The much talked about new Association Rules are back before Parliament and unfortunately for those in the business of dealing in or developing property or erecting buildings, the Bill has not been substantially changed.

The new expanded definition of association has largely survived the Select Committee process and the new rules are likely to come into force in August, potentially from early August.

We are currently working through the rules so if you are looking to buy a rental property in August please contact us for advice if you are concerned about potential tainting.

Important Note for Builders

If you are in the business of erecting buildings this is the one activity that could lead to tainting of existing properties. To explain, if you are a dealer or developer only (ie. not involved in the business of erecting buildings) any rental property that you own now and that was not tainted under the existing rules will not be affected by the new rules. Further purchases could be, but your existing rentals will not be.

On the other hand, if you are in the business of erecting buildings, existing rental properties that you have could be tainted if you carry out improvements on those properties. If you are in the business of erecting buildings and are looking at making improvements to a rental property then contact us immediately as you need to know the implications of this.

Changing Use on Existing Stock

The other major impact that the change in Association Rules has is for those of you who have property bought for dealing and development purposes where you are considering a change of use. If you have a property bought for dealing and development purposes and you are considering holding it (ie. making a complete change of use in respect of that property) you need to contact us urgently.  You should consider restructuring the ownership of that property in the next two weeks before the new rules come into play.

Summary

In summary, the new Association Rules are coming in and as feared they are wide reaching and going to make it very difficult for those engaged in a business of dealing in or developing property or erecting buildings to prevent future rentals from being tainted.

More immediately than that though, if you have property owned by your dealing and development entity that you now wish to hold long term you may need to take action within the next two weeks to restructure the ownership of that property before the rules change. If you are in the business of erecting buildings you also have to be extra careful if making improvements to existing rental properties.

If you want tax advice in relation to these issues please contact Anthony at GRA on 09 522 7955 or at anthonyl@gra.co.nz.

Thank you.

Matthew Gilligan

A recent article by the NBR concerning the wilful trashing of the former family home of bankrupt Merlot Homes director Stuart Herron, which recently sold at mortgagee auction, raises some interesting issues.

To summarise the story, in the four weeks between the auction hammer falling and the moving-in date by the new owners, the house was torn to shreds.

It seems the loss was not only limited to the removal of chattels (shower heads, carpets and stove hob for example), but also malicious and wilful damage including the poisoning of trees and other damage.

Who caused the damage? Who knows, it seems there could be a number of culprits from creditors to the Herron’s themselves – but that’s speculation - despite calls for the Police to get involved.

The new owners are now faced with the expense (both financial and emotional) of fixing the property.

Get Real & ‘Caveat Emptor’

So what does this mean for house-hunters looking for a bargain?

Each week there are pages of mortgagee auctions in the major newspapers and it's naïve to imagine that the former owners are going to walk away ‘quietly’. It’s well-know in the real estate industry and there stories around of how disgruntled debtors have done damage ranging from leaving rubbish to trashing the place.

And as a bargain-hunter looking to buy one of these properties, you too need to get real and be aware that it just might happen to you. It’s a risk that exists which is why you must build in a factor because you know that there’s a potential for this.

Remember, buying a house at mortgagee sale is like buying a car ‘as is – where is’. The normal rules don’t apply. All the usual warranties are taken out of the normal Sale & Purchase contract, so the vendor (the mortgagee) doesn't warrant that the place will have any chattels in it, or even be in a good state or even vacant when you settle.

The reason properties sell at mortgagee sales for typically 30% less than their open market value is that you are NOT buying the chattels and fixtures.

So as the purchaser, you buy knowing all of this in advance and take your chances in fact when you buy a house at mortgagee sale.

In the absence of any contract with the owners and with the Bank documents SPECIFICALLY EXCLUDING CHATTELS AND FIXTURES, any purchaser must be sure of what they are buying.

It is accepted law that chattels are furniture, drapes, dishwasher, microwave and any non hard wired appliances. Fixtures are chattels that have been attached to the property. For example this would include the kitchen the bathroom fittings all light fittings, TV aerials and any hard wired appliances.

At a stretch it could even be argued that doors, handrails and anything in the garden is a fixture. The Vendor clearly states that it is not passing title to any of these items.

