How to Protect Yourself as a Real Estate Money Partner

One of the more elegant features of the real estate world is the way the whole ecosystem encourages symbiosis. Investors often are stronger together, especially in the face of an obstacle. For most investors, start-up capital or even cash flow to expand will become issues at some point in an REI career. Money partnership is one creative way REIs are helping each other by offering complementary skills to one another and combining forces on an investment. This is a clever way to square a capital issue or get help finding deals, depending on your role. Everybody wins when these arrangements work out. Here are some of the things you need to know to make sure yours does.

Money Partners and Credit Partnerships Explained

The money partner is the term for the person in this arrangement who has capital to spare. As for the person that has time or scouting skills or other resources, they are sometimes called the entrepreneurial partner. Other terms for these types of arrangements include credit partnership and partner funding.

Many of our investor clients are at the stage in their careers where they’re richer in capital than time. But don’t get discouraged, most beginners start out rich in resources other than cash. It may be your willingness to spend time researching, number-crunching, your day job skill set, or even your charm or tenacity--but there is certainly something about you that makes you valuable to another investor even if you’re cash-poor. Eventually, as your career progresses, your time will become “expensive” enough that you may assume the other role. Many REIs transition into mentorship.

How to Protect Yourself as a Money Partner

If you’re the “bank” in any kind of deal, you’ve got to look out for yourself. Money partnerships aren’t any different. You’re taking a risk, so of course you want to take the steps you can to mitigate that risk. Here are some of the most important tools you can use to keep yourself protected.

Option #1: Create Clear, Thorough Contracts

If you’ve got concerns about what your new partner may do if they’re not responsible in their duties. But that’s why the smart folks in our early legal system (and its predecessors) gave us contracts: to get everyone’s roles, responsibilities, and rewards in ink. Simply using basic contracts to solidify your verbal agreements can prevent nasty disputes, and even lawsuits, down the road.

If you have specific concerns, address them in the contract. Ask your attorney what some wise provisions would be given the specific fears or worst case scenarios you’re aiming to prevent. Odds are good you can rule out a lot of shenanigans by simply taking the time to create an effective contract. Anyone who wants to make money with you should be willing to sign a contract with fair, reasonable, comprehensible terms.

Option #2: Use Entities To Limit Your Personal Liability

Where a contract can’t always help you out is in the realm of lawsuits. Unfortunately, partners sometimes get bad blood. Deals sometimes don’t go as planned. Of course, most people get angry and play the blame game. Some people’s preferred venue for the blame game just happens to be the courtroom.

Don’t become a victim to your partner revealing themselves to be bitter or litigious. Protect yourself by creating an LLC and operating it in a manner to a venture-specific LLC. Use your Operating Agreement to clarify your relationship to as fine a degree as you like, and even divvy up profits and losses as you agree is fair. The great thing is you can have equal power if you like, or a money partner may want a greater share of profits. These are all the details you can get on paper when you file your LLC, but filing your LLC serves a second purpose: asset protection.

The LLC limits liability around real estate investments. Moreover, a Traditional or Series LLC separates you from the asset and its problems. You’re separate and no longer “own” it, but control it. What’s great about not owning something is it’s impossible to lose it in court. But of course, you retain legal control. Clever business structures can have many benefits on top of helping you CYA in a money partnership.

Finders' Fee Arrangements for Real Estate Investors: What You Need to Know

Finders’ fees can have a few meanings in real estate, but generally the term refers to the chunk of change a “middleman” in your deal can take. Sometimes they’re gifts, other times it’s a commission or percentage. Usually, real estate agents pay finders’ fees, not investors directly. But it’s also true that commercial REI transactions will almost always involve paying at least one finders’ fee. So what’s an investor mixed up about this concept to do?

Read on, that’s what. Today we’re breaking down everything you need to know about real estate finders fees, what’s normal, what’s not, and even what’s illegal. By the time you’re done, you’ll understand how finders’ fees work and protect yourself from unethical people in the real estate game.

