Having a Great Idea and Potential Product are Not Enough
There's a chasm between the brilliance of defining a new product and finding its market fit -- and developing the financial foundation to scale the business. What makes someone a great entrepreneur frequently makes him or her pretty bad at steering the financial side of their business. So, what distinguishes someone from the pack is the ability to make both happen.
For commercial real estate investors, the boom mentality continues, and those seeking opportunities continue to flock to New York City. That can spell trouble if your clients are not prepared for the consequences real estate investment can bring, including results that are hard to foresee.
Many investors have concluded New York is the safest, best place to park their money. They may be right. Although there will probably be bumps along the way, real estate in New York City has always rebounded and, over time, grown in value.
The fact remains that real estate investment is full of traps for the unwary. You are already aware of many of them. Some are more subtle: Risks await investors – and their counsel – who enter into investments without a full understanding of their overall tax and financial picture. Even sophisticated investors can be caught out. Consulting with a tax professional as early as possible – while still in the planning stages – can prevent trouble in the long run.
The first lesson for real estate investors, especially those just now getting into commercial real estate (and particularly as a limited partner), is that a real estate transaction or partnership is going to end. Your clients need to take the right steps on the way in, so they will be protected on the way out.
You can help by reminding them that real estate investments can be very good and very profitable, but there are potential pitfalls. Commercial real estate investors seeking to become limited partners in properties and deals need to be encouraged to avoid common mistakes, including:
What are the danger signs? Look closely at who’s running the deal, how the cash is distributed, what the special payments or promotes are for the person running the deal; and how tax income and loss are allocated among the partners.
It can be extremely costly to miss details in the operating agreement. I know of one investor who owned a very successful hotel property – but was losing $10 million a year because of phantom income that was taxed.
It is in this instance in particular that you may want to consider having a tax or financial professional at the table. The tax professional can support your due diligence, and also provide you with a broader understanding of the client’s full tax and financial picture.
Bottom line – if your client is tiptoeing or plunging into a commercial real estate investment, help make it a good one - both while it lasts and on the inevitable way out.
Abe's article was originally published in The Metropolitan Corporate Counsel, April 2014.