What Is a Joint Venture in Real Estate?
In essence, a joint venture agreement in real estate is simply an agreement between two or more parties to develop a parcel of land together as an alliance or business undertaking. A joint venture agreement can take on many different forms, but generally requires that the participants each contribute something of value to the venture, such as cash, services, real property (land) so it can complete a real estate development and make a profit .
By creating a joint venture agreement, participants pool their resources to create something bigger than any single participant could accomplish on their own. Typically, participants enter a joint venture with the intent of generating a profit via the development of a commercial property. However, it is possible for a joint venture to be formed for non-profit generating purposes.
A joint venture agreement can serve multiple purposes, for example:
The Key Components of a Real Estate Joint Venture Agreement
Typically, all real estate joint ventures comprise the following key elements:
Section 7.1 – Capital Commitments of the Partners
Each of the partners will be required to make a capital investment into the venture.
Section 7.2 – Percentage of Ownership and Profits
Each partner will own an interest in the venture and will be entitled to a percentage of the profits in accordance with their respective ownership interests.
Section 7.3 – Management of the Venture "The Manager"
There will be a third-party or one of the partners who will oversee the business of the venture and manage the operations. That person is referred to as "the Manager."
Section 7.4 – Labor, Material and Work
One of the parties will typically be responsible for providing the labor, materials and work to the project. It can be either a partner or a third-party.
Section 7.5 – Responsibilities and Authority of the Manager
Set forth in detail the powers and limitations of the manager or the managers. Specify what they can do and what they can’t do without consent from the partners.
Section 7.6 – Authority of the Partners
Set forth the authority of the named partners. Specify what they can do and what they can’t do without consent from the managers.
Section 7.7 – Business Judgment Rule
If one of the partners occupies the position of a Board Member, and exercises his or her authority that is granted by the agreement, that decision will be granted the protection of the business judgment rule.
Section 7.8 – Operating Budget
Set forth the venture’s annual operating budget, which will be subject to review and comment by the partners and approved by the managers.
Section 7.9 – Books of Account
The agreement should provide for books of account to be kept showing all payments and other receipts, all disbursements and other expenditures, and all other transactions of the business of the venture.
Different Types of Joint Ventures in Real Estate
Unique to real estate enterprises and development projects are the different forms that a joint venture can take. For instance, there are horizontal joint ventures, which involves co-ownership of land to develop in a similar way. This is common among developers looking to have a larger footprint if they acquire all or a large portion of the contiguous land above and beyond what they need. The downside is that you will likely get caught up in the development of the other portion as well, which may or may not be a similar development project.
A vertical joint venture, on the other hand, involves one owner developing a parcel and leasing space to a tenant who then builds out their space. An example of this would be a grocery store or anchor location in a community shopping center, where the developer leaves that space as a shell for the end tenant to build out the interior core and according to their specific needs. This type of arrangement, much like a traditional commercial lease, can be beneficial in so far as it allows the developer to lease up space before obtaining financing for the entire project.
Many developers and/or investors will elect to utilize the more common single-purpose entity joint venture, meaning that the entity favors neither party in the venture by strictly serving only that defined purpose and only the parties are separately liable. Again, this is similar to the lives of various leases in a commercial property, which makes it highly amenable to a traditional form of commercial real estate investment.
The final option identifies the party who blueprints the transaction as the sponsor, which will create the entity and control the additional partner. The primary benefit is because the sponsor often has significantly more experience, credibility, and financial means than the other partner, it ensures the success of the deal. The downside, of course, is that the usual benefits from a joint venture do not apply here, as it more resembles a direct investment than a joint venture.
Advantages and Downsides of a Real Estate Joint Venture
Many real estate developers and operators are beginning to form joint venture relationships to combine their financial resources and expertise with other companies to compete more effectively in an otherwise weak economy. Joint ventures may also be used to qualify for financing, as well as for tax benefits and liability reduction.
