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Forming an entity to purchase, develop and operate real estate is generally a good idea for many reasons. There are tax considerations and liability implications that should always be at the forefront of any discussion when investing in real estate.  These are primary questions whether there are multiple partners or only a single investor involved in the deal.  But, when there will be more than 1 partner in a project, some sort of entity will need to be formed, whether a corporation, general or limited partnership, or a limited liability company or similar limited liability entity.  The “partners” (I am using this term generically to cover all  possible entities) should enter into an agreement carefully to set forth the rights and obligations of each partner so that there are not any questions about what happens in the future if/when certain problems arise.

Every relationship starts out with the best of intentions. Friends and family members, even acquaintances, generally trust each other to do the right thing.  But when money is involved or deals turn side ways, all bets are off.  Here are 6 provisions that should be considered in every shareholders, partnership or operating agreement, particularly when real estate is involved:

  1. Management Authority and Major Decisions – going into a real estate deal, 1 or 2 people might be the sponsors, or, 1 partner might have certain expertise and another might have a different expertise. Very likely, 1 partner might be the real estate guy and the other or others might be providing the capital.  It is important to determine who will make the day to day decisions and what decisions constitute “major decisions” requiring a vote of the partners.  Will  major decisions require a majority vote or a super majority?  Perhaps even a unanimous vote?

 

  1. Admission of New Partners – it is important to determine whether there will be spelled out criteria for admission of new partners and whether a vote of the partners is required to admit new partner or if the managing partner may admit new partners on his/her own. More importantly, will the admission of new partners dilute the voting interest or equity interest of the existing partners?

 

  1. Transfer of Ownership Interests – there are 2 concerns here, voluntary transfers and involuntary transfers. A voluntary transfer is the ability of a partner to freely transfer or sell his/her interest to 3rd parties.  Should this be permitted?  Or, should voluntary transfers be tightly controlled or absolutely restricted?  Involuntary transfers include transfers due to bankruptcy, divorce and death or a partner.  These are of concern to the partners because often, the non-transferring partners don’t want to be partners with the ex-spouse or surviving spouse, or be forced to deal with the bankruptcy trustee.  Therefore, it is important to provide mechanism for dealing with involuntary transfers.

 

  1. Capital Calls – the partners must determine the procedures for dealing with the need for additional capital and what happens when a partner does not fund.

 

  1. Buy/Sell Provisions – often, partners want to add provisions allowing for a partner to buy out the other partners. Sometimes, these mechanisms allow for “put and call”, requiring a potentially purchasing partner to sell his interest instead so that the financially stronger partner can’t force out the weaker partner any time he/she desires.  These provisions also can include rights of first refusal.

 

  1. Exit Strategy and Other Obligations – what is the partnership’s overall exit strategy? Have the partners agreed to sell the property at a fixed benchmark such as the exercise of a purchase option by a major tenant? What about other obligations like loan guaranties?  Are any of the partners obligated to provide guaranties for financing for the project?  These kind of provisions must be included in the partnership agreement.

 

These 6 provisions might only scratch the surface of issues relative to real estate deals. Every partnership and real estate transaction is unique.  If there are deal specific provisions, they should be added to the partnership agreement so that no questions or expectations are left unanswered.

Mortgage Rates Rise Following Trump’s Election

Many in the real estate industry were cautiously optimistic following the election of Donald Trump on November 8. For the first time, a real estate titan will occupy the Oval Office and Mr. Trump, it has been argued, will be good for real estate.  His policies should favor our industry.  For example, Mr. Trump has campaigned against Dodd-Frank, promising to repeal the law.  He has promised to roll back government regulation of the financial industry allowing banks more freedom to make loans.  And, he has promised to cut taxes.

        The immediate impact following Mr. Trump’s election has been record high closings on the stock exchanges.  Investors seem to be encouraged by the possibilities ahead.  However, the opposite seems to be happening with mortgage rates.  Since election day, mortgage rates have been slowly climbing.  30-year fixed rate mortgages were, on average on election day, 3.57%.  But, just last week, the average 30-year fixed rate mortgage was advertised at 4.03%, the highest since July of 2015.  While this rate is still historically low, the trends indicate that rates will continue to climb for the foreseeable future.  Rates are climbing despite the fact that the President Elect has yet to announce any new or concrete economic proposals or spending cuts.  The markets are simply reacting to campaign promises and rhetoric.

         What is likely to happen following inauguration day?  Bond rates have also been climbing since election day.  10-year treasury notes have risen from 1.85% to 2.24% in the week following the election.  This causes rates to rise and experts expect these rates to continue to rise.  Additionally, the Federal Reserve continues to suggest that it will raise its rates at an upcoming meeting.  This will also affect mortgage rates.  After inauguration, we can expect mortgage rates to continue to tick up as a result of these factors.   Unless Mr. Trump makes a radical change in policies, the trend will continue.

        In the short term, buyers will scramble to close on new homes quickly, hoping to catch rates while they remain low.  But, as rates increase, homes will become less affordable for buyers and sales will begin to slow.  By the end of 2017, some predict that housing inventory will begin to increase and prices will begin to fall.

        The first real estate president will have a great influence on our industry.  But it may not be what we have expected.  It might be negative.  Rate increases and severe tax cuts could lead to rising inflation.  It might not simply be higher mortgage rates that we have to worry about.  The residential sector should begin to brace.

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    Welcome to Assouline & Berlowe’s Florida Real Estate Law and Investment Blog with news, insights, and commentary for investors, developers, and their advisors.

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