Agreements Relating to Real Estate Investments
Most investors in real estate intend to retain ownership for a period of time. These investments, by their nature, do not provide liquidity for people who wish to sell in order to access funds on short notice. In all cases where there are numerous persons involved in a single acquisition, it is necessary to record the agreement between them that relates to the day-to-day management of the real estate, major decision-making procedures, and the eventual sale of the property.
Whether the vehicle for the investment is a joint venture, a partnership or a corporation, the parties should always be advised to have an agreement reflecting their understanding of the relationship.
The most important issues that need to be considered relate to the following:
- The appointment of a property manager and the scope of the management activities (i.e. the day-to-day management) that would include the collection of the rents, the paying of the normal operating expenses, and the distribution of funds to the owners.
- Arrangements with a property manager would not normally give the manager the authority to make decisions relating to major issues such as negotiating mortgages, authorizing major capital expenditures, and entering into major leasing arrangements.
- Within the framework of the agreement with management, it is necessary to record the basis on which they are to be remunerated.
The period that it is intended to hold the investment should be recorded as should the methodology for making the decision to sell (i.e. is this a decision that can be made at any time by a majority of participants?). It should be noted that each participant should not necessarily have one vote, but that the voting should be weighted according to the amount invested by each participant.
It is also common to make provision for the option that a participant may wish, for various reasons, to realize his or her investment. Consideration needs to be given to the extent to which this is possible. Normally, provision would be made for any participant to be free to transfer his or her investment to any other person who was a participant in the particular real estate, or to an outside party approved of by the other participants. It may also be that if the participant is in a position to sell to a third party that the right of first refusal should be given to the existing participants.
When Financing is Needed
One of the more difficult problems to deal with may arise where financing is needed such as when a mortgage term ends and is required to be repaid and because of the state of the market at that point in time, it is not possible to raise sufficient new funds to affect such payment. Participants would then need to provide funds and in such event, it is necessary to legislate how a participant who fails to produce his pro-rata share of the funds is to be dealt with. There are various issues that need to be considered. Some agreements provide for the interest to be valued and taken over by the remaining participants. Others provide for the remaining participants to provide funds in excess of their pro-rata amount and to receive a handsome rate of interest on such advances. There may also be agreements that provide, in these circumstances, that the interest of a participant who fails to provide his share of the funds will have his participation reduced.
It is also necessary to provide the basis for determining from time to time the amounts that are available for distribution to the participants. It is often left to the property manager to deal with this on a month-to-month basis.
Such agreements also normally provide for the appointment of the lawyers and the accountants to the particular venture.
Unfortunately, failure to agree to these matters in advance can create major problems in the future.