February 10, 2018

JF1257: How To Approach Partnerships & What To Look For #SituationSaturday with Mark Kenney

Mark started investing in real estate at the age of 22. Now with over 2300 units and plenty of partnerships had, he can tell us a thing or two about good and bad partnerships. If you enjoyed today’s episode remember to subscribe in iTunes and leave us a review!

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Mark Kenney Real Estate Background:

Seasoned real estate investor, published author and founder of Think Multifamily

-Over 20 years experience and has extensive experience in property valuation, acquisition, and operations

-Has a passion to help others succeed in the multifamily arena and is invested in 2100 units

-Mark also is a CPA

-Say hi to him at http://thinkmultifamily.com/

-Based in Dallas, Texas

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Joe Fairless: Best Ever listeners, how are you doing? Welcome to the best real estate investing advice ever show. I’m Joe Fairless, and this is the world’s longest-running daily real estate investing podcast. We only talk about the best advice ever, we don’t get into any of that fluffy stuff. First off, I hope you’re having a best ever weekend. Because today is Saturday we’ve got a special segment for you called Situation Saturday, where we’re gonna talk about a tough situation and how the Best Ever guest overcame it; that way, if you come across a similar situation, you have a playbook and you know exactly how to overcome it, or you have some tools and techniques for what’s worked with previous people in that situation.

With us today to walk us through how to approach partnerships, what to look for and some hard lessons learned along the way, Mark Kenney. How are  you doing, Mark?

Mark Kenney: I’m good, Joe. How are you doing?

Joe Fairless: I am doing really well, and thanks for being on the show again, Mark. Best Ever listeners, you might recognize Mark’s name, and that’s because he was a guest on episode 975. It’s titled Hotels And Multifamily Investing On a Passive Level, and you can hear his best ever advice… He has money in over 1,000 units as of that time… And you began when you were 22 years old, did I get that right?

Mark Kenney: Yeah, I started when I was 22; I guess 21 probably really, and now we’re at about over 2,300 units.

Joe Fairless: There you go, wow. And you’re also a CPA based in Dallas, Texas. The company is Think Multifamily, and you can just go to ThinkMultifamily.com, that will be in the shownotes link. Mark, let’s start out with partnerships, obviously, and maybe a story about a partnership that didn’t go the way you wanted it to go, and then we’ll kind of extract the lessons learned from that.

Mark Kenney: Sure. So I’ll give you an example of a very recent tough lesson learned as we had a partner in a deal. It’s a little confusing, because he actually was already in another deal with another partner, and we bought his partner out. So we came in, bought his other partner out, assumed everything – same company, same LLC, same loan, everything. And when we did that, we found out fairly quickly that he was doing something he shouldn’t be doing, so within two months we kind of discovered some things…

Joe Fairless: Like what?

Mark Kenney: Not recording any payables, and not like 10k-20k, but like $300,000 from 12 months old…

Joe Fairless: Well, 10k-20k is a big deal, too… [laughs]

Mark Kenney: Yeah… Well, try 300k. And frankly, a lot of it is bogus, scam between him and a vendor…

Joe Fairless: And we’re talking a multifamily property, right?

Mark Kenney: Right.

Joe Fairless: Okay. Was is self-managed? Is that why he was able to do that, or…?

Mark Kenney: Yeah, self-managed. He had a partner in the deal, a general partner as well… And since we took over, we inherited all those sins, if you wanna say… We did a lot of due diligence ahead of time, but at the end of the day if someone wants to be deceitful, they’re gonna get away with it. We called him quickly, took legal action…

Joe Fairless: How did you catch him?

Mark Kenney: Well, first I went down there, surprise visit… That’s one key thing I think if you have properties. Even if your partner is running the deal, do a surprise visit. They’ll always be like, “Why didn’t you tell me you were coming?”, I’m like “Because I don’t want you to know I’m coming.” Things kind of looked a little bit — not super bad, but kind of like not quite as good as they should be… And it had only been two months.

