One of the best pieces of business advice I ever got was “You can’t do a good deal with a bad partner.”
Having had many partners over the years, I can say that this statement holds true. So I thought I’d offer some personal experiences I’ve had with partners both good and bad.
All Play and No Pay
The first partner is a former CPA who does spectacular pro forma projections. His numbers on the future viability of a real estate project are always well laid out and convincing.
In fact, after first meeting him and his business partner, a Wall Street whiz kid, and looking at some photos of a property they were interested in and an architect’s rendition of what it would look like upon completion, I was sold. I became their money partner.
So far I’ve done three deals with this pair, and to date, we haven’t made a dime. The numbers still look neat and tidy every quarter, just the way a CPA should present the financials. The problem is in execution: The projects never finish on time or on budget. Something always goes wrong, and there’s always some kind of drama — problems with environmentalists, city planners, or banks.
Finally, after years of squabbling, his partner (the whiz kid) left the relationship. The projects of theirs that I invested in are still operating, but to date I haven’t made any money on them.
A Complementary Relationship
The second partner is Ken McElroy, a writer and personal friend. My wife, Kim, and I have made the most money with Ken. There are several reasons why:
• We share the same investment philosophy.
We buy, improve, hold, and refinance. We generally don’t like selling our properties.
• His expertise makes up for gaps in mine.
Ken owns the largest property management company in the Southwest, and his partner, Ross, is a real estate developer. Both men have nearly 20 years of experience in their respective fields.
Because of Ken’s years as a property manager, he has the experience and skill to evaluate the value of an existing property. And Ross has the know-how to bring the reconstruction of properties in on time and often under budget.
• We adhere to the same strategy.
Ken, Ross, Kim, and I like to put our money in, improve a property, bring in better tenants at increased rents, reappraise the property, and then borrow our money out and move the equity on to the next property. We then repeat the process.
A Near-Infinite Return
For example, we put approximately $2.5 million into a $9 million, 300-unit apartment house, and secured a construction loan to improve the property. A year later, due to attracting better tenants at higher rents and a lower vacancy rate, the property was appraised at $14 million.
With the higher appraisal, we refinanced the property with a new loan at a better interest rate, and were able to take out $4 million tax-free. The money is tax-free because it’s a loan, not profit. The debt service — the monthly mortgage payment — is paid for by the tenants.
With this investment strategy, our ROI is practically infinite. We have no money in the investment, yet we collect a monthly cash flow and still have control over the property. To me, this is better than buying a property, selling it, and having to pay taxes on our gains — or be in a rush to buy a new property just to avoid capital gains taxes via a 1031 tax-deferred exchange.
(A 1031 tax-deferred exchange gives sellers a certain number of days to move money from a sale into another property and defer paying taxes on the gains. The process is more complicated than it sounds, which is why I strongly recommend using an exchange agent to guide and assist you in the process. Most real estate brokers can recommend an exchange agent if you live in the United States; other countries have different rules.)
Finding a great partner like Ken is similar to finding a great husband or wife — you have to kiss a lot of frogs before you find the prince or princess of your dreams. I don’t know of a magic formula other than to keep kissing.
My rich dad often said to me, “You need to be a good partner if you want to find a good partner.” Obviously, this is as true in business as it is in love. In my opinion, the best way to begin is by looking in the mirror and asking yourself, “What do I bring to the table? Am I the kind of person I would want to do business with?” It’s important to evaluate your strengths and weaknesses honestly.
One of the reasons Ken, Ross, Kim and I do so well together is because we all love real estate; we complement each other in terms of our individual strengths and weakness; and we’re all adept at raising money. We make a good team because there’s synergy between us, and synergy is money.
A Way Out
My most important partner is my wife, to whom I’ve been married for nearly 21 years. When Kim and I first met, I was deep in debt from a disastrous business partnership. Regardless, on our first date I asked her, “Do you have a problem with being rich?” It’s tough to get rich if your partner doesn’t share that goal, and I would never have become rich without her.
That brings me to my next point: All partnerships should have an exit strategy. My partner Donald Trump says that married couples should always have a prenuptial agreement. True, a prenuptial is important if one partner is much richer than the other before marriage, but Kim and I don’t have one. Instead, we have our own corporations that we control independently.
Still, Donald is right: The best time to think of an exit strategy is before becoming partners — that is, after you’ve kissed a few frogs and have found your ideal business companion. But remember: They sometimes turn back into frogs, and you can’t do a good deal with a frog.