The purchaser has contracted to buy the property with none of those items included in the purchase price. This is the legal reality.

Minimising the Risk

Arranging to settle with vacant possession on or as close to the auction day as possible will help to minimise risk as well as factoring the risk potential damage into the price you are prepared to pay.

As a structuring advisor to investors and business people, one very common mistake with many  business and property structures is a spouse being offered as a guarantor to the banks, landlords or creditors of a business.

Their personal guarantee is often not required to get a deal done, yet it is provided because the advisors around you do not stand up for you and say 'hey, don't let your spouse sign that - you don't need too'. The result is that if total business or investment failure occurs, both spouses are fully liable instead of just one.

Of course the creditor, banker or landlord requesting your spouses guarantee will insist it is necessary 100%, because it is in their interest.

But it is contrary to your interests.

My advice is NEVER give your spouses guarantee in business or property dealings if you can avoid it. I have developed over 80 million dollars in property, and guaranteed numerous business and banking obligations, purchased multiple investment properties, - and my wife has never signed a personal guarantee on the loans.

Why ? To shelter her from the obligations.

How did I avoid her being liable? By saying no to the banks and creditors when they asked. Did it hamstring her legal or matrimonial rights to recover the property if we divorced? No, - she still gets the assets because she jointly controls the Trusts and various entities borrowing. So this is not about stripping power off your spouse and potentially wealth, it is purely about minimising risk to your household.

Examples of this include:-

1. Borrowing money from the bank to purchase an investment property or even your home. If one spouse is a homemaker, has no income or their income is not required to meet debt servicing criteria of the bank, - then why allow the bank to take their guarantee? The only use of the guarantee will be to apply more pressure to your family if you have a problem, and both spouses go bankrupt instead of one ( which could be viewed as malicious in this light).
   
   One point to note here is that you may need to use a mortgage broker to manage the negotiation with the bank, - and the broker will have to work a bit harder to achieve this. If you deal with a bank direct, they will likely tell you 'no spouse guarantee is impossible in your circumstances'. It may be true if your borrowing position is not strong, but how do you know unless you have a lot of banking and commercial experience?
   
   The answer is use a broker who has the experience, and who is willing to try hard for you. I have found many brokers lazy, or unsophisticated - they are just not equipped for these sorts of discussions with bankers or do not value asset protection concepts. Remember they get paid on commission, and asking for tough things from the bank means more work and time for the broker, with no more money. For this reason it may be appropriate to pay your broker to deal with the complexities, if your affairs are complex. Otherwise they may put you in the 'too hard' basket. If you need a good broker, email me mg@gra.co.nz . We have contacts all over the country, and for the record we do not get commission from these relationships. We just want our clients better protected.

2. Dealing with landlords over commercial leases and guarantees: always try to divide leases out into separate 'tenancy companies' and make one spouse a director of this company, Your opening position should be no personal guarantee, and if 'no personal guarantee' is a deal breaker with the landlord, - then only the director/one spouse gives a guarantee. Try not to give an unlimited guarantee, - limit it to say 6 months rent, or a fixed sum as a cap.
   
   For example my rent is around $260,000 per annum for our premises, on a 3+3. If I guarantee it for an unlimited amount, that is a $780,000 personal obligation. Firstly, I limited the guarantee to 6 months rent ( $120,000) and secondly made sure that the shareholders (a Trust) and my spouse did not guarantee the loan. This turns a potentially disastrous obligation into a manageable commercial obligation.

3. Dealing with creditors over personal guarantees: creditors in business will generally ask for a personal guarantee. Refuse to give it if you can get away with it, and most of the time you can. Where you have to give one, just as with a landlord 'limit the guarantee'. Only this week I was arranging some advertising with Fairfax, and they asked me for two GRA directors personal guarantees over the obligations of our supply relationship with them for advertising. I was so annoyed, I told the salesman I did not wish to advertise with Fairfax if a personal guarantee was required. I told him clearly his company's view was that my company was unreliable in character, if they were not willing to deal with the company without the director's guarantee.
   
