Joint Ventures
When multiple companies or individuals are involved in owning a property, they are structured as joint ventures, often referred to as JVs, where each party has a specific role.
What are Joint Ventures?
In commercial real estate, it is quite common for entities to form symbiotic, mutually rewarding partnerships. These partnerships are known as joint ventures (JVs). In most joint ventures in the commercial real estate space, one party typically brings commercial real estate expertise to the table while the other entity provides capital. A joint venture is almost like a commercial real estate syndication, only it is generally an agreement between 2 or more entities that will work together in a partnership rather than one sponsor and a larger group of investors. Joint ventures are typically structured with one operating member, often an experienced investor, property manager, or developer, taking lead on the management of the asset — capital members, on the other hand, have a less active role depending on the exact nature of the JV structure.
There are several different types of joint venture structures, the most common of which is a limited liability company (LLC). Beyond that, JVs can take the form of corporations or more simple commercial partnerships. Regardless of the complexity of the joint venture, it’s important that the right structure for a project’s individual needs is chosen, as the JV structure can have a big impact on the rights, responsibilities, and power dynamics between its members.
As an illustration of this point, consider that an LLC puts the operating member (the member involved in the day-to-day operations of the project) and the capital member (the member behind the financing of the project) on relatively equal footing. Conversely, a limited partnership (LP) — in which the capital member is a limited partner — significantly reduces the amount of control that the capital partner has over the venture, though they benefit from the reduced risk that comes with limited liability.
Joint Venture Agreement Breakdown
Aside from determining the type of corporate or partnership structure the project should have, the members of a joint venture must also create, agree upon, and finally sign a joint venture agreement. JV agreements generally include:
The strategy and goals of the venture: This initial section of the agreement typically details the assets that the JV plans to develop/acquire, how these assets are to be acquired, and the penultimate vision and reasoning for the project.
Expected contributions from each member: Joint venture agreements must detail the responsibilities of the partners involved. Typically, a capital partner (or partners) will contribute the majority of the capital to a project. The operational partner (or partners) may still be required to contribute a smaller stake, but many JVs exist where the operational member is not required to contribute any capital at all. This section of the agreement should also clearly state if the venture plans to take receive commercial real estate financing, and, if so, the details of the loan.
Profit splits/management responsibilities: The agreement should detail exactly how profits are to be allocated. In the most common joint ventures, the operating partner is typically allocated a larger share of the profits due to their additional management responsibilities. Many joint ventures compensate operational members based on a waterfall/promote structure, in which members will receive a proportionally larger share of the profits (referred to as a promote) as the project exceeds defined profitability hurdles.
Ownership rights: The agreement must also address how ownership of the property is to be handled after the primary investment period is over. For instance, some agreements include language that allows the capital partner the right to buy the operating partner’s ownership stake in the property after a certain period of time.
Exit strategies: Partners in a joint venture must come to an agreement regarding the terms of exit. The JV agreement should detail the estimated timeline for exiting the project — including how it will be done, and under which circumstances a member is allowed to exit the agreement early.
Contingencies: How emergencies are to be handled is a critical part of the joint venture agreement. “Acts of God” or Natural disasters, lawsuits, and other unplanned events can easily derail a real estate investment or development project — so having certain contingency structures in place helps to reduce risk and prevent heavy losses.
Operating Member Fees: In addition to receiving a share of the profits through a promote, some agreements reward the operating member of a joint venture for their work via certain fees. The exact nature of these fees must also be detailed in the joint venture agreement.
Related Questions
What is a joint venture in commercial real estate?
A joint venture in commercial real estate is a partnership between two or more parties, typically one with commercial real estate expertise and the other with capital. The parties will agree upon and sign a joint venture agreement, which will detail the plans and goals of the joint venture, how much each party will contribute, profit splits/management responsibilities, long-term ownership rights, exit strategies, and contingencies.
For more information, please see Joint Ventures in Commercial Real Estate.
What are the advantages of a joint venture in commercial real estate?
The advantages of a joint venture in commercial real estate include the ability to pool resources, share risks, and leverage the expertise of multiple parties. By combining the capital of one party with the expertise of another, joint ventures can often develop larger projects than either party could do on their own. Additionally, joint ventures can help reduce the risk of a project by spreading it out among multiple parties. Finally, joint ventures can also help to reduce the cost of a project, as the parties can often negotiate better terms with lenders and other vendors due to their combined resources.
