Real Estate Partnership Operating Agreement: Essential Terms to Protect Your Investment

Real estate partnerships can accelerate wealth building by pooling capital, expertise, and labor. However, partnerships also create complexities—disputes over money, decision-making, and exits destroy relationships and investments daily.

A comprehensive operating agreement protects all partners by establishing clear rules before conflicts arise. This guide covers essential provisions every real estate partnership agreement needs.

Why You Need an Operating Agreement

Legal protection:

• LLC operating agreements govern member relationships
• Prevents reliance on default state law
• Enforces agreed-upon terms
• Protects minority partners

Conflict prevention:

• Clear rules prevent disputes
• Defines roles and responsibilities
• Establishes decision-making processes
• Outlines exit procedures

Financial clarity:

• Capital contribution requirements
• Profit distribution formulas
• Expense allocation
• Funding additional capital

Without written agreement:

• State default rules apply (may not match your intent)
• Verbal agreements unenforceable
• Disputes have no resolution mechanism
• Partnership dissolution may be only option

Partnership Structure Options

General Partnership (GP)

Characteristics:

• All partners have management authority
• All partners personally liable
• Pass-through taxation
• No formal filing required (but should have written agreement)

Advantages:

• Simple formation
• Flexible management
• Low cost

Disadvantages:

• Unlimited personal liability
• All partners bind partnership

Use when: Informal arrangements, trusted partners, low risk

Limited Partnership (LP)

Characteristics:

• General partner(s) manage and have liability
• Limited partners passive investors with no liability (beyond investment)
• Formal state filing required
• Pass-through taxation

Advantages:

• Limited liability for LPs
• Clear management structure
• Attracts passive investors

Disadvantages:

• GP has unlimited liability
• Less flexibility
• More expensive formation

Use when: Raising capital from passive investors

Limited Liability Company (LLC)

Characteristics:

• All members have limited liability
• Flexible management (member-managed or manager-managed)
• Pass-through taxation (default) or can elect corporate taxation
• Formal state filing required

Advantages:

• Limited liability for all members
• Maximum flexibility
• Simple taxation
• Professional image

Disadvantages:

• State filing fees and annual fees
• Operating agreement essential
• More complex than GP

Use when: Most real estate partnerships (most common and recommended)

LLC Taxed as Partnership (Most Common)

Default LLC taxation:

• Pass-through taxation (not taxed at entity level)
• Income/losses pass to members' personal returns
• Members pay tax based on ownership percentage
• Self-employment tax considerations

Essential Operating Agreement Provisions

Article 1: Formation and Purpose

Include:

• Legal entity name
• Formation date
• State of organization
• Registered agent
• Business purpose (specific or general real estate investing)
• Principal place of business

Sample language: "The LLC is formed under the laws of Texas for the purpose of acquiring, owning, managing, and disposing of real estate investments."

Article 2: Members and Ownership

List all members:

• Full legal names
• Addresses
• Initial ownership percentages
• Initial capital contributions

Example:

• Member A: John Smith, 60% ownership, $60,000 initial capital
• Member B: Jane Doe, 40% ownership, $40,000 initial capital

Capital accounts:

• Track each member's investment
• Adjusted for contributions, distributions, and allocated income/losses

Article 3: Capital Contributions

Initial contributions:

• Amount and form (cash, property, services)
• Due dates
• Consequences of non-payment

Additional capital calls:

• Process for requiring additional capital
• Member obligations
• Consequences of non-payment (dilution, default, etc.)
• Maximum capital call amounts or frequency

Sample provision: "Each member agrees to contribute capital as called by the Manager, up to [amount] per member. Failure to contribute within 30 days results in proportional dilution of ownership."

Alternative provision (no mandatory calls): "No member is obligated to contribute additional capital beyond initial contributions. Additional capital needs will be funded by willing members in exchange for increased ownership."