   He got the message - I really cared more about the guarantees than the advertising and they would not get our money unless they backed away from the guarantees. He rang later to advise the guarantees would not be necessary. To my knowledge, GRA directors have not guaranteed a single supplier obligation (apart from the limited guarantee to the landlord). So it can be done, but I do acknowledge that some suppliers just won't deal with you without providing a personal guarantee.

Summary

Keep your spouse out of the liability chain if you can. Personal guarantees and spouses should not mix.

If you are dealing with a landlord or creditor in business and have to provide a guarantee, try not to give a guarantee at all, or limit the guarantee to a fixed sum Eg: 6 months rent.

If your spouse has no income, you should be able to avoid their guarantee being given to the bank. Consider using a mortgage broker to achieve this. Generally the banks (if dealing direct) will be very hard to manage on this point, especially in this recessionary environment.

I hope you have found this information helpful.  If you require assistance with any financial matters, please fell free to request an interview.  We are here to help.

Have a good month!

As accountants we are often asked, what can we do to manage our exposure of our affairs to banks, as we increase our business or property borrowing?

There are lots of things you can do to reduce the effectiveness of bank securities and protect yourself from the banks. Ultimately the goal is to stop them taking everything, - just allow a bank to take the investments (and equity in them) that you allot them security over.

Gearing Rules Of Banks

You will need to work within their gearing rules to achieve what is discussed below - so as background generally banks will be happy if you have a 20% deposit on residential property, or 33% deposit for large or commercial investors. Of course you need cashflow to support the credit application, and interest cover of 2.5 to 3 is also required in NZ, rule of thumb. ( Interest cover is rent+ income / interest expense).

Strategies include to beat bank securities (stop them getting everything if you are insolvent):-

1 Use a 'Split loan structure'

Use two banks: Bank 1 lends to the LAQC, secured by the rental, and personal guarantee(PG); the other bank ( bank 2) provides the deposit secured by the family Trust asset. As soon as you can, revalue the rental and refinance with bank 2 to remove bank 1. You end up 100% financed with no Trust guarantee.

2 Put your home in a Trust

Obviously put your home in a Family Trust and complete a gifting programme. Don't give bank 2 a security over the Trust. They will ask, say no. If you do not put your home in a Trust, your personal guarantee exposes the home to bank 2.

3 Use a 'Hawkins Clause'

While you are conducting a gifting programme, if you go bankrupt you will have the ungifted loan called upon to be repaid from the Trust by bank 2. The process is bank 2 calls your PG ( because your company has failed and lost money leaving the bank unsatisfied, etc); the bank demands you pay - you don't and they apply to the court to bankrupt you; the official assignee examines your assets and finds the ungifted loan balance - and will call upon trustees to pay it out in full.

So to defeat a claim against an ungifted loan to your Trust, put a Hawkins clause and debt entrenchment clause in your deed of acknowledgment of debt. The former makes says the OA cannot call the loan, if you are bankrupted ( effectively) and the latter says if the loan is called ( say the clause is struck out at court of appeal, as our clause has high court support in case law), then you leave the remaining loan balance subject to a call notice of 8 years, slowing down the OA for that time.

Watch the video below for an explanation of the Hawkins Clause.

 4 Use the GRA one one one rule, being

* One company ( LAQC ) ( or Trust or whatever you are investing in)

* One bank

* One million dollars worth of debt

By doing this you quarantine all of the banks from each other; if one entity ends up in trouble with a bank, you do not lose all of your property at once - because the banks are ring fenced off from each other in separate companies. This gives you a timing advantage if you end up in a scrape with say bank one, because you can be moving the assets in company 2/3/4 etc and they will have no control over the assets.

It is all about what I call 'getting positional advantage' on a bank. IE Getting to a position where they do not have your entire life stitched up, so they can destroy your family and life savings if something goes wrong.

Strategy 5 No Spouse Guarantee

Don't give a banker your wife's or husbands guarantee. Only one of you should be a director and guarantor. Negotiate HARD to avoid both spouses giving guarantees.

We have more information on property structures and family trusts on this website as well as our family trust blog a www.familytrusts.co.nz.

In summary, you make it really hard for the banks, and they tend to give up. Do nothing and allow them to cross secure everything - you will lose the lot.