Then we actually had a board set up over that property; I won’t go into all the details on that, but we had an SEC attorney from Harvard and some pretty high caliber people… But essentially, I was requesting information on the rehab – it was a very large rehab project – and I wasn’t getting the answers. It was more like, “How much is this stuff gonna cost?” “Well, probably more than we thought?” “Well, how much?” “Well, you know…” – kind of those answers.

So we had a formal board meeting, we requested information formally through the board, five members total including himself, and gave him a deadline, he didn’t produce the information. We didn’t even know what he spent on rehab and things like that, and what still needs to be done and all those basic questions that he should get. That’s where it started. And then when we kind of uncovered more and more… We didn’t find out until after we removed him – it took us almost two months to get him out, somewhere around there, after we requested information and then we had the attorneys involved and everything like that… Then invoices showed up – two weeks after we booted him out invoices showed up from one vendor for $160,000; that went back from December 2016, so at that time nine months old…

So if your gut is kind of telling you something just doesn’t seem quite right, and fortunately for this, we took action quickly… Our basis is low on the property, but nobody wants to go through that; we lost essentially about five months of our business model right off the bat…

Joe Fairless: When you went to the site visit you said things didn’t look exactly how they were supposed to; it was a surprise visit… What specifically did you see that was a little off?

Mark Kenney: Vandalism, which isn’t uncommon with a class C property, but broken windows and doors that were sliding doors that were broken… It’s a huge rehab project and there were a total of three guys that were working. I was like “This doesn’t seem quite right.” And there was always an excuse given. They are tough, but the city is giving them problems, which they weren’t; the lender is not giving him money from the reserves, and things like that… But we met with the lender directly ourselves and kind of got the story on that, and it was like “Well, we don’t believe everything is being done the way it should be done…” But for that big of a project, and have three guys working there, and then before that requesting information like “What percent are we complete?” and “How much did we spend versus how much we have?” – the typical information wasn’t provided, and it still has not been provided to this day.

Joe Fairless: It was really quick that you were able to identify that… Would you say that ties into your CPA background?

Mark Kenney: No, not in this case, really. I think it was somewhat probably timing; I just happened to go there at the right time when things kind of looked a little suspicious. It is very quick; you can argue “Well hey, you wish you would have called him day one”, but at the end of the day it’s the guy I’m gonna partner on another deal with… I think at that time I trusted him. But you know, it really wasn’t — I have something to compare it against. I have a lot of other properties with other management companies, and I can be like “Well, I get this information from them, why am I not getting this from you?” We had some luck, and then it was taking action immediately. We didn’t give him any wiggle room.

Joe Fairless: You said it took almost two months to get him out – that seems lightning fast, to get someone out of a — did you kick him out of the general partnership?

Mark Kenney: Yeah, we have an overall company with five members in it that kind of oversaw this property, and thankfully we have attorneys that were involved, and one is on the board, an SEC attorney, Harvard graduate, and things like that… So we were able to finagle things. If it had been left up to me, he’d still be there, but we engaged the appropriate legal people immediately, and that helped. Without them, frankly, probably all our money would be gone.

Joe Fairless: Yeah, yeah. And you said that you bought his partner out, and you assumed the previous partner’s position, and congratulations, you’re now partner with what turns out to be a crook… [laughter] So did the person that sold you their ownership interest know what was going on?

Mark Kenney: No, not that we were aware of.

Joe Fairless: Why did they sell? What was the reason they sold?

Mark Kenney: The story was that he was a New York guy, had properties up there, and I think with he was frustrated with the lack of communication, but to my knowledge had no indication whatsoever was going on, because a lot of things didn’t really come to fruition until after we removed him. All these invoices showed up, and liens on the property… It was bizarre, and kind of a little bit fascinating, as I would never go in that situation again buying out a partner, because you inherit everything from before.

There were some advantages to doing it; we got to keep the same loan, we didn’t have to  pay additional fees and things like that, but personally, from my own perspective, I would never do that again.

Joe Fairless: Okay. So now that you know what you know, what would you say about — if you were presented a similar opportunity, how would you qualify that partner?

