DUMPING A PARTNER

Serendipitous Partnership

When the two men decided to become real estate partners, they had never met before being introduced by their common real estate agent two months earlier.? Donny was looking to diversify his company beyond multifamily residential to commercial rentals.? Eric was seeking to relocate his insurance firm from rental space into about 7,000 square feet in a building he would own.? Donny’s plan was to start with a small building with a secure tenant;? there were few buildings that size on the market just then, and most were vacant and needed some upgrading.? Eric could not identify a building that was the size he needed and in move-in condition;? there were larger buildings but Eric did not want to take on the rental risk and be a landlord.

A 14,000 square foot office building on a secondary street near an interstate exit caught the attention of the realtor that coincidentally both men were employing.? It was one story, common corridor down the middle, each side had a pair of single bathrooms.? Ample parking, no elevator, no shared restroom issues.? The realtor was struck by the idea of making this building work for both his clients.? He walked each man separately through the building, raising the possibility of a real estate partnership only at the end of the tour.? Donny could share the risk with a partner who also had a long term lease, and could take care of maintenance with the crews his company already had working at the residential complexes.? Eric would have equity in the building, and could move in as soon as they closed, avoiding more penalties for delaying his departure from his current rental space past the lease end date.? Both men had the cash to swing the deal.? They met together over lunch with the realtor, and next with their lawyers present.? The deal was made quickly, with little in the paperwork they found to disagree about.? The purchase closed in 60 days from the initial walk through.

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Misalignment

That was the last time that Donny and Eric agreed about anything or had a discussion that could be characterized as amicable.? The first clash occurred over rental of the vacant side of the building.? Eric was only interested in tenants that would pay for their own leasehold improvements.? Their realtor advised the partners that this put the space at a competitive disadvantage.? Tenant fit out allowances were the industry standard, with the costs amortized over the life of the lease as part of the rent.? Costs above the allowance could be a lump sum charge to the tenant.? Donny had understood the fit out responsibilities of a landlord, but insisted that his inhouse construction crew do all the fit out with proper permitting.

While Donny eventually agreed to front the cost of the renovations, Eric remained suspicious that Donnie was overcharging for the construction costs.? Why not receive three bids, including a bid from Donnie’s inhouse crew?? After some investigation, Eric was finally convinced that the volume of interiors construction work by Donnie’s crew, plus his ability to switch them over to do yard maintenance and snow plowing, was actually a cost advantage in the leasing.

The next conflict was over who would be considered as tenants.? Neither wanted any tenant that was handling food or medical offices with numerous sinks that would need to be removed for a next tenant.? Eric was adamant that he did not want a competitor across the hallway, even an agency selling a different type of insurance than Eric was now offering, but may want to proffer in the future.? A palate studio was deemed too noisy.? A recruiting firm for industrial workers would bring “undesirables” into their building.? They finally settled on a church tenant that was willing to take the mostly open space vacancy “as is,” for a very reasonable rent.? Eric was appeased that this tenant would mostly be using the space evenings and on weekends, when his agency was closed.

The third unanticipated consequence of this ill-fated partnership was over the care of the building by Donnie’s crew.? These invoices for maintaining the common areas and grounds were also suspect.? Eric had not understood that he was responsible for cleaning his office and restrooms, including trash removal.? Donnie was willing to do that cleaning too, but they haggled over the charge for weeks.? This resolution ultimately required the involvement of their lawyers.? Eric also objected to the additional landscaping Donnie wanted to install in order to increase the site’s “curb appeal” prior to securing the church tenant.? Donnie was unsure how a man who had such a solid reputation as an insurance broker could be so unbusinesslike as a real estate partner.? At this point the partners were no longer speaking to each other.? Donnie wondered whether Eric’s legal bills were now exceeding the insignificant amounts of money he was fighting over.

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The Disengagement Plan

After a year of what seemed to be a continuous battle, Donnie declared that he had enough of this partnership.? His first offer to buy out Eric was angrily rejected.? Eric advised Donnie (through their attorneys) that the only way he saw to recover all the unexpected costs from this endeavor was to wait until the real estate market for commercial properties improved to allow Eric to sell at a hefty capital gain.? Plus, Eric would also still sought to own the building that housed his office.? What he most certainly didn’t want was to be Donnie’s tenant.? Eric did make a counteroffer to sell to Donnie at a price far above what the property would be worth in the best of markets.? Donnie next offered to sell to Eric.? Eric’s asking price was so low as to be insulting, his claim of unrecovered costs and depressed real estate values as his explanation.? Donnie was unwilling to sell at such a low figure just to no longer have to deal with Eric.

The relationship was in a stalemate until Donnie was golfing one afternoon with a friend who was a prominent local divorce attorney.? The friend found Donnie’s recounting of the downfall of this partnership reminiscent of a number of divorce settlement negotiations where he was able to leverage his client’s soon-to-be-ex-spouse’s anger to his client’s advantage.? This discussion led Donnie to a plan that ultimately extracted him from the partnership.

First, he contacted another real estate broker and had her make a cash offer on behalf of an anonymous client for the building.? This unidentified buyer, an LLC, was to be interested in occupying Eric’s suite and was willing to including a sweetener to the offer of an allowance to pay Eric’s move costs with 4 months to find and occupy another space.? The proposal was definitely above market.? Eric snapped at the price, even though it was considerably below the counteroffer he had made to Donnie a few months before.? Donnie pretended to be dismayed but willing to allow someone to overpay for the property.? To further play on Eric’s anger, he relayed through his lawyer his refusal to make an offer above the one received, and his intention to leave the commercial property market and focus only on residential.

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The Next Plan

The sale proceeded without Eric ever meeting the buyer.? Donnie even retained a lawyer from another firm to do the closing so Eric would never make the connection.? Unfortunately, that was not the end of the saga.? With cash in hand from the sale, Eric was not very motivated to find a new place.? Finding a 7,000 square foot building in move-in condition was no easier now than 18 months ago, especially when there was no sense of urgency.? Four months passed after the closing and Eric had yet to identify a building that suited him.? Donnie was unable to show the space to prospective tenants in fear of tipping his hand that there was no buyer about to move in.? He started having his outside attorney send letters on behalf of the anxious owner-occupant. ?Subsequent letters to Eric threatened eviction and compensation for the buyer having to pay extra rent and penalties at his existing leasehold.? Eric was indifferent, the premium he had earned from the sale still available to cover such incidental costs in finding just the right situation for his business.? Donnie was not yet willing to pay the legal expenses for an eviction.

Another round of golf with his attorney friend, discussing how to deal with an ex-spouse, helped Donnie come up with a new plan.? When he heard the Eric had recently fired his real estate agent, Donnie contacted another broker who was willing to stretch his business practices.? Donnie worked diligently with this broker to find the right building for Eric.? Donnie developed proformas for buildings to demonstrate how Eric could be a profitable landlord for each property, with the broker pretending that he had done the financial analysis.? In a few months, Eric had purchased a two story building, and soon after moved into the second floor.

A year later Donnie and Eric saw each other at a Chamber of Commerce event.? Donnie asked Eric how the new building was working out and was he having any luck leasing out the first floor. ?Eric reported that his real estate broker had done an unsatisfactorily job in finding the right tenant, and had been fired.? He was now looking for a new broker.? Then Eric asked Donnie why he hadn’t yet removed his real estate company sign from their former building.? That was when Eric revealed the identity of the “mystery buyer.”