Get rich without leaving home
A limited partnership lets you be a real estate mogul and keep your day job. But do it right.
NEW YORK (MONEY Magazine) - If you've dreamed of investing in real estate but don't want to miss out on the kids' Little League games, partnerships may be the answer.
A limited partnership allows a group of people to pool their money to invest in one or more properties. But you won't chase tenants or stay up nights worrying whether to replace the roof. These pools are run by a general partner who oversees all the work, while you can collect your quarterly check and get your lawn mowed.
And unlike with real estate investment trusts or funds, you'll be able to invest in properties located in your own backyard, where you're more likely to know a thing or two about local values.
That's the good stuff. The bad stuff is that today's partnerships may remind you of the notorious tax shelters of the early 1980s. True, one of the attractions of any real estate partnership is its tax advantage.
Investors write off depreciation, claiming a portion of the value of the investment each year; on paper this might wipe out much of your earnings that would be reported to Uncle Sam. (Careful: The taxes you'd have owed are deferred, not forgiven; you'll have to pay the IRS sometime, just not now.)
But Stan Ross, chairman of the Lusk Center for Real Estate at the University of Southern California, says that's where the resemblance to the 1980s ends. "Today's partnerships have more equity and less leverage. They're driven more by the economics of the deal, not the tax break."
Who's selling these things? Sometimes it's an accountant or financial adviser with real estate contacts. Mostly, though, it's up to you to develop a network that could lead you to such deals. Ask a local real estate attorney if she knows someone who knows someone. A local real estate investor club can be a good start too.
Do your research
But before you pony up the $20,000 or more it takes to participate in a partnership, take this advice to heart.
Devour the prospectus Every deal has a write-up of the investment that you will want to study. You learn about the property, the time horizon for the investment and the general partner's record.
Look for the words "preferred return." This is the amount of money the general partner has to earn and hand over to people like you before he takes his cut of the remaining profits. Typically, a preferred return is 7 to 9 percent.
Vet the top guy You're riding on the general partner's coattails, so make sure he's running the project on behalf of you and your fellow shareholders.
Skip a G.P. who doesn't have skin in the game -- or not enough. His investment should represent at least 5 percent of invested capital.
Compare this money with the fees the G.P. stands to make: If he plans to invest $50,000 but will make $100,000 in fees over the life of the partnership, that's a clear warning sign to stay away.
Watch the fees Index fund fans, steel yourselves: Partnerships are pricey.
You can pay from 1 to 5 percent in acquisition fees up front and 3 to 5 percent on each year's gross receipts, plus an asset management fee on profits.
Therefore, consider passing on a deal with a preferred return below 5 percent, says Glenn Sonnenberg of Legg Mason Real Estate Investors.
Be patient Partnerships are tough to sell if you need to retrieve your money fast. (There's not much of an after-market for partnership stakes.)
Typically, your money will be locked away for up to 10 years; if you can't afford to think of it as out of circulation, invest elsewhere.
Go for vanilla Invest in familiar things that make sense no matter the state of the economy, like apartments and stores.
"Everyone needs a place to live and a place to shop," Sonnenberg notes. "Buy rental income that has stood the test of time."
In other words, head for the exits if someone starts touting restaurants or hotels or assisted-living centers or such. And always keep your investment close to home -- where you can benefit most from your knowledge of the market.
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Gerri Willis is host of CNN's Open House. Write her at email@example.com.