Mark Kenney: One thing you could do is just background checks, which lots of times you’re not gonna find some of these things like this anyways. I would talk to their old partners, which at this time I had already partnered with this guy and he gave me his story, so I’m kind of like “Okay, well I don’t need to go check with his partner”, but I would say “Can I talk to your other partner? What would your partner say if I talked to him? What would he say?”, kind of go from there.

Then the other piece is regardless of what’s said, is everything in writing. In this case, there were some existing agreements that we were never even provided, that made it more difficult to get him out. It’s almost like you have to do a do-over. If I come in and buy a partner out, we need to restructure everything, all the agreements that were done between the construction companies and the existing company – they all need to be redone. If you don’t do that, there could be things in there that makes you liable for things you never even dreamed of.

Joe Fairless: So you do background checks, talking to old partners, asking them “What would your partner say about you if I talked to him/her?” and then gathering all of the paperwork that is in place, even though they might not share everything with you, but at least you can ask for it, right?

Mark Kenney: That’s right, you ask for it.

Joe Fairless: You ask for it in writing, probably.

Mark Kenney: In writing. In some cases — like, he had a construction company that was doing work there too, I would have asked to redo those agreements that we were never even provided… They still haven’t been provided. So that’s the thing – you don’t know what’s out there, unfortunately, in a situation like this.

Joe Fairless: Okay, so those are the three… Have you done a background check? I’ve had people do background checks on me and I have to give them my social, and my name and stuff. Have you asked that of a partner before?

Mark Kenney: Yes. I did not with him, because he was a prior partner, but I have… And if the partner has an issue with you running it, then I would just say don’t do business with them. And I mean, it’s like, “Really…?”

I think there are a lot of things when you enter into a partnership, and this is not an exaggeration – I just had dinner last night with two of my best friends; one is an attorney and the other one is a financial guy at a large organization, and he had some rental properties as well. He had mentioned he’s been trying to sell his rental properties for the last 18 months and his partner doesn’t want to… So lesson learned, guys, if you’re gonna have a partnership, you need to have tag along clauses and things like that [unintelligible [00:13:21].23] legally you can force your partner to sell, and they can force you to sell, provided some sort of stipulations are met.

So he’s stuck there not being able to sell his properties for 18 months because the partner doesn’t wanna sell them. The other partner – he’s known the guy for 23 years, went to law school with him, had been in partnership with him for 9 years, and his partner came in Wednesday before Thanksgiving, came in and said “I’m done. I don’t wanna partner with you anymore.”

So if you’ve been partners long enough, with enough people, I can guarantee one of them will not go as planned, and you had better make sure you have things in writing, even simple things like “What do you do in a tie-breaker? If you’re in a 50/50 ownership in one of these partnerships, how do you break ties? (legally break them) How do you resign if you wanna get out?” There’s a whole slew of things…

I don’t know what you do, Joe, but the partners — I know a lot of banks don’t support dual verification; your partner could go and withdraw $100,000 and say “Thank you very much”, and you could after the fact address it, but you can’t address it typically before it happens.

I think partnerships are great, I really do. I think you look for people that have some sort of skillset that you don’t have, you plan for the worst-case-scenario in writing, because eventually something will probably happen – hopefully, it doesn’t – and have it in writing that way… But yeah, at the end of the day your reputation can be tarnished. Think of all the people that you don’t think of as individuals, and their names are presented together… If your partner is doing something that they shouldn’t be doing, there’s a good chance — and it’s not even doing something; I mean, that’s the extreme example. But if they treat people differently than the way you want people to be treated, because fundamentally they don’t have the same — the way they interact with people, maybe they’re very harsh or brash and you’re not like that, you can sometimes inherit their reputation, unfortunately.