Article 4: Distributions

Distribution timing:

• Frequency (monthly, quarterly, annually, as available)
• Minimum reserves before distributions
• Manager discretion vs. automatic

Distribution formula:

• Proportional to ownership (most common)
• Preferred returns (common in passive investor deals)
• Tiered waterfalls (performance-based splits)

Tax distribution:

• Mandatory distributions to cover tax liabilities
• Calculated based on highest tax bracket
• Example: 40% of taxable income distributed for taxes

Sample provision: "After maintaining minimum $25,000 reserves, remaining cash flow distributed quarterly pro rata to members based on ownership percentages."

Article 5: Profit and Loss Allocation

How taxable income/loss is allocated:

• Usually matches ownership percentages
• May differ from cash distributions
• Special allocations possible (consult tax professional)

Sample provision: "Profits and losses allocated among members in proportion to their ownership percentages."

Article 6: Management and Decision-Making

Management structure:

Option 1: Member-managed

• All members participate in decisions
• Major decisions require majority or unanimous vote
• Day-to-day by designated member(s)

Option 2: Manager-managed

• One or more managers (can be members or non-members)
• Manager(s) handle all decisions
• Members passive
• Manager owes fiduciary duty

Major decisions requiring higher approval:

• Purchase or sale of property (75%+ or unanimous)
• Refinancing
• Leases over certain term or amount
• Capital improvements above threshold
• Admission of new members
• Amendment of operating agreement
• Dissolution

Day-to-day decisions:

• Property management
• Maintenance and repairs (up to $X limit)
• Tenant matters
• Routine operations

Sample provision: "The LLC shall be manager-managed. John Smith is appointed initial Manager. Manager may make all ordinary decisions. The following require 75% member vote: property acquisition/sale, refinancing, capital expenditures >$10,000, admission of new members."

Article 7: Compensation

Management fees:

• Who receives compensation
• Amount or percentage
• When paid
• Conditions

Acquisition fees:

• Finder's fees for locating properties
• Typical 1-3% of purchase price
• Paid to member sourcing deal

Asset management fees:

• Ongoing management compensation
• Typical 1-2% of property value or revenue
• Annual or monthly

Sample provision: "Manager shall receive monthly asset management fee of 1.5% of gross rental income for services rendered."

Article 8: Books and Records

Record keeping requirements:

• Where records maintained
• What records kept
• Member inspection rights
• Annual accounting to members

Financial reporting:

• Monthly or quarterly financial statements
• Annual tax reporting (K-1s)
• Access to bank statements and records

Sample provision: "Manager shall maintain complete records of LLC finances and operations. Members may inspect records upon 5 business days' notice. Manager shall provide quarterly financial statements and annual tax information."

Article 9: Transfer Restrictions

Transfer of membership interests:

• Consent required (typically unanimous or majority)
• Right of first refusal to other members
• Transfer to family trusts allowed
• Prohibited transfers

Purpose:

• Control who becomes a partner
• Protect against unwanted members
• Maintain relationship-based partnership

Sample provision: "No member may transfer their interest without unanimous consent of other members. Members have 30-day right of first refusal to purchase offered interest at third-party price."

Article 10: Buy-Sell Provisions

Triggering events:

• Voluntary withdrawal
• Death
• Disability
• Bankruptcy
• Breach of agreement
• Irreconcilable disputes

Valuation method:

• Fair market value appraisal (name appraiser selection process)
• Formula-based (cap rate, multiple of cash flow)
• Agree on value annually
• Arbitrary valuation disputes lead to problems

Payment terms:

• Lump sum or installment payments
• Down payment amount
• Interest rate on balance
• Security (promissory note)

Sample provision: "Upon voluntary withdrawal, departing member must offer interest to remaining members at fair market value determined by independent MAI appraiser. Purchase price paid 20% down, balance over 5 years at 6% interest."

