This is the part two of our Joint Venture in Real Estate series
Real estate investment and real estate development convey significant investment yields from development of a site to actual sales or leasing of the final development. However there are parallel risks that can arise such as increase in costs of constructions, rival claims to land, dispute with government authorities amongst others hence the need to reduce or spread the risks by partnering with 1 or 2 parties.
Structure of a Real Estate Joint Venture
In most cases, the operating member and the capital member of the real estate joint venture set up the Real Estate project as an independent Limited Liability Company (LLC). The parties sign the joint venture agreement, which details the conditions of the joint venture. such as its objective, the contribution of the capital member, how profits will be split, delegation of management responsibilities for the project, ownership rights of the project etc.
However, a real estate joint venture is not limited to an LLC. Corporations, partnerships, and several other business arrangements can all be used to set up a joint venture. The exact structure of the JV determines the relationship between the operator and the capital provider.
Factors to Consider for the Structure of your Joint Venture:
Lets look at the main factors to consider before selecting the way a joint venture will be structured.
The actual relationship between the parties involved with the joint venture should be considered. If the joint venture is formed of a number of potentially passive investors who have no prior relationship with one another, then a structure which limits liability may be suitable, however, if the joint venture is formed by two long standing friends who both invest an equal amount, then they may be happy to share the liability on debt.
Which ever the case may be, it is important that a relationship is built on trust and transparency.
How the joint venture will be funded is a key consideration to how it should be structured. Is the project being funded by a number of potential investors or is it funded purely by two companies who are taking a 50/50 equity position, or in reality, the structure may need flexibility to allow for a number of different funding methods. The way in which funding will be found and the security offered to the investors will need to be considered.
Does the structure require the flexibility to allow interests of the partners involved to change during the project or the ability to introduce new partners to the structure? This may then point you towards a certain type of joint venture structure to consider.
How will the project be finished and ‘exited’? It might benefit, for example, for an office development which is being sold as an investment to be sold as a company rather than a property. Factors like this may rule out certain types of structures within property development.
This is usually a major consideration and often a primary reason for setting up joint venture structures in certain ways. You will want to ensure that the tax implications are considered for all parties involved, as well as, the potential transactions which will happen within the structure. Tax advice is imperative when setting up a joint venture and is something all developers need to consider before agreeing the final structure in property development.
Management and Control:
This is an area which can be overlooked in joint ventures, but the structure needs to consider how management of the project and control of the project is envisaged. How hands on will investors be and does a limited company board structure suit all parties?
Certain ways of structuring a joint venture in property development will allow for all parties to remain confidential and information will not be available in the public domain. For some joint ventures, this can be critical, however, for others it will not be a concern.
Advantages of Joint Venture in Development
Each party in the venture contributes a certain amount of initial capital to the project, depending upon the terms of the partnership arrangement, thus alleviating some of the financial burden placed on each company.
Each party shares a common pool of resources, which can bring down costs on an overall basis.
Technical expertise and know-how:
Parties to the business often brings specialized expertise and knowledge, which helps make the joint venture strong enough to move aggressively in a specified direction.
New revenue streams:
Small businesses often face having limited resources and access to capital for growth projects. By entering into a joint venture with a larger company with more financial resources, the small business can expand more quickly. The larger company’s extensive distribution channels may also provide the smaller firm with larger and/or more diversified revenue streams.
Intellectual property gains:
Advanced technology is often difficult for businesses to create in-house. Therefore, companies often enter into joint ventures with technology-rich firms to gain access to such assets without having to spend the time and money to develop the assets for themselves in-house. A large firm with good access to financing may contribute their working capital strength to a joint venture with a firm that has only limited financing capabilities but that can provide key technology for the development.
It typically takes some significant period of time for a young business to build market credibility and a strong customer base. For such companies, forming a joint venture with a larger, well-known brand can help them achieve enhanced marketplace visibility and credibility more quickly.
Unlike a business merger or an acquisition a joint venture is a temporary contract between parties that dissolves at a specific future date or when the project is completed. The parties entering into a joint venture are not required to create a new business entity under which the project is then completed, providing a degree of flexibility not found in more permanent business strategies. Also, parties do not need to give up control of their businesses to another entity, nor do they have to cease ongoing business operations while the joint venture is underway. Each party is able to maintain its own identity and can easily return to normal business operations once the joint venture is complete.
High chance of project success:
Chances of success of the development project will become higher as partners will pull together resources and capabilities from different field.
Joint venture will help to build relationships and networks, even though partnership is only for a specific goal, it enables partners to create long-lasting business relationships.
However, like all relationships, there are pitfalls and challenges of which to be wary and it is best to start the relationship built on a stable foundation of communication and trust, as well as an equitable spread of profit and loses.
Disadvantages of Joint Venture in Development
Lack of clear communication:
As a joint venture involves different companies from different horizons with different goals, there is often a severe lack of communication between partners. Partners may have different objectives for the joint venture, and pursuing separate objectives may threaten the success of the venture. For this reason, it is important when forming a joint venture arrangement that the objectives of the venture be clearly defined and communicated to everyone involved at the outset.
Cultural mismatches and different management styles between the firms engaged in the JV can lead to poor integration and cooperation, again threatening the success of the enterprise. It’s best to pursue JV opportunities with companies that have a corporate culture similar to that of your own company.
Because different companies are working together, imbalance in the levels of expertise, investment, or assets brought into the venture by the different parties may lead to problems between the parties. One party or the other may begin to feel that it is contributing the lion’s share of resources to the project and resent a 50/50 distribution of profits. This can be avoided by frank discussions and clear communication during the formation of the joint venture, so that each party clearly understands and readily accepts its role in the JV.
It may be hard for you to exit the partnership as there is a contract involved
Once again, even though a joint venture is temporary, it is crucial that you know what you are getting into if you don’t want to be locked in a partnership.
Because of the separate nature of a joint venture, it is possible that the partners do not devote 100% of their attention to the project and become unreliable.
There is no such thing as an equal involvement.
An equal pay may be possible, but it is extremely unlikely for all the companies working together to share the same involvement and responsibilities, the level of expertise and investment cannot be equally matched.