Joe Fairless: Going back to the story you were talking about, if you had asked for a background check, if you had talked to his old partner – which you talked to the old partner, but you didn’t do a background check – and if you had asked for everything in writing prior to going into the partnership, then you likely wouldn’t have gotten everything in writing, so then the question becomes would you have known that you weren’t getting everything in writing, so here’s a hypothetical question to you – if you would have asked and had everything in writing, do you think he would have shared with you enough stuff to lead you to believe that you had everything, or would he not have shared with you enough where you’re like “Wait a second, something’s off…”

Mark Kenney: He would share enough, without a doubt. He is an extremely intelligent, crafty individual; I’m kind of back to where I would personally never buy into another partnership like that, where I’m inheriting potential liabilities and risks that happened before I was even involved. And he washed his hands, he’s gone now, and “Thank you very much, Mark! You can take all of this stuff, and look at these vendors and old invoices from nine months ago that were never paid, and didn’t pay sanitary for 12 months… I recorded it all in the books, though; they’re all in the P&L.” [laughs]

Joe Fairless: Sanitary is a pretty important service.

Mark Kenney: Bizarre to me how you can get away with that.

Joe Fairless: Yeah. So let’s talk about never buying into another partnership like that, because there are opportunities for you – or as an investor for us – to buy an LLC from the seller, and then… Is that what you’re referring to?

Mark Kenney: No, not so much. If you do that, I think you can put language in there where anything prior to that you’re not liable for, and things like that. This was literally just buy a partner out of existing everything. My partner still stayed in, so it was kind of a different structure. The loan stayed the same, everything was the same.

The example where we buy an LLC out I think is different. One reason you might do that is for your tax basis. People kind of do it that way. But I think if you ever consider doing that, you need to put in verbiage about anything prior to the day you took over, you’re not liable for.

Joe Fairless: With the approach that you took with this gentleman in the partnership, anything that if you had to do it over again… Obviously, there are some things that you’d do and we’ve talked about that, but if you did those things – the background check, talked to the old partner and looked at everything in writing – you still wouldn’t enter into another partnership like this?

Mark Kenney: I would not.

Joe Fairless: Burn the bridge, baby.

Mark Kenney: Burn the bridge; there’s other deals I can do that are a little less risky, I guess.

Joe Fairless: Yeah, fair enough.

Mark Kenney: It could work out, right? You could do 100 deals and 99 of them work out perfectly, and it’s just that one that taints you.

Joe Fairless: Well, this is good information. If we’re presented a situation like this, we will all reference this episode and have a cautionary tale for what to look out for and proceed with caution if we do proceed. Anything else as it relates to partnerships that you wanna mention?

Mark Kenney: No, just back to having everything in writing. I see people that have these loose agreements that exist; you need to contemplate everything going South and how you account for it. Always having someone that can break the tie, because you’re gonna have disagreements. I think having really just the core fundamental beliefs that are the same, let alone the skillset for your to help each other, but having the same way you treat people is critical.

Everything in writing. If your partner doesn’t wanna put things in writing, then there’s an issue. I just wouldn’t do business with them. You need the ability to maybe also — people have a different perspective, but if you’re in a partnership, more than likely one partner thinks either what they do is more important than the other one… “Hey, I find deals.” “Well, I raise money so you can get deals” or “I raise money”, “You can’t do that without deals.” It’s like, “Hey, don’t do that.” But inevitably, someone’s gonna think that what they do is more important.

I recommend maybe doing things deal by deal, because life events happen, and yes, you wanna help each other, but if you’re doing 90% of the work on three deals and I’m doing 10% on three deals, then I think you should be compensated deal by deal, splitting up by category – who found the deal, who raised the money, whose earnest money is in there, whose balance sheet is being used… And do it deal by deal. That’s what I would suggest doing it. That way there aren’t those hard feelings potentially where you get two years into the partnership and one person thinks they’re doing a lot more because the other one’s wife is sick… You know what I mean? Something like that.

Joe Fairless: Sure. Great stuff, and this has been helpful from a very practical standpoint when we go through the scenario, and also just from a — it was kind of entertaining, too… Sorry to tell you that. [laughter]

Mark Kenney: Thanks, Joe… Thank you! [laughs]

Joe Fairless: I was actually entertained by your story.