Purely from a financial perspective, if all parties to the joint venture have sufficient financial resources to contribute to the proposed transaction (including the assets to be invested in the joint venture), then structuring a joint venture is simply an agreement on how to pool, share and use these assets to accomplish a business objective, i.e., purchasing or improving real estate. In structuring any joint venture, regardless of the types of agreements that are considered, developers need to consider whether their objectives can be better achieved by a corporate structure (e.g., forming a single purpose limited liability company) or by an entity taxed as a partnership.
For instance, if raising money to carry out the business plan of the joint venture is needed, then the joint venturers may want to create a single purpose structure that will minimize the number of investors required to achieve this objective. In this context, and unless limited by the investment agreement, or securities laws, the new entity can issue "private placement" equity securities in lieu of an investor’s cash (such as land or fund-raising services) into the joint venture. The new entity can also issue debt securities or "notes" in lieu of cash or according to the terms of the joint venture. The notes can be convertible (i.e., allowing the holders to convert the notes into stock under certain terms and conditions) or non-convertible. In return, the developer will be required to make coupon payments at fixed intervals and repay the principal investment. Depending on the type, the debt securities may or may not require registration with the SEC.
The potential risks of a joint venture include:
• the possibility that one of the parties may appropriate an opportunity that should be provided to the joint venture, and competition among joint venturers can sometimes lead to disputes;
• the parties’ contradictory or conflicting interests (beyond the venture) that can impede the operation of the venture, and their reluctance to commit the resources or capital to grow the venture, and/or
• the parties’ lack of experience with the investment objectives of the venture, such as recognizing the importance of investing for income rather than appreciation. In order to mitigate these potential risks, developers should clearly define the purpose of the joint venture in the joint venture agreement. It is also advisable to have "buy-sell" provisions in the joint venture agreement so as to restrict or provide rules with regard to a party’s right to purchase the interest of another party in a joint venture.
Legal Issues for a Real Estate Joint Venture Agreement
When entering into a joint venture, a developer should take extraordinary care to articulate the terms of the joint venture in as much detail as possible. It is important to establish not only the scope of work for each party but also the specific rights and obligations of each party to the joint venture. For example, the joint venture agreement should detail all of the "carve outs" to the exclusive development rights to be granted to the joint venture (such as self-development exceptions, traditional investment opportunities or exclusivity exclusions for one party or the other), any carve outs to the exclusivity (for instance, like the prior rights of a master developer for the site), what are appropriate carve outs for the permitted uses, the level of involvement of the other party in those carve outs and whether there are any minimum levels of financial performance . In addition, the degree of exclusivity should be carefully drafted. In the theory of the joint venture, it would only apply to the property with respect to which the application has been made. However, one must account for the potential for minor reconfigurations of the boundaries of titles or minor revisions to a site plan to better meet code requirements or street access requirements, etc. The unintended consequences of failing to account for those minor revisions would render the exclusive right inoperable. The developer should also account for the ability to apply for off-site approvals associated with the Property.
Finally, the parties will need to decide the degree to which either member of the joint venture has approval rights with respect to such things as budget, contracts, management, leasing, financing, marketing, advertising, asset management, and construction if the joint venture is to be hands-off.
How to Form a Successful Real Estate Joint Venture
Structuring a real estate joint venture requires careful planning and collaboration between the involved parties. There are two main types of joint ventures in real estate: development and cooperation. Development joint ventures involve investors collaborating on the acquisition of land for redevelopment or new development, including ground-up construction. Such joint ventures typically require detailed joint venture agreements that outline responsibilities, contribute funds or other resources for the project, and share in profits or losses from the venture. Cooperation joint ventures are typically formed between real estate firms that will complete the project together (e.g., an architectural firm forming a joint venture with an engineering firm). These joint ventures create a partnership between related businesses.
Before forming a joint venture, the involved parties must do their due diligence. This means researching the other members of the potential joint venture for financial stability and experience, as well as possible conflicts of interests. They should also verify that they have the resources they need so that they can effectively complete the project. Once the terms are agreed upon, it is important to move forward with a formal written joint venture agreement to protect their legal interests.