Try to ring fence them and manage them with a good broker, - you will be in a much stronger position if you have problems, and you should be able to defend your family home and contents of your Trust.

We have for years told people to do the above, and their brokers, and lawyers have said we are over complicating it, just allow cross securing. Well that is and was crap advice, and many clients are in trouble because they were led into short cuts by their lawyers or brokers.

Split loans take a bit of time to set up, and a bit more energy on your broker's part, - but they are really really effective in a recession. Problem is, in a recession, they are really really hard to put in place ! ( for weaker borrowers.)

Last point: you need a broker to do this - the banks will not want you to do it. Its not illegal, but no bank will help you defeat their interests with split loan structures - they will discourage it and say don't do it. Of course - that is best for them.

I hope this information has been useful.  For a free review of your financial affairs including how to best structure your assets, please request a call now.  We're here to help.

Til next time,

Partnership really means two or more people or entities coming together in a common undertaking or enterprise.

You can trade your partnership through various trading vehicles including companies/LAQC's, joint ventures, general partnership, special partnerships, limited partnerships, or Trusts. Each trading vehicle should have an agreement created between the partners to the investment defining their rights and obligations. In a company for example, this is done in the shareholders agreement. In a partnership, the partnership agreement. In a joint venture, the joint venture agreement etc.

Which Trading Vehicle ?

Choosing the right structure is a combination of assessing many factors and choosing the vehicle that delivers maximum benefits for your particular circumstances. While a more detailed discussion on these issues are explored elsewhere on this site, a brief review of things to consider would include the following (looking at partnerships from a property investor's context):-

1. Asset protection implications (including limited liability vs unlimited liability for actions of the partnership, and liability for the banking obligations of the partnership by the partners) LAQC's for example require shareholders that are electing into the LAQC regime to personally guarantee the IRD for income tax.

This can be managed for small shareholders, but is one asset protection consideration in the mix. Another thing to review, - is your proposed structure creating wealth outside of a trust, and if so is it possible to both have your losses accessible and contain capital gains inside your Trust for asset protection and avoiding future gifting problems ?

2. Flexibility of ownership; (Ccan you change partners without triggering depreciation recovered ? 'Yes' for an LAQC, 'No' for most partnership circumstances.

3. Flow through of tax losses: will the trading vehicle let you access the losses?

4. Flow through of capital gains: will the trading vehicle allow easy access to capital gains at the end of the investment, or do you have to liquidate (for example a company will require liquidation unless it is a qualifying company to access capital gains tax exempt in NZ).

5. Cross border tax considerations: for those investing off shore or cross boarder, have you thought through the complex tax issues that arise? Like capital gains tax, non resident withholding tax, the implication of the New Zealand Accrual rules and foreign exchange movements, and double tax on dividend income.

Generally there is a simple and effective structure for most circumstances. Contact me if you require assistance with any matter above.

First of all with the OCR announcement this week, what about interest rates ? What will the banks do and what should be thinking about at present? You will remember in my last blog post I sent to you on interest rates just over a month ago, I suggested that you consider the cost benefit of breaking your fixed interest contracts and locking up on the 5 year rates, which at the time were a tad inside 6.5% for 5 years ( on average).

I suggested to you that the money market for long term borrowing was showing a steep rise in cost for the banks, indicating the 5 year rates would rise, while the short term rates were staying low.

And they have. The long term rates went up 1% on average the week after I emailed you. Thankfully a heap of you fixed long at 6.5% and some have emailed me telling me some of their savings they get from doing it.  I was thrilled to hear one person saved $86,000 over 5 years.

1. This was clearly ahead of expectation, because the the exchange rate fell 1.5c on the Aussie Kiwi cross rate, to around A$.7750 from early $A.792
2. He has very clearly indicated the rate will stay down, until late 2010 ( to encourage recovery) and suggested the immediate need to fix long and pay a premium over floating rates is unnecessary.
3. He has indicated may drop the rate further.

The Money Markets

Two things are happening to the cost of funds for the banks. Firstly the local cost of money, reflected in the OCR is falling.
Secondly (and less focused on by the media), the offshore LIBOR rates measuring interbank lending costs are falling, indicating banks are trusting each other more and placing less of a risk premium on the rates they charge to lend to each other.