Article 11: Dispute Resolution

Resolution process:

1. Good faith negotiation between members
2. Mediation (non-binding, facilitator helps reach agreement)
3. Arbitration (binding, arbitrator decides)
4. Litigation (last resort)

Benefits of mediation/arbitration:

• Faster than litigation
• Lower cost
• Private (not public record)
• Preserves relationships better

Sample provision: "Disputes shall first be subject to good faith negotiation. If unresolved after 30 days, members agree to binding arbitration under AAA rules in [city, state]. Prevailing party entitled to attorney fees."

Article 12: Dissolution and Winding Up

Dissolution events:

• Vote of members (typically 75%+ or unanimous)
• Expiration of stated term
• Occurrence of dissolution event in agreement

Winding up process:

• Pay LLC debts and obligations
• Liquidate assets
• Distribute remaining proceeds to members per agreement

Order of distributions:

• Return of capital contributions first (or pro rata)
• Profits distributed per ownership

Sample provision: "Upon dissolution, Manager shall liquidate assets, pay debts, and distribute remaining proceeds: first return of members' capital contributions, then remaining amounts pro rata to members per ownership percentages."

Article 13: Miscellaneous Provisions

Additional important clauses:

Amendment:

• How operating agreement can be amended
• Typically requires unanimous or supermajority consent
• In writing and signed by all members

Governing law:

• Which state's laws govern the agreement

Severability:

• If one provision invalid, remainder still enforceable

Entire agreement:

• Operating agreement supersedes all prior agreements

Notices:

• How official notices given (email, certified mail, etc.)

Specialized Partnership Structures

Passive Investor Structure

Common in syndications:

• General Partner (GP) or Manager: Active management
• Limited Partners (LPs) or Members: Passive investors

GP/LP split examples:

• 70/30 (70% to LPs, 30% to GP after preferred return)
• 80/20 with 8% preferred return to LPs
• Tiered: 90/10 up to 12% IRR, 80/20 from 12-18% IRR, 70/30 above 18% IRR

GP responsibilities:

• Find deals
• Raise capital
• Manage operations
• Execute business plan
• Handle disposition

LP rights:

• Passive investment
• Limited liability
• Receive financial reports
• Typically no voting rights except major decisions

Joint Venture (JV) Agreements

Project-specific partnerships:

• Typically one-off deals
• Clear beginning and end
• Exit at property sale

Common JV structures:

• 50/50 split (equal partners)
• Capital partner + Operating partner (different contribution types)
• Developer + Investor partnerships

Key differences from ongoing LLC:

• Defined term (until property sold)
• Single asset focus
• Dissolution automatic upon sale

Family Partnership Structures

Special considerations:

• Gift and estate tax planning
• Generational wealth transfer
• Asset protection
• Income splitting

Family-specific provisions:

• Transfer to family members allowed
• Buy-sell triggered by divorce
• Successor management (next generation)

Professional guidance essential for family partnerships.

Common Partnership Mistakes

Mistake 1: No Written Agreement

Problem: Relying on handshake or verbal agreement

Consequences:

• No enforceable terms
• State default law applies
• Disputes become litigation
• Partnership may dissolve

Solution: Always have written, signed operating agreement before investing together

Mistake 2: Vague Decision-Making Authority

Problem: No clear process for who decides what

Consequences:

• Deadlock on decisions
• One partner acts without authority
• Resentment builds
• Projects stall

Solution: Clearly define manager vs. member decisions and voting requirements

Mistake 3: No Exit Plan

Problem: No provisions for partner wanting out

Consequences:

• Forced liquidation
• Below-market sales
• Stranded partners
• Litigation

Solution: Include comprehensive buy-sell provisions with valuation method and payment terms

Mistake 4: Ignoring "What If" Scenarios

Problem: Agreement doesn't address death, disability, divorce, bankruptcy

Consequences:

• Unwanted heirs or creditors become partners
• Business disruption
• Forced liquidation

