If you tell a financial planner you’d like to invest part-time in real estate, he’ll suggest either REITS (real estate investment trusts) or limited partnerships. REITS are like stocks. You have no control over them, you have little chance to interact with management, and your knowledge of the business and its prospects is likely to be based on the information the business gives you.
When you invest in a REIT, you are gambling on very limited information. That might be appropriate for a very small part of your stock portfolio (for balance), but it’s not the kind of investing that gives me comfort. Legally, a limited partnership is a passive investment. As a part-time partner, you generally go in as a limited partner.
That means (a) the money you risk is limited to the money you put in (you can’t incur any further obligations, and (b) the money you get out will probably be less, proportionately, than the money the general partners take out. I’m not generally a fan of limited partnerships, because they are very complicated, entail all sorts of risks, and are often set up by unscrupulous people who use them to mulct investors. There are many ways you can get cheated when you give your money to a real-estate developer.
* A general partner can use the electrician your deal is paying for to do some “free” work on his home or on another project. You pay the bill for both jobs but get the benefit of only one. Since this is done entirely with a wink and a nod, you won’t have any way of knowing that it’s happening — and if even if you did, you would have no way to prove it.
* You can put your money into a deal that never gets off the ground. The general partner can take your initial investments, make the money disappear into some inflated subcontractor bills, declare bankruptcy, and walk away, leaving the job unfinished.
* You can get screwed by the lawyers and the bankers and the brokers too. It’s a messy, complicated business — and everybody has an angle. Still, it can be a very good part-time business for you if you are dealing with honest partners in a good market. In one case recently, for example, I doubled my money in 18 months by investing in some high-end homes in Snowmass, Colorado.
In another deal, one in Florida that I got into four years ago, I ended up making (though not the 25% projected) 15% over a four-year period on a considerable stake. The general partner, in the latter case, apologized for the performance. I was quite happy with it. The most important rule about investing in limited partnerships is to know and trust your partners. If you aren’t 100% certain you’ll be treated fairly, either don’t get involved at all or invest only what you can easily afford to lose. The next-most-important rule is to get actively involved on a part-time basis.
By this, I mean you should carefully review the contract, compare it to others, speak to outside experts, get to know the other limited partners, arrange regular interviews with the general partners, study the building plans, go to the job sites, etc. Make it clear from the start that you intend to be a very active passive partner. If they are good people, they will agree to it — but they will probably want to set some reasonable limits so they don’t end up spending all their time with you.
In addition to doing all that, you’ll need to make sure that the contract is written fairly. “Fairly” means that (1) the limited partners get their money out of the deal before the general partners do, (2) the general partners are not double-dipping by charging large management fees, (3) the projected ROIs are reasonable and appended to the contract, (4) you have the right to sue them if you feel you must, and (5) all the partners (general and limited) put actual green cash in the bank — and leave it there throughout the life of the deal. But the ultimate consideration is trust.
Never, ever invest in a limited partnership (of any sort) that’s run by someone with whom you don’t have an established working relationship unless you can afford to (emotionally and financially) lose your money. There’s that old saying: When two people get together for business and one has the money and the other the knowledge, at the end of the deal the guy with the money has the knowledge and the guy with the knowledge has the money.