Monday, 13 August 2012

Investing in Real Estate with family members or friends

Investing in real estate in some countries (such as Australia) are seen as the 'easiest' way to make money and so everyone clamours to get into the real estate market.  However saving for a deposit is one of the hardest parts about entering the property market and so people who are looking to get on this supposed gravy train look to go with other people to get into the market quicker.

Although there are some positives to investing with others, especially with family, in my opinion these are largely outweighed by the negative factors.  I have listed both the pros and the cons of investing with family or friends and things you should consider before you invest.

Benefits of investing in property with family members or others

There are a few clear benefits to investing with others.  These include
  • As mentioned above it is easier to enter the property market if you are not saving on your own for a deposit.  Banks are also more willing to lend you money as they have two incomes as security
  • It reduces your exposure in any given investment
    • One of the biggest downsides of property investment is that because of the prices of houses it is hard to spread your risk because the capital requirement for each property is so high
    • When you invest with others your effective risk and capital contribution is much lower
  • Provides a fall back in the event one of you get sick or lose your job
    • If you get sick or lose your job, your mortgage still has to be paid and your property still generates expenses. 
    • Having more than one person means that in the event one of you get sick the other can still take over the responsibilities
Cons of investing in property with family members or others

I think the cons far outweigh the benefits when it comes to investing with others.  While I have outlined almost all of the benefits of investing with others above below are just a few of the cons of investing with family members or others
  • You are completely liable for any liabilities at the property
    • This means that if the person you are investing in is unable to pay their share or refuses to for any reason you are liable for the full amount
    • People always say 'this can't happen to me' and you often have a high degree of trust between yourself and family members or close friends but sometimes their inability to pay is not their fault - they may lose their job or have an accident.  The bank does not care about this and they will come after you.
  • You may not have the same investment philosophy or time horizon
    • When you own a property on your own you control everything including when maintenance gets done, when you sell, if and when you refinance.
    • It is very rare that two people are in exactly the same financial situation at all times and so there can be conflict over what is to be done with the property (i.e. they want to sell at any price and you want to hold on to the property because you think the price will increase)
  • There are serious legal implications for buying properties with others
    • In common law countries (Australia / UK / Canada), properties are general bought under one of two types of title - tenants in common or joint tenancy
    • Under joint tenancy if one person dies their interest in the property automatically goes to the other owner
    • Under tenants in common the person that dies can will their share away to someone else
  • How do you split the profits / benefits if one person has contributed more than the other?
    • This can be a very touchy subject especially if one person has contributed more OR if one person was contributing while the other was out of a job and vice versa
  • What happens if you have an argument?
    • This is something you need to consider carefully.  People fall out all the time over a variety of reasons that have nothing to do with their financial dealings.  However if you buy a property together you are stuck with that person and that investment - there is no way of making a clear break (unless you are taking to take a serious hit on your investment value and sell it and walk away)
Things you should consider when deciding whether to invest with others

There are many things to toss up when trying to work out whether to invest with others.  Here are some things you should consider and rules which I think you should stick to
  1. Never invest with friends - family or nothing
    • Friends come and go.  There are enough issues and trust situations with family but the probability that you have issues with your family are a lot lower than the issues you are likely to have if you decide to invest with friends
    • I still think investing with families has it's own set of issues but it is certainly better than investing with friends
    • On a related note do not invest with a person you're in a relationship with unless you are in a REALLY long term relationship or married.  Relationship breakups are nasty enough as it is - add financial dealings and you've got a recipe for disaster
  2. Make sure you have EVERYTHING in writing
    • You want everything in writing.  This includes things like
      • What happens if one person contributes more than the other
      • When do you anticipate selling the property and what do both of you have to agree to when selling or deciding not to sell
      • How is everything going to be split (expenses and profits)
      • How are disputes to be settled?
    • Have a lawyer look at this agreement before you sign it.  The amount you spend up front will seem tiny compared to the benefit and piece of mind you get
  3. If you're only doing this to be able to get into the investment property market consider your other options
    • People often invest with others because they cannot save up enough to do it themselves
    • However you need to consider whether you will be able to handle the financial burden of this investment in the event the other person gets sick / losses their job etc
    • There are plenty of other options out there including listed property trusts which allow you to buy a share in a selection of properties
  4. Realise that your dealings with this person will never be purely financial (especially in the event of a dispute)
    • You have a relationship and trust this person you are going to invest with so the chances are that you have a history with them which comprises good and bad
    • Keep in mind that these are likely to contribute to any discussions you have about this investment (especially disagreements) and decisions you make are unlikely to be purely financial
I think the disadvantages definitely outweigh any advantages there are when it comes to property investment.  Consider carefully why you are going into this investment before you do and if you decide to go ahead make sure both of you understand what you're getting yourself in for.

Have you invested with others?  How did you find your experience?

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