Solution: Include triggering events and consequences in buy-sell provisions

Mistake 5: Unclear Capital Contribution Rules

Problem: No process for additional capital needs

Consequences:

• Properties undercapitalized
• Partners contribute unequally
• Resentment over unfair burden

Solution: Define additional capital call process, obligations, and consequences clearly

Mistake 6: Unrealistic Valuations

Problem: Buy-sell provisions use arbitrary or outdated valuations

Consequences:

• Disputes over price
• Unfair advantage to buyer or seller
• Litigation to resolve value

Solution: Use independent appraisal, formula-based on comparable sales, or regular agreed-upon valuations

Mistake 7: Not Using Attorney

Problem: Using online template without legal review

Consequences:

• Missing essential provisions
• Unenforceable clauses
• State-law non-compliance
• Tax inefficiencies

Solution: Have experienced real estate attorney draft or review operating agreement

Negotiating Partnership Terms

Fair Terms for All Partners

Balance considerations:

• Capital contribution vs. sweat equity
• Risk vs. reward
• Active management vs. passive investment
• Experience and expertise value

Common splits:

• 50/50: Equal partners contributing equally
• 70/30: Capital partner (70%) + Operating partner (30%)
• 80/20: Investor (80%) + Syndicator/GP (20%)

Questions to resolve:

• Who contributes what? (cash, credit, expertise, labor)
• Who manages day-to-day?
• How are profits split?
• How do we handle disagreements?
• What if someone wants out?
• What if we need more money?

Red Flags in Proposed Terms

Warning signs:

• Partner refuses written agreement
• Pressure to sign without attorney review
• Vague or missing key provisions
• Unreasonable restrictions on your exit
• No financial reporting requirements
• Partner has sole control over money
• Excessive fees to one partner

Trust your instincts—if terms feel unfair, negotiate or walk away.

Working with Attorneys

When to Hire Real Estate Attorney

Essential situations:

• First partnership or LLC formation
• Complex partnership structures
• Significant capital involved ($50,000+)
• Multiple partners
• Passive investors involved
• Family partnerships

What to Expect

Attorney services:

• Drafting or reviewing operating agreement
• Explaining legal implications
• Suggesting protective provisions
• Ensuring state law compliance
• Tax structure guidance (with CPA)

Typical costs:

• Simple LLC operating agreement: $1,000-$3,000
• Complex multi-member agreement: $3,000-$10,000+
• Review of existing agreement: $500-$1,500

Return on investment:

• Prevents disputes worth far more
• Protects your investment
• Peace of mind

Questions to Ask Attorney

1. What partnership structure do you recommend for our situation?
2. What are key protections I need in this agreement?
3. How do we handle partner wanting to exit?
4. What happens if we disagree on major decisions?
5. How do we prevent being stuck with unwanted partners?
6. What are tax implications of this structure?
7. What if a partner stops contributing or performing?

Conclusion

A comprehensive operating agreement is the foundation of successful real estate partnerships. It prevents disputes, protects investments, and provides clear procedures for all scenarios—from daily operations to partner exits.

Never enter a real estate partnership without a detailed, written operating agreement. The small upfront investment in legal fees pales in comparison to the protection and clarity provided.

Key elements every agreement needs:

• Clear ownership percentages and capital contributions
• Defined decision-making authority
• Distribution formulas
• Buy-sell provisions with valuation method
• Dispute resolution process
• Exit strategies

Work with an experienced real estate attorney to draft or review your operating agreement. Your partnership—and your investment—depend on it.

For investors ready to partner on real estate investments requiring financing, HonestCasa offers DSCR loans for rental properties, making partnership acquisitions more accessible.

Related Articles

• Real Estate Syndication
• LLC for Real Estate: Complete Asset Protection Guide
• Building a Rental Property Portfolio
• Joint Venture Real Estate Deals: Structure and Strategy
• Family Real Estate Partnerships: Wealth Transfer Strategies