What is a Real Estate Joint Venture (JV)?
A real estate joint venture (JV) is a deal between multiple parties to work together and compile resources to develop a real estate project. Most large projects are financed and developed as a result of real estate joint ventures. JVs allow real estate operators (individuals with extensive experience managing real estate projects) to work with real estate capital providers (entities that can supply capital for a real estate project).
The basic principle surrounding a Real Estate Joint Venture can be illustrated through the following example. Company X owns a plot of land in the city of Los Angeles. However, Company X is based out of New York. John was born in Los Angeles and grew up there. In addition, John lives next to the plot of land. Company X wants to develop the land and build an office block there. Company X gets into a Joint Venture with John where Company X takes care of the capital and John provides the expertise.
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The Different Players in a Real Estate Joint Venture
As mentioned above, most real estate joint ventures are comprised of two separate parties: the operating member and the capital member. The operating member is usually an expert on real estate projects and is responsible for the daily operations and management of the real estate project. A typical operating member is usually a highly experienced professional from the real estate industry with the ability to source, acquire, manage, and develop a real estate project. The capital member usually finances a large part of the project or even the entire project.
In a Real Estate Joint Venture, each member is liable for profits and losses relating to the joint venture. However, this liability only extends as far as the particular project that the joint venture was created for. Aside from this, the joint venture is separate from the members’ other business interests.
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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.
Key Aspects of a Real Estate JV Agreement
A real estate JV agreement involves the following factors:
1. Distribution of profits:
An important distinction to make when drafting the terms for a joint venture is how the members will distribute profits generated from the projects. Compensation may not necessarily be equally distributed. For example, more active members, or members that have invested more into the project may be compensated better than passive members.
2. Capital contribution
The JV agreement needs to specify the exact amount of capital contribution expected from each member. In addition, it must also specify when this capital is due. For example, a capital owner may agree to contribute 25% of the required capital but only if this contribution is made at the last stage of the development process (last money in).
3. Management and control
The JV agreement is expected to specify in detail the exact structure of the JV and the responsibilities of both parties regarding the management of the Real Estate JV project.
4. Exit mechanism
It is essential for a JV agreement to detail how and when the JV will end. Usually, it is in the best interest of both parties to make the dissolution of the JV as economical as possible (i.e., avoid legal fees, etc.). In addition, the JV agreement must also list out all the events that might allow one or both parties to trigger a premature dissolution of the JV.
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Reasons to Form Joint Ventures
Real estate development partners enter into joint ventures for the following reasons:
GPs bring industry expertise and put time and effort to manage the project, while LPs provide the capital required to fund the equity portion of the project financing.
GPs are provided with disproportionate returns to keep them motivated to work hard.
Investors possess limited liability and liquidation preference in the case that the assets of the partnership are liquidated.
Other Uses of JV Agreements
A joint venture agreement also allows businesses to take part in investment projects that they normally would not be able to join. Primarily, it allows a company (home company) to invest in projects in other countries by entering into a joint venture with a local partner. In this case, the home company may either be the operating partner or the capital partner.
Many countries impose restrictions on foreigners entering the domestic real estate market. In such cases, setting up a joint venture agreement with a domestic company is often the only avenue into the country.
Thank you for reading CFI’s guide to real estate joint ventures. For further information on real estate and business financing, see the following resources.