What is a Real Estate Finders’ Fee?

A finders’ fee may is also often called a referral fee (or even “referral income”). It’s a type of commission paid to a middleman of some kind for brokering your real estate transaction. Such fees are indeed commonplace, but they’re also regulated by law. For instance, some states have laws prohibiting paying finders’ fees to “unlicensed persons.” Usually, these types of laws are designed to prevent real estate agents from paying such individuals--not the original customer.

That said, most states have laws that allow intermediaries to request anywhere from 3-35% of the deal’s value. Does that mean you have to pay it? Of course not, but some folks will pay on the high end to get the pad of their dreams, so you can’t really blame these middlemen and women for trying. Hustlers have to hustle, after all.

Real estate agents are the big gatekeepers to the world of finders’ fees. Realtors and agents across the country use finders’ fees to encourage business contacts to remember them if they hear of someone property-hunting.

There are, of course, licensed brokers whom it is absolutely ethical to pay for tips on clients, property types or asset classes, neighborhoods or names of individuals preparing to sell, and of course, individual deals. While the type of conduct one may engage in to secure a lead may vary by state, because again, that’s the level at which this concept is most regulated, finders’ fees are indeed fairly universal to real estate investing. Federal and state law generally permits licensed individuals to collect fees within reason. They may be the reward a licensed broker gets for:

What’s the Point of a Finders’ Fee?

Now that we’re clear about what finders’ fees are, let’s talk about why they still exist in real estate. First and foremost, it’s important to recognize that finders fees are a form of incentive that keeps the entire buying-and-selling economy of real estate humming along for us investors to come in and capitalize on. The finders’ fee is the incentive, essentially, for making a deal happen: after all, that’s what this REI game’s all about--making the best deals possible.

The whole idea is that but for the intervention of your intermediary, the deal wouldn’t have happened. Or at least, this assumption has fueled the continued existence of finders’ fees. Whether this underlying assumption is true in your case is a completely different discussion, but it’s accepted enough in the REI world that the practice continues.

What Should Real Estate Investors Know About Finders’ Fees?

We’re all likely to encounter the finder’s fee, so the best thing to do is be prepared. At the very least, we can come armed with the knowledge of what’s normal and what’s not, even if this is our first ever real estate transaction

Remember that even if you are new to the game, you can act as if you’re not. Act with the confidence of the knowledge you gain here and anywhere else you study investing strategy. If you don’t yet believe in yourself, it’s a good investing psychology practice to learn to believe in your abilities and brain first. Let’s talk about some of those sticky situations where you’re going to be hit up for money. It’s best to at least not look surprised (unless you’re handed an absurd number), so these tips should help. 

What’s Normal With Finders’ Fees

Since finders’ fees help make the real estate world go ‘round, you can absolutely expect to encounter them during the deal-hunting or deal-making process. It’s just part of the game.  

Your real estate broker informing you they plan to pay a finders’ fee isn’t unusual. It’s even better if they ask and get your opinion or thoughts.

Ordinarily, these fees are paid between brokers, and real estate agents draw up “Cooperating Agreements” to streamline the referral and payment process. Basically, the agent can pay a broker out according to a pre-existing contract.

Keep in mind there’s more than one “normal” way to pay finders fees. Agents usually make payments, but sometimes if there is no contract, they will simply write a check as a “gift” to your friendly intermediary. This is a perfectly ordinary practice and shouldn’t alarm you. As you can see, most of the time you as the investor don’t make a payment at all.

What’s Not Normal With Finders’ Fees

First of all, you’re never legally required to pay a finders’ fee. It’s a practice in the industry, and nobody is legally entitled to such payments. Not agents, brokers, or anyone else. They can ask, but under no circumstances do you have to pay.

Anyone who says otherwise is generally just trying to hustle you in some form or fashion. So move on and feel free to place such people on your personal blacklist.

