meetings and have PERSONAL CONVERSATIONS with our investors. This accomplishes two things. One, it keeps the investors involved in the deal. In our case, we have to be very careful to remind the limited partners that they are not being asked to make project decisions as they are just that, limited partners. By Texas law the limited partners can have very limited activity in the decisions. But in our case most of the investors are experienced real estate investors and deal makers. As I have said before, this is one of the real advantages to the SEC. We are blessed with partners that we can confer with. As a small developer/investor there is nothing more valuable than having experienced counselors and mentors that we can brainstorm with. Remember, no matter how good you might think you are there is always something new that you have not seen. One of your investors probably has been in a similar situation. We learn from these little issues.

SHOW ME THE MONEY! There is a reason that I put partner distributions towards the end. Personally I think distributions are not the most important “rule” to our happy partners. If we lose money on a deal (and we have – remember the 1980’s) it is acceptable to most partners if you have communicated and counseled with them. Our philosophy on partners is that we do not allow unsophisticated partners in our deals. Sure doctors and lawyers make a lot of money and need to spend it. I think there are plenty of public entities (REITs, etc) to take their money. Although we do allow professionals such as attorneys in our deals, they are all experienced real estate investors. And we make certain that they understand the real estate components of the deal, something that most experienced real estate professionals are already aware of. It is YOUR RESPONSIBILITY as a sponsor of a venture to make certain that the deal fits your investor. Do not take funds from someone that should not be in your deal – ever. It will almost always result in an unhappy partner. All that being said, nothing makes happy partners like DISTRIBUTIONS. We all want to see our funds returned with a good return on the investment.

Watch the TIMING OF DISTRIBUTIONS. Get the partner distributions out as soon as possible but taking into consideration the tax implications. For instance, we negotiated a deal recently where the buyer wanted additional time for city approvals. As part of our extension of the contract, the deal is closing the first week of January instead of in December. In this instance, we are not going to 1031 the funds so what we in effect did was delay the tax liability until April 2007 instead of 2006.

Beware of PHANTOM INCOME. If you want to tick off a partner, just tell them in February that they will owe a big check to the IRS in April (or that their quarterly estimate was understated) because of phantom income in your deal. Don’t hesitate to pay the fees of professionals like attorneys and CPAs to help you plan.

In summary, we try to keep several things in mind: protection from outside liability, communication, distributions and tax effects of the investment. There are other important issues but these are some of the most important. Don’t be afraid to take on partners – just be certain that you are willing to be in “bed” with them for the duration of the particular venture.