This means NZ banks are paying less for the money they borrow offshore and less for the money they borrow locally, - all good news for borrowers as rates must drop in this environment.

So great news for property investors, businesses and households who are borrowers, terrible news for deposit holders whom rely on their fixed interest  savings for their income.


Rates – Short v Long Term

As you will be aware, the money borrowed from the overnight and short term money markets is cheaper than the long term bonds being issued by the banks, whom are all chasing the 5 year investors for their cash deposits.

The deposit holders know that rates are likely to rise over the medium to long term (the 10 year average interest rate in NZ is closer to 8%) and investors are reluctant to lend to banks at the current ‘super’ low rates, when they can lend to corporates like Fonterra at closer to 8%, and wait for the banks to pay more.

So one trend that is emerging is the corporates are cutting out the banks and going direct to the public (raising capital), competing for the long term investors money.

Another trend is the avalanche of investors locking up long over the last month,  causing pressure on the cost of these funds over 5 years, and rates are popping up as a result.

So where are rates going in at present ?

Short Term Rates ( Floating, 1-2 year rates)

The sort term money supply is forecast to remain cheap for 2009 and into 2010, all things being equal. We should see much of the above mentioned drop in the OCR passed through by the banks, and I would expect the floating and 1-2 year rates to fall over the next 90 days in line with OCR and LIBOR dropping.

Long Term Rates

The long term rates are still showing a premium supporting a rate in the early 7% range, with a recent easing in long term swap rates (falling nearly 15 basis points in the last 10 days). This indicates 5 year rates could fall off the 7.5% high at present, and in my view we could see a quarter to a half of a percent fall in 5 year rates in the next 2 months or so to the early 7’s. Thus there is no hurry to fix long term this month, as the 5 year rates are not likely to rise, and more likely to fall slightly.

So this months advice from me is WAIT and do not lock up long, because we are in a different place to where we were a month ago where the five year rates were obviously cheap and likely to rise.

Breaking Fixed Interest Contract

Many investors are still asking should they break their fixed interest contracts and re-fix or float. This is a tricky question, look at the cost benefit between the cost of breaking and the benefit derived from the cheaper rate over the period you re-fix or float for.

To help our clients, I have created a Fixed Interest Break Cost Analysis tool, a ‘rough and ready’ spreadsheet that helps you make a decision and estimate cost benefit.

Go ahead and visit our free resources section to download some useful tools from our wonderful new website, designed for business owners and investors.

And if you would like a hand working out what to do, we have a debt consultant that you can get to for free by Requesting an interview. Just explain that you wish to talk to one of our debt consultants.

Have a good month!

In a welcome development for taxpayers, the Minister of Revenue, Peter Dunne, has recommended to the Finance and Expenditure Select Committee considering the new associated persons rules ( for dealers in land, developers, and builders) that the implementation date of these rules be delayed.

To recap, legislation has been drafted which is proposed to apply to land acquired on or after 1 April 2009. The proposed legislation includes new associated persons rules which drastically widen the existing definition of an associated person, - causing developers/traders / builders other entities (and potentially their relatives) to have their capital gains taxable, no matter what structure they adopt.

Executive Summary

The legislation is currently before Select Committee but has been significantly delayed due to the intervention of the election. The Select Committee is only due to report back to Parliament on 30 June of this year. This has raised the issue of the legislation having retrospective effect which would mean that taxpayers would not know when they acquire property after 1 April but before the enactment of the legislations whether property that they have is tainted under new associated rules or not. For example despite the legislation not being passed, if a builder, or dealer in land or developer acquired a property in an LAQC not associated to their Trading Trust on the 1 of April, - they may or may not have been tainted under previous indications from IRD. It was unclear as to the position taxpayers were in Now it is clear – the old rules still apply until at least July, but possibly later ( perhaps even next year).

Background

Fortunately it seems that common sense is going to prevail and that the implementation of these rules is going to be delayed. In his recommendation, Peter Dunne has suggested that the new rules apply to land acquired on or after the date of the Bill’s enactment or, where there is association to a builder, applying to improvements on or after the date of enactment.