Mark Kenney: Yeah, it’s bizarre — I mean, I never would have dreamed (literally) anything like this would happen. It’s almost like a story you have on TV, it really is… But I’ll share anything with anybody, because at the end of the day I do not want anyone else to go through some of the lessons we’ve learned over the years.

Joe Fairless: Why did you have a board? That’s not typical.

Mark Kenney: It’s not typical at all. So we had a larger organization with these grand plans which included this other individual, and as a result of that we had a board structure. We had a CFO from a publicly-traded company, the SEC attorney, a large broker guy involved… It was really more to make sure everything’s structured upfront, legally, and how we potentially — my other partner’s plan was “Let’s bring this together and eventually create a REIT.”

Joe Fairless: That’s not gonna happen with him, is it?

Mark Kenney: Oh, hopefully he ends up in jail; I hope he ends up there, I truly do, because he needs to stop doing this. And it goes back to the reputation; my reputation gets hurt because of what he did. But I think if you can be very open with investors – and that’s the key, to be very open with them and share everything you can… Of course, things don’t always go as fast as everyone wants, but if you have an open communication with them, most investors – not all, but most – will be okay and supportive. It’s that one or two that it doesn’t matter what you do, they might not be quite supportive like they should (nothing’s ever good enough), but communicating out is key.

Joe Fairless: How much are board members in a scenario like that – if you can’t say exactly how much they’re compensated, but in a scenario like that, how much are they compensated?

Mark Kenney: The board members – because I was in the board, and then this other individual was in the board… We had 50% total between the two of us, and then the other board members – that’s somewhat getting diluted down, but that’s very high… I never like that structure; it was actually set up before I got involved with him. But this goes back to the compensation piece again, who’s doing the work.

One individual has done virtually nothing, because his time hasn’t come yet. He’s the CFO, and we’re not at that point where we need him, so why give away some sort of percentage upfront that might never happen? it doesn’t make sense to me. I think it should be reevaluated deal by deal.

Joe Fairless: I’m a little confused… You said 50%, so you had 50% and the board had 50%?

Mark Kenney: He and I can get around 50%. We were on the board, though; he and I were both on the board.

Joe Fairless: But you said there were many board members.

Mark Kenney: Five.

Joe Fairless: There are five. So five board members, each of them roughly had what percentage?

Mark Kenney: 75%, the four board members. That’s how we had the right to rule them out.

Joe Fairless: So everyone had about 18%?

Mark Kenney: Yeah. It varied, depending on the role.

Joe Fairless: Okay, cool. That’s a ginormous amount.

Mark Kenney: It’s insane, and it shouldn’t be, and it’s actually not gonna be, frankly… It’s getting adjusted. I got into that with him and he had some grand scheme plans and things like that, but yeah, there’s actually not reason to be giving that type of percentage away. it makes no sense.

Joe Fairless: Cool. Well, Mark, thank you for being on the show again. How can the Best Ever listeners get in touch with you?

Mark Kenney: Our website, ThinkMultifamily.com, and the e-mail is mark@thinkmultifamily.com.

Joe Fairless: When we look at partnerships, we’ve gotta obtain background checks or run background checks, we need to obtain everything in writing, and ask for everything in writing… Because we might not get everything in writing that has been memorialized, but if we ask for it, at least there’s a paper trail of us asking for everything in writing. And then talk to other people who have partnered with the person we’re planning on partnering with, and ask the potential partner “What would your partner say if I talked to him/her? What would your old partner say if I talked to him/her?” Those are three ways that we can attempt to mitigate the risk…

But ultimately, as you said, Mark, if they’re trying to pull a fast one, they’re probably gonna pull a fast one, and it’s just a matter of having a plan in place for if a fast one gets pulled, then what are the steps that we need to take in order to get that individual out of here.

Thanks for being on the show, Mark, I really appreciate it. I hope you have a best ever weekend, and we’ll talk to you soon.

Mark Kenney: Thanks, Joe. Take care.

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