A peek behind the curtain

Have you ever missed out on a great investment because you didn’t know how to quantify its risk and return? Or even worse, because you didn’t even know what to ask to make an informed decision?

If you fancy yourself an investor, you need written investment criteria you can refer to when someone offers you an opportunity. Here’s a sample. Once you fill it out, answer these questions:

What type of investment is it?

If I buy it, how will it affect my allocation distribution?

What is my estimated Return On Investment?

A simple description of the investment:

The above sample real estate investment includes multiple scenarios that affect the ROI, including varying rents and whether you (or your business partner) plan to live in the condo. If you do, you can include the federal $8,000 first-time homeowner credit if you buy before December 1.

Here are 2 ways you can construct a joint venture between you and whomever’s bringing you the proposal:

#1: Bought by owner-occupant. This is perfect for a parent who wants to help her kid buy a home, yet still reap an ROI.

You lend the entire price of the condo, without interest.
Say the monthly market rent is $700. You’d charge 80% of that to your daughter, which is $560.

-$490 goes to you
-$70 goes to a reserve account for property maintenance.

Your daughter saves 20% off fair market rent. In return, you get to write the property expenses off on your tax return instead of she.

#2: Bought by LLC. Investment partners would use this proposal when one partner (the Finder) has the time & expertise to find the property and the other (you) has the money to finance it.

Again, you lend the entire price of the condo, without interest. However, you’ll rent it out to some stranger at the full market price of $700.

-$490 goes to you
-$70 goes to a reserve account for property maintenance.
-$140 goes to the Finder.

Always describe the worst-case scenario and decide if you can survive it:

-Property values may continue to fall. You might have to hold the condo for 5 years to break even.
-If the condo doesn’t rent immediately, the return will decline.
-The condo could get damaged. (So you need a security deposit.)
-You and your partner might disagree on management or sale of the property. (So you need a properly worded operating agreement.)

Since you’re creating a partnership, I recommend an operating agreement clarifying these issues:
•   Whose name will the condo be in? (You can own it outright, your partner can own it outright, you can own 63% and your partner 37%, etc.)
•   When you sell, how will you split the profits?
•   Who will manage the condo and rent it out?

The answers depend on whether your partner will be your kid or someone else.
If you’re setting this up as a business arrangement, create an LLC to hold title to the property. In the LLC’s operating agreement, you can set out details such as who gets to write the property expenses off and what each partner’s duties are. The LLC also protects against liability if your tenant or a visitor gets litigious.