Promissory Note instead of Partnership LLC?

[Chivas Miho]

Hey BP, I know this partnership subject has been discussed thoroughly throughout the years, but hoping to get some advice here. I have a coworker that I've been discussing real estate investments with for the better part of a year, now that I picked up a OOS rental he's been more interested and serious about investing with me. I'm a little concerned with starting up a Partnership LLC mainly with all the formalities and potential issues that could cause a strain our friendship. From the discussions we've had, he's mainly focused on the returns and less on the nitty gritty details.

Does asking a lawyer to draft up a promissory note on interest only terms for 12 months with a balloon payment make more sense on our first deal? The plan would be to BRRRR the property and pay back the note before the 12 month period is over. I'm leaning toward this path until I get a little more comfortable with doing business together before jumping straight into an LLC together, especially since I've been down this road twice already and failed after previous partners lost interest or couldn't meet commitments. Looking for any advice from others in the community and if anyone has successfully repeated this. Thanks!

[Tim Joyce]

As debt, a promissory note certainly brings with it different expectations of the kind of involvement required from your money partner. If other partners have fizzled on you before and you think you can handle coordinating the work solo, I don’t see much wrong with this situation. The analysis I would be doing is along the lines of (1) can I handle the interest only payments in the meantime, and (2) what happens if I can’t refi by the time balloon comes due. The main risk shifting that this does is put the burden on you as the sole equity person in the deal that things don’t go as planned. Your creditor (this lender friend you have) will expect to get paid regardless. One variation you could consider (though I’ve not heard of it done in REI before; speaks more to my relative newness to the field than anything else) is convertible debt. There you would determine what percentage ownership of the property his loan would convert to, and whilst conditions would trigger talk of conversion. You more often see it in startups that are ongoing enterprises, but that could be one way to hedge your bets.