What is a Real Estate Joint Venture (JV)?
A Real Estate Joint Venture (JV) plays a crucial role in the development and financing of most large real estate projects. A joint venture is a business arrangement in which two or more parties agree to combine their resources in order to accomplish a specific task. In a Real Estate Joint Venture, this specific task is the development of a real estate project. The joint venture allows real estate operators (professionals who are experts in managing and developing real estate projects) to partner with real estate capital providers (individuals or organizations that can provide the capital needed 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 consist of two separate entities: 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 of the participants is responsible for profits, losses, and costs associated with the joint venture. However, the joint venture is its own entity, separate and apart from the participants’ 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 two parties sign the joint venture agreement, which lists out the details of the joint venture project such as the objective of the joint venture project, the capital contribution of the capital member, distribution of profits arising from the project among the operating member and the capital member, 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:
A key consideration while structuring a JV agreement is how members will split the profits that they make from the venture. The members may not be all compensated equally. For example, some parties may be compensated for a greater contribution of their time while passive members may not be compensated as well.
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.