This is a potentially significant development for taxpayers and one which GRA welcomes. What this means is that taxpayers will have certainty on transactions that occur post 1 April but prior to the enactment of the new rules as to how they are going to be treated.

As the original application date of 1 April 2009 has loomed we have been dealing with a number of clients in relation to moving property between entities prior to that date to make sure there is no tainting. We now note that there is further opportunity for that to be done and we encourage you to contact us if you have any queries in this regard.

In terms of the implementation of the rules, at GRA we still see it as almost inevitable that there will be amendment to the associated persons provisions. Our pick is that the breadth of the rules as proposed will be narrowed, but we certainly expect them to be wider than the current form in relation to land tax provisions.

As to a potential application date it seems that it will be no earlier than the enactment date which is likely to be mid to late this year and we also note the prospect of it being delayed further and we are aware of submissions to the Select Committee that strongly suggest that it be delayed until at least 1 April 2010. Naturally we will keep abreast of these developments and let you know any progress.

There are pre-rule change planning opportunities for those in the business of dealing, developing and trading. Feel free to call us if you have queries in this regard, contact Matthew Gilligan mg@gra.co.nz

As I have said on several occasions, property and stock markets react much faster than local businesses to the bad news.

The property sector and stock market wear the downside of recession very quickly, as does the entire supply chain underneath these sectors of the economy.

But right behind them are the rest of the economy, tightening the belt off tight credit and fear driving reduced consumption.

The whole of 2008 and the first quarter of 2009 has been about falling/bear markets, fear and deleveraging. Deleveraging leads to rapid devaluing of assets, because there are so few buyers relative to sellers. This will continue in my humble opinion for all of 2009 and 2010, though the biggest drop in the markets has occurred and we are approaching the floor in property markets in my view this year / right now.

2011 ( world Cup Rugby Year for NZ ) in my view is the year we will start to see it turn and 2012 will be a growth year. If I am correct in this, then we are ½ way through this nasty patch and there is no hurry to do anything aggressive on the investment front.

Flood of Mortgagee Sales Cued with the Banks

I was told last month that the big 5 trading banks have 2500 properties cued for mortgagee sale, with 12,500 property law act notices cued behind those. ( That’s 15,000 properties on their way to be sold at mortgagee auction.) But the banks are being smart, and not dropping them all on the market at once, - coordinating a release of them on a budget for each bank monthly to protect the market.

If this is true – this is very smart on the banks part and I applaud them for not repeating the mistakes of the 87 and 97 recessions, where the banks drove the market down by flooding the markets with mortgagee sales.

Strangely the biggest villain I hear clients complaining about is BNZ, - their name comes up a lot as a very aggressive banker if you get into trouble. On the positive side, I keep hearing ASB are great to their clients whom are in trouble, - working through their issues constructively.

Banking Horror & Happy Stories

If you have horror stories or happy stories about your bank, I would like to hear them. Email me at mg@gra.co.nz and tell me on a confidential basis.

Opportunity Knocks In Recession

Doom, gloom and continued financial assaults flowing out of America and the World are now so commonplace, they are losing their sting when reported. Relentless media focus has desensitised us, and we now find the extraordinary financial disasters ordinary.

With the shock of it all passing, life seems to be returning to the property markets in New Zealand with March 09’s sales across the county beating any month in 2008. With good reason too – there is significant value to be gained by an informed investor on the hunt and there is a resurgence in finance applications and activity in the market across NZ.

You might have caught the New Zealand Herald’s article on affordability of housing recently, basically showing that for the first time since 2004 in many Auckland suburbs, rent now covers 100% of borrowing costs. ( Looking at average rents over average rental incomes), and if you buy at a discount ( hunt for a good deal), you can find property that pays for interest and all outgoings ( rates, insurance, repairs and maintenance, management, etc) with 100% financing.

This is a function of property values falling, interest rates falling, and rents comparatively holding up. So if you go hunting at present, you can buy a property in Auckland (and around the country), 100% finance it and all cash costs are covered by rents. That means you get the tax refunds on top as a bonus, and the capital gains in the medium term for free!

