One of the great investing maxims is: “Your best business partner is always the bank; all they ask is that you pay the interest.” Yet due to high property prices, it is becoming common for people to consider pooling their money with friends or family members to go into a real estate joint venture.
Such activities are fraught with danger, and the outcome is often the end of the friendship between the parties as well as the loss of a large sum of money. When things start to go wrong they can quickly go horribly wrong, and the original good intentions, trust and tolerance are quickly forgotten. Remember American policeman George Napper’s line, “When you're up to your ass in alligators, it's hard to remember that your purpose is draining the swamp!”
Major difficulties can be caused by differences in the temperaments of the parties involved. Some investors are aggressive, some are timid; some like to make decisions quickly and others like to mull over them for days. Put two different investment personalities together and you have a recipe for strife.
CASE STUDY: Alex and Val decided to make their fortune in real estate by buying a rental house, putting in $40,000 each and borrowing the balance. The first problem arose when they came to finance it. Val was an aggressive investor who wished to borrow on an interest-only basis using a five-year fixed interest mortgage – the method used by most serious investors.
Alex was a less adventurous borrower, who felt people who borrowed on an interest-only basis never got anywhere because the debt did not reduce, so pushed for a short-term principal and interest loan. Val stood firm, and Alex reluctantly went along with the interest-only loan.
Then came the decision of who was going to manage it. Alex wanted a real estate agent to do it, due to feeling nervous dealing with tenants; Val believed this was a total waste of 10 per cent of the rent, and once again persuaded Alex to agree.
Val – an ambitious person with an increasing workload – began leaving more of the rental management and maintenance to Alex, who started to resent doing the lion’s share of the work. Friction started to build, and the situation worsened when Val was transferred to an executive position in Sydney, leaving Alex to take care of all the management.
By this stage Alex had met their dream partner and had far better things to do than manage an investment property. The new couple decided to buy a house to live in, but to fund the deposit Alex had to sell the investment house. Only then did they find out there would be a substantial penalty for paying out the loan before the end of the agreed term. Val was not in a position to buy Alex out, and was even less happy when a large capital gains tax bill hit.
Another common problem arises when one of the joint investors loses their job and cannot make the monthly contribution required. The one who is unemployed is likely to insist the house be sold so that they can fulfil their obligations, but this might coincide with a time when the market is in one of its long flat spells, forcing a sale on unfavourable terms.
The lesson from this? People's situations never stay static. The high-income earner of today may be unemployed tomorrow; the single person with no thought of marriage may be walking down the aisle within a year. Today you can buy property with just 10 per cent deposit and borrow the rest from the bank at about 5 per cent. If you can’t make it work on your own you probably shouldn’t be in the deal anyway. There’s no joy in risking your friendships, as well as your money.
Noel Whittaker is the author of Making Money Made Simple and numerous other books on personal finance. His advice is general in nature and readers should seek their own professional advice before making any financial decisions.
Adapted from The Sydney Morning Herald