For more information, please see the following sources:
What are the risks associated with a joint venture in commercial real estate?
Joint ventures in commercial real estate can be rewarding, but they also come with risks. Without proper planning, a joint venture can easily be a sand-trap, in which one (or both) parties can lose valuable investment capital and even expose themselves to serious liability. Some of the risks associated with joint ventures include:
- Choosing the wrong partner can sink a joint venture, while choosing the right one can help it skyrocket to success.
- Misunderstandings can occur if responsibilities are not delegated carefully.
- Conflicts of interest can arise if the operational member of a joint venture is also a property manager or a general contractor.
For more information, please see this article.
What are the legal requirements for a joint venture in commercial real estate?
The legal requirements for a joint venture in commercial real estate depend on the structure of the joint venture. Generally, the partners will need to agree upon and sign a joint venture agreement. This document will generally state:
- The plans and goals of the joint venture: This part of the agreement should detail the property that the JV plans to develop/acquire, and how will they do it.
- How much each party will contribute to the venture: In most cases, a capital partner or partner(s) will contribute the majority of the capital to a project, while the operational partner will contribute a smaller stake. However, in some cases, the operational partner will not contribute anything, while the capital partner contributes 100% of the required capital. In addition, the joint venture agreement should clearly state if the venture plans to take out a commercial real estate loan, and, if so, for how much.
- Profit splits/management responsibilities: The agreement should detail exactly how profits are split. In many situations, the operating partner will take in a larger share of the profits due to their additional management responsibilities. They will often be compensated in the form of a waterfall/promote structure, in which they will receive a proportionally larger share of the profits (called a promote) should the project exceed certain profitability hurdles. In addition, the operational partner will typically be awarded certain fees.
- Long-term ownership rights: The agreement should also detail who will be able to own the property after the primary investment period is over. For instance, if the operating partner has a significant ownership stake, the capital partner may have the right to buy his stake after a certain period.
- Exit strategies: The exit strategy should detail the estimated timeline for the project exit, how it will be done, and under which circumstances a party can exit the agreement early.
- Contingencies and how various emergencies will be handled: Natural disasters, ‘acts of God’, lawsuits and other unforeseen events can easily derail a real estate investment or development project. However, having certain structures in place may be able to reduce risk and prevent a bad situation from getting worse.
A joint venture can be structured in several different ways, with a limited liability company (LLC) being the most common. Other options include partnerships, corporations, and other structures. However, it’s important to choose the right structure for a project’s individual needs, as the structure can have a big impact on the rights and responsibilities of (and the power dynamics between) members. For instance, an LLC puts the operating member and the capital member on relatively equal footing. In contrast, a limited partnership or LP (with the capital member being a limited partner) significantly reduces the capital partner’s control over the venture, though they would carry very little liability were the project to fail.
What are the tax implications of a joint venture in commercial real estate?
The tax implications of a joint venture in commercial real estate depend on the individual project. Generally, the operating member (the one with commercial real estate experience) is often an experienced developer or property manager, who takes the lead on the management side of the project. The capital member, who provides the money, generally takes a more passive role, but their level of activity can vary depending on the individual project.
The wages you pay to employees or independent contractors will be tax deductible on Schedule E of the tax return. If you pay independent contractors more than $600 in a single calendar year, you will have to send and file 1099s for them, since you qualify as a professional commercial real estate investor. Additionally, any professional fees you incur, such as legal fees, property management fees, and accounting fees, can be deducted.
For more information, please see Federal Tax Implications for Commercial Real Estate in 2022 and Joint Ventures in Commercial Real Estate.
How can I find a partner for a joint venture in commercial real estate?
Finding a partner for a joint venture in commercial real estate can be done through networking, online resources, and other methods. Networking is a great way to find potential partners, as you can meet people in the industry and build relationships with them. You can also use online resources such as real estate forums, websites, and social media to find potential partners. Additionally, you can use services such as commercial real estate brokers, investment banks, and venture capital firms to help you find a partner.
It is important to remember that when entering into a joint venture, it is important to have a joint venture agreement in place. This agreement should detail the plans and goals of the joint venture, how much each party will contribute to the venture, profit splits/management responsibilities, long-term ownership rights, exit strategies, and contingencies and how various emergencies will be handled.