Unlicensed middlemen also fall in the “not normal” category. If a person can’t explain their job, how they became involved in the transaction, or who they specifically know involved with your deal, this is a major red flag. Fees paid between brokers and licensed agents are common--after all, it’s good for everyone to pair up customers and properties, and frankly, some people will always have more of one than the other. But you don’t want to pay just anyone: make sure they’re really facilitating your deal in a meaningful way. 

What’s Straight-up Illegal

An investor directly paying finders’ fees is bizarre. Sometimes it’s illegal.

You never have to personally pay a fee just because a person says they helped your deal happen. A friend’s referral can actually become illegal if say, you’ve paid that friend for other business referrals and they claim to have facilitated your real estate transaction.

When someone requests a finders’ fee you think is off, don’t pay it. Odds are good it would be illegal in the “friend” situation (unless you’re certain your soon-to-be-ex-friend is an appropriately licensed facilitator under state and federal law). Never pay anything if you’re not sure it’s legal, or if your gut’s just screaming not to. 

Finders’ Fees: The Informed Investor’s Way

Understanding both the law around finders’ fees and what you’re personally willing to pay is important if you’d like to define personal boundaries around this matter. You can always choose other real estate agents if your agent’s policies are wrong, unlawful, or just not your style. Knowing when to pay and when to walk away can make you the smartest investor in the room.

Using a Series LLC for Real Estate Investment Protection

One of the best asset protection companies for real estate investors is the Series LLC. It's been around since 1996, originally started in Delaware but it spread through a number of states now. This allows you to form a Series LLC in their state and use the company in any state.

First, learn about the Series LLC vs LLC you probably know about. Then you'll start to understand that the Series LLC (unlike its more traditional counterpart) operates much like a parent-child type of relationship. You have one series LLC, this is the company named something like "Worldwide Investments LLC," for example. It will actually be filed in the state of Texas and that will have its certification of formation and all of those formal documents. Documents which certify that is a legitimate LLC inside of that state.

Series LLC Formation

Series LLC has special provisions inside of a formation as well as operating agreement which gives it the ability to have children, as many children as it would like in fact. Each child is known as its series. So we'll have series A. Later you can form series B, which is separate legally from the first. You can have unlimited series within a Series LLC. That's advantageous, because each series is treated individually for liability purposes, just as if it were its own limited liability company.

This means that if you have a property, a single property that's held by series A, which is what I'd recommend. We should be compartmentalizing our assets as investors. Because what we want is if there's a lawsuit regarding series A, it doesn't affect series B, C, D,etc. for every asset that we have. A incident works much like a single purpose LLC.

Series LLC Taxes

Series LLCs is also advantageous because they allow one EIN number that's filed underneath this company name. That allows us to streamline our tax preparation so that we're not having to do individual company filing.

Legal Considerations

Now, there's some apprehension in the industry regarding whether a series LLC would be recognized in a state that doesn't formally have a law both in Washington and created there. I personally believe that there's good reasons to think that due to the growing trends nationally these companies will be recognized if ever challenged. There's not a lot of case law on that fact though, but there's a lot of good reasons and precedent that we typically do recognize a company formed in Texas that would be operating, say, in Idaho. Idaho will recognize a Texas company.

These are LLCs. Just like any other LLC. Just with one small caveat, that it can create tiers. But, for the more conservative investor that has any apprehensions about that, I would recommend using a traditional single purpose, limited liability company for each property.

Costs Of Operating An LLC Vs. a Series LLC for Real Estate

You have to pay for the series LLC tax preparation for each one of those companies at the end of the year, you're gonna have to pay for the formation of those companies, operations, management, and registered agent of those companies which can be hundreds of dollars per year. And you're gonna have to pay what the overall complications and operations of those companies.

So you have to weigh your odds and how you feel about the Series LLC versus the single purpose limited liability company. My opinion is that the Series LLC is the way to go.

My name is Scott Royal Smith, with Royal legal solutions, I'm an asset protection attorney focused in real estate, and I'd like to help you. Set up a consultation to see how the Series LLC can streamline your asset protection protection today!