By the way while I remember, make sure you check out what we're doing in our new Property Procurement Division.  If you like the idea of 'zero cost property ownership, but lack the time to learn and search for the right property youself, then we can help.  There's a lot that can go wrong, and our team has the experience to remove the risk for you.

In my view this winter will be filled with mortgagee sales by banks, bad weather and cold days. Investors tend to get depressed on cold wet days, and not turn up to the auctions. This winter then should reveal some real bargains on those cold wet days in auction houses, and don’t be surprised if you bump into me at a few, - because in this market I am definitely a buyer and I recommend every household start to consider investing against the public mood.

The bargains purchased this year will look very good in 5 years and if you buy right, you will get a huge discount in this environment and positive cashflow all the way through at present.

Happy investing to you.  Go ahead and Request an Interview if you would like a hand getting your taxation and finance arrangements in place with our asset planning team. 

Finally, If you would like to read and comment on more of my articles to designed especially for business owners and investors please visit my blog.

Have a good month!

Partnership Property: Buying Property With Friends & Family

One common theme that seems to be on the 'up' this year, is two or more investors coming together to buy property through small private partnerships, LAQC's or joint ventures.

Common examples include:-

1. Family members buying an asset from the deceased estate of a relative;

2. Family members or friends pooling resources of capital to get enough deposit to buy a property together;

3.  One partner has good cashflow, but no deposit. The other has equity in a home or a deposit, but no cashflow. Together, through a partnership they are bankable and safe investors, ticking both the cashflow and equity boxes and qualifying for finance.

4.  An 'asset rich, time poor' investor agrees to back an 'asset poor / time rich ' investor with skills in property. One funds the other, the other finds the deals. Together they can be a clever investing partnership, combining human and financial capital.

Combining Resources Can Make Sense

Combining resources can make sense for people in various circumstances, but care needs to be taken in setting up a good foundation structure. Any partnership agreement should deal with dispute resolution, and the rights and obligations of partners in advance of the partnership starting. Unfortunately over the years we have seen many a client spoil a relationship with a friend, business colleague or family member through bitter feuds in partnership.

Personally I have found partnerships very powerful and rewarding, allowing me to grow and extend my business and property interests. But in saying that I have seen a few train wrecks emerging in the client base too, with clients very bitter and angry with their business partners.

Partnership Agreement The Key To Avoiding Disputes

I have always found that where a clear partnership agreement is put in place ( for whatever your trading entity form eg LAQC, partnership, or joint venture), problems are less likely to arise because the parties to the agreement know their rights and obligations before they begin. If you like, the time to have the argument is at the start of a new investment or enterprise, rather than 'working out the issues as they arise'.

The latter approach is fraught with risk as to the respective parties view of what is right and wrong, what is fair and reasonable. And when the chips go down....sometimes you learn things about people that surprise you and 'moral agreements', 'handshake agreements', 'gentlemen's agreements', turn out to be disasters...a pathway to hell for some.

What should you think about in your Agreements?

Whether you are going to trade through an LAQC, trading Trust, general partnership, limited partnership, ordinary company, or joint venture.....the story is the same and the arguments that arise are similar.

Typically one party will say ' I am doing all the work ( or more of the work), so I should get all the money'. Another party will say 'I am doing all the funding ( or taking risk through securing bank loans) so I should get all of the money'.

Both parties likely have a point. Resolution lies in agreeing a remuneration formula which addresses both the issues of payment for work done, and payment for risk taken / capital supplied to a venture. By this method you simply agree over:-

1. Payment for work done: The fee for time spent working on the investment portfolio will be an hourly rate of $x, payment by agreed method ( either when the property is sold or week/monthly or as suitable between the parties). Where both parties agree that time spent is equal, they may elect not to draw remuneration. Where time spent is slightly unequal, the parties may agree that the party doing slightly more work will draw for their 'differential work' done. IE If one party does 7 hours work a month and the other 3 hours, then the party doing 7 hours gets paid for 4 hours and that addresses the imbalance.

