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Here’s a modern-day finance hack we’ve noticed growing within our community. Many are buying homes or second houses together via an LLC. Here’s a checklist to reduce the likelihood of it become a complete disaster. But before we get there, let’s address how it works.
How does this work
One friend, Rocio, realizes that it’ll take her six years to reach $40k on her downpayment goal. Rocio then comes up with this brilliant plan to partner up with her best friend Jessica to buy a home together. If Rocio can come up with the first $20k and Jessica can come up with the other $20k for the down payment, then they can purchase a $200,000 home together. However, there are all types of legal/life scenarios that they need to consider. Hence, investing in a home via an LLC might be the best option in case Jessica and Rocio are no longer friends, but enemies.
A huge part of this process is considering opportunity costs. Should Rocio wait out the six years saving up on her own vs. buying real estate within the next two years and potentially ruining her lifelong friendship with Jessica? Alright, let’s kick off the checklist!
1. Ensure they are someone you trust and are financially savvy
Okay, so this part might sound like a no brainer, but seriously, ensure it’s someone who can hold an objective headspace when sh** hits the fan. It has to be that one friend who is often the most principled and responsible one. Do they have a 6-9 month emergency fund? Do they have a good credit score? Are they able to hold stable jobs? Are they building careers?
2. Consider what does the bestie-LLC process works best for
- Beware: It may not always work well when buying a home and may work better when buying real estate for passive income.. What’s the difference? Well, we assume you’ll be living in your home. Consider this case, Rocio falls in love and maybe one day wants to invite her partner to live in the home. How does this affect the business agreement between Rocio and Jessica? Alternatively, if it’s real estate that is (hopefully) generating passive income, Rocio and Jessica can decide to rent/airbnb the place out for 10 months of the year and 1 month Rocio can vacation home in it and Jessica can vacation home in it the other month. If you’re considering buying real estate for passive income purposes, please take time to consider how building passive income can disrupt the communities you’re investing in (*cough, gentrification*) and what you can do to bring a more positive element to these communities. Perhaps investing in a new and upcoming area can really boost an area.
- The house price falls in a mutually agreed risk range. Paint this picture, you have $10,000 and a friend has $10,000. What if you guys decided to go 50/50 on a $100,000 house in a cheaper area. A $10k down payment sounds like a better real estate risk investment vs. $20k.
- Need a way to source cheaper homes, check these sites out that were recommended to us by the community.
- When kicking off this process, it’s smart to start small. Losing $10k vs. losing $50k are two completely different scenarios.
- There’s a lot to consider in this process. Are you a first-time real estate buyer? Are you familiar with the home buying process? Are you willing to put the time and energy in sourcing deals both of you can agree on? Is your stomach ready to battle the difficult house hunting process?
3. Mitigate financial risk together:
Your financial plan should address risk management:
- Determine a comfortable mutual risk range on the monthly related expenses:
- All parties involved should determine what is the total monthly payment they can handle for a Best Case Scenario and a Worst Case Scenario
- The total monthly payment should account for the mortgage, estimated monthly property tax, maintenance, operational costs, etc.
- Determine a buyout date
- Having a potential end date to the business transaction could be agreeable to both parties.
- Most, and hopefully all businesses have a dissolution plan (in case the LLC no longer exists). Having a dissolution plan ahead of time when both parties are in a clearer headspace is less messy than dealing with dissolution in an emotional place.
4. Mitigate Equitable Labor Scenarios
Determine equitable labor efforts:
- Write down all the tasks that will be related with managing and operating this new real estate property. Determine who will manage the vacancy, maintenance, accounting, payment processing, and operational issues. Having a strict line of tasks that rotate every quarter helps create accountability and fairness.
5. Create an LLC, draft up an operating agreement and sign that paper
- Still got the guts to go forward with this? Okay! Easily look up the states that offer the cheapest LLC operating costs, start an LLC and get all these agreements written and signed together. Enjoy house hunting! Oh, and we most certainly emphasize, start small.
For those that have tried this process, please comment below.
My next real estate purchase will definitely be with a friend. I’ve always wondered how do you split rental income if person x invested $10,000 while person y invested $20,000. I guess something to take up with a lawyer.
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