Bad method at this stage

Jay wants to build an apartment complex, but he doesn't have the cash to fully fund the venture. He asks Dave about lining up investors, but Dave thinks this is a bad idea.

QUESTION: Jay is looking to build an 18-unit apartment complex, but he doesn’t have the cash to do it on his own. He has a net worth of around $400,000, and $100,000 cash he can put toward the $1.2 million project. He asks Dave if lining up investors, who will take a percentage of the profits, is the same thing as acquiring debt. Dave says no, and explains his reasoning.

ANSWER: No, because if there are no profits, the investors get nothing. It’s not debt — it’s partners. It’s what you would call an equity position, meaning they’re owners in the business. Now, they may have limited rights as owners, but essentially you’re taking on partners.

There’s a method that was used in the old days, and is still available, called syndicating a piece of real estate. You would set yourself up as the general partner and set the investors up as limited partners. They would certainly be limited in their input — the general partner runs the show. They can be given the lion’s share, for instance, of the tax write-off — the depreciation schedule can be given to them. The general partner, traditionally in those models, takes less of the depreciation schedule but gets a fee for running things and has a position of ownership.

You can do all that, a limited partnership or syndicate a piece of real estate, but it can be very messy and time consuming for the money you get out of it. At this stage of your investing life, I don’t think this is a good method for you to buy an apartment complex. It’s more like a way for you to get into the business of running a bunch of limited partners with a ton of paperwork and bookkeeping thrown in. And honestly, it doesn’t sound like a lot of fun to me.

If I were in your shoes, I’d use the $100,000 in cash to buy a money-making property — maybe a nice rental house. Then, save your money, invest and buy another one. And again, save the money, invest and buy another one, over and over again. It’s a gradual process, but I don’t teach or advise people to go into partnerships or borrow money.