Synergy is important for real estate joint ventures because it ensures that the parties are alike. This means that they have similar objectives, philosophies, and goals for the project. If there is not synergy between the parties, it may complicate matters as the project moves forward.
A well-structured real estate joint venture requires significant collaboration with other parties to ensure that it can achieve their desired goals. The parties must strive to maintain synergy to keep the collaboration running smoothly throughout the project. With careful planning, research, and cooperation, the individuals involved can see a successful outcome.
Examples of Successful Real Estate Joint Ventures
Real Life Examples of Successful Real Estate Joint Venture Agreements
When it comes down to it, real estate industry entities pursue joint ventures for three main reasons: to share resources, expertise and risk. They also seek to minimize their weaknesses and capitalize on their respective strengths. For all these reasons and more, joint ventures play a key role in the industry.
Successful joint ventures often share certain characteristics. They tend to be structured to align the goals of the parties and are designed to create synergies that will enable them to achieve objectives they may not be able to accomplish individually.
Below are three real-life examples of joint ventures in the real estate community.
One of the earliest examples of a commercial real estate joint venture occurred in 1902 when J.L. VanDusen, William Hesketh Lever and Karl Oskar Gebhard formed the Grand Isle Development Company. Through the joint venture, they combined forces to develop a hotel, two piers, a golf course, and other luxuries on Grand Isle, a barrier island that is now part of Grand Isle, Louisiana.
The Grand Isle Development Company was designed with joint venture characteristics. The parties to the joint venture were all involved in the real estate or tourism industry. The joint venture enabled them to pool their expertise, human capital and resources to make the most of the opportunity before them.
The resulting development was the St. Charles Hotel, a world-famous resort with its own post office (the only hotel with its own post office in the U.S.at the time) and three movie theatres. The developers of the Grand Isle Development Company were early adopters of real estate joint venture agreements, ahead of their time. Today’s joint venture agreements draw on the best practices the founders of the Grand Isle Development Company established.
Leona Helmsley, aka the Queen of Mean, was a major player in New York City’s real estate industry in the mid-20th century. She grew her business from a small , 104-room structure called the Park Lane Hotel on Central Park South to an empire with 274 properties (mostly hotels and resorts).
During her career, she partnered with several top hotel companies, including Westin Hotels (1989), Hilton Hotels Corporation (1998) and Starwood Hotels & Resorts (1998). In 2011, Helmsley’s family trust, the Leona M. and Harry B. Helmsley Charitable Trust, led a consortium that acquired the site of the former Alexander’s Department Store on East 59th Street in New York City for $80 million. The consortium was comprised of a number of investors who pooled their financial resources to purchase the property (formerly worth $50 million but now current with an estimated appraised value of $658 million) for six times what it was worth in order to redevelop it.
Through innovative joint venture agreements, Helmsley was able to leverage her stature, strong marketing skills and unique partnerships with many of the top hotel companies in the U.S. Her business savvy helped her create profit-building synergies. Like the Grand Isle Development Company, the Helmsley joint ventures provided her with the results she sought.
In 1992, American Tower Corporation (ATC), a major telecommunications real estate investment trust, acquired American Wireless, a local wireless company, through a joint venture agreement with U.S. Wireless. The agreement called for ATC to acquire as much as 40 percent of American Wireless’ common stock in exchange for an undisclosed amount of cash. The joint venture allowed ATC to quickly expand by adding 232 wireless sites to its portfolio in 1992. While some were only leases, ATC was able to convert many of them to ownership in the years following the joint venture. ATC utilized the services of U.S. Wireless to oversee the integration of the new sites. The Joint Venture Agreement Alliance (JVA) solved the financing issues ATC would’ve faced, as it would’ve been nearly impossible for the company to have acquired or financed the entire acquisition in one fell swoop.