2. Payment for risk / capital invested: The remuneration for capital invested is interest, paid periodically. By paying interest on partners advances at pre-agreed rates, no partner can claim any grievance for 'doing all the funding / doing more funding' because they have agreed to fund at that rate for the term of the investment. Where the capital is by way of security being provided, it may be appropriate to address the security risk by paying for it. Say your sister puts her house up as security for a loan in a joint LAQC to buy a rental property, pay a guarantee fee. Such fee may be say 5% annually, of the maximum security risk exposure. ( Example: Your sister provides a cross security of 20% for a $300k house purchase by your joint LAQC with her. At 5%, the annual fee is 5% of $60k = $3,000 annually).

Where one party is providing equity, and the other is providing time, it might be appropriate that by partnership you agree that one parties contribution ( time) offsets the other's ( capital risk). By putting numbers into the equation, you can maintain by partnership agreement a common understanding that if time goes up, or security risk goes up, then the imbalance is addressed by more wages paid or more interest or guarantee being paid for the emerging imbalance. This is fair, commercial, and stops arguments in their tracks.

Typical Partnership Agreement Considerations

Your partnership agreement should address the following as part of its scope:-

1. Funding obligations: Who's responsibility is it to fund and to what extent ? Is it based on proportion of entitlement ( pro-rata) or is it unequal ? Consider the funding obligation both in the context of initial advance and ongoing advances for any capital that is required to be injected in the future - what is the obligation to fund by the respective partners and in what proportion at what time frame?

2. Remuneration for time spent by partners: as stated above, what remuneration are you entitled to for time spent working on the portfolio and affairs of the company/partnership, if any. Will you draw the wages, or offset against the other parties contribution ( of time or capital) ? Where time spent is equal, typically no wage is drawn. Remember wages require tax considerations to be addressed so should be avoided if possible.

3. Default of a partner: What will you do if one party cannot pay ? Force a sale or exit from the investment ? If so what penalty should be paid by the defaulting partner ? In some joint venture agreement's I have written, I have provided in the agreement a provision that says the defaulting party loses their capital / shareholder's loan and all shares/units in the investment if they do not pay their dues. This is to stop people 'riding on the goodwill of others'. This is particularly effective between people that do not know each other well, as it provides real incentive to behave and meet obligations without stressing partners. If someone is interested in this concept, contact the writer (mg@gra.co.nz) and I can provide assistance here - this is a great idea that makes your partners behave properly and honorably.

4.  Voting rights and arrangements: generally when partnerships are going well, formalities of voting are irrelevant. But when disputes emerge you should have a clearly defined voting process and your voting rights should be set out. It may by that if you are the partner with the most at stake ( eg you are the funder), then you may require a 'governing directorship', giving you the ability to make unilateral decisions and force your will, if you believe the action of your partners is threatening your capital or security position.

5. Dispute resolution: going to war in court can be expensive. It's best to have a pre-defined mediation or arbitration process that is binding on the parties, or at least an obligation to explore mediation. It's also best to have financial consequences for not following the rules...otherwise there is no incentive to follow them. If something matters to you, define breaking the rule as a 'default' and apply the 'forfeiture of capital' rule in point 3 above.

6. Rights and entitlements / obligations on dissolution of the partnership: When you sell property, sometimes the costs have exceeded the sale proceeds. Who loses and in what proportion ? Should capital advanced rank in front of payment for work done by partners, should interest rank in front of capital gains ? Agree and write it down at the beginning, and you won't have a problem at the end.

7. Restraints: Are you allowed to steal tenants off the partnership, or resources for your own private activities? If not write it down.

8. Exit rights: Partnerships will always end. Someone will die, retire, go broke, remarry, or just have a change of heart. Give yourself the right to exit and stipulate when (at the earliest) this can be, how it will be done, and what penalty there will be for early exit. For example if you agree you will be in an investment for 10 years minimum, and someone exits at year 2 because they have a change of heart, perhaps they forfeit their deposit and shares ? It's up to you - you define the rules the way you want.

Summary

Investing with your friends and family is a powerful way to combine human resource and capital and get a great investing outcome. Make sure you think about what your rights, obligations and profit sharing agreements are. Set rules and consider penalties for rules not being adhered to. Do this upfront and you will be much less likely to have a problem later on when partners circumstances or the investment circumstances changes.

Anyone forming a partnership who would like a hand with the tax or agreement drafting, is welcome to contact me on mg@gra.co.nz

Thank you for reading this.