Joint ventures are a time-honored vehicle through which to develop real estate projects.
In their simplest form, joint ventures combine the expertise of a developer with the equity of a capital member.
This marriage of resources has obvious benefits, however poor planning can lead to ugly divorces.
Paying careful attention to the following considerations will increase the likelihood of a prosperous relationship:
- Choose the right vehicle
Obtain advice from your lawyer and accountant about the right structure for the joint venture, taking into account tax consequences etc.
- Keep finance in mind
Nearly all projects will require third party financing. Construction lenders almost always, require full completion and payment guarantees and capital members generally have an expectation, that their risk will be limited to their investment.
A joint venture agreement, should address all guarantor obligations with regards to financing the project throughout all stages.
- Timing is everything
Joint venture agreements and any other binding agreement, should be completed prior to the capital members’ funding any capital. The agreement should establish contributions, with regards to pre-formation costs like due diligence and lender fees.
- Establish the returns
Provisions regarding percentage distributions, are the most critical part of a joint venture agreement.
Typically, real estate joint ventures establish thresholds that provide a set percentage return to each member, based on their capital contribution.
There are also often additional incentives added in the agreement, for a greater share of the distribution after the preferred returns are achieved.
- Describe management responsibilities in detail
Typically, the developer oversees the construction and day to day operations. A joint venture agreement should include a set of major decisions, for which the capital member’s express consent is required.
For example, admitting new members, re-investment of proceeds, refinancing, sale and approval of budgets etc.
- Make provisions for unexpected capital needs
Real estate developments can often require more capital, than what is initially budgeted for.
Unanticipated capital needs combined with a lack of clear language in the agreement, can lead to major disputes between the parties.
The agreement should specifically state, which members are entitled to require a capital call and consequences for a member, who fails to provide the additional capital.
There should also be provisions, dealing with overrun costs and whether or not these are treated as capital contributions or costs.
- Disclose all Fees
JV agreements should prohibit fees to members/affiliates, that are not approved by the other members. All fees should be delineated in the JV agreement.
- Allow for removal of managing member
In Most JV’s, the developer is also the managing member. JV agreements should define the circumstances, in which a capital member can remove the developer as a manager. Capital members should review any property management agreements carefully and developers should negotiate release as guarantors of third party loans, if they are removed as managers.
- Have an exit strategy
A JV agreement should provide a clear mechanism for any member to exit the company. Agreements can provide for either member, to set a price at which they can sell their interest, or buy the other member’s interest. Another strategy is to allow members to market the property for sale to third parties, after the hold period. Exit strategies can be very complex, so it pays to give extra consideration to this part of the agreement.
- Anticipate disputes
Clear language is the best means by which to avoid disputes. Sometimes however, conflicts are inevitable. A good JV agreement should provide, for either arbitration or mediation and should establish the jurisdiction and venue for the litigation of disputes.
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