How Does Joint Venture Real Estate Financing Work?
In the world of real estate and commercial property financing, there’s one style of acquiring capital that’s in a category of its own—joint venture real estate financing. So how exactly does this unique structure to acquiring capital work, and how can you apply it effectively to your own goals to boost your chances of success? Let’s find out.
How Does Joint Venture Real Estate Financing Work?
A real estate joint venture is structured to help with the financing and ongoing development of projects in the real estate market. In general, a joint venture between a developer and financier involves a business deal wherein the two parties (or more, depending on the situation) both agree to pool their resources in order to complete a real estate project or development.
Through a joint venture, the operator of the real estate property partners with a provider and expert in capital, combining their areas of expertise and resources in order to achieve a common goal—usually increased profit for both.
Oftentimes, a joint venture can look like this. A real estate developer wants to develop a certain area but lacks the capital to do so, so they go to a capital provider and make an agreement. Another common scenario is that a developer owns a piece of land outside their normal areas of operation, and they partner with someone who knows the local market on a deeper level so that they can leverage their expertise in a more lucrative development.
A real estate joint venture is not a normal capital agreement, in that it’s not so much a direct loan with interest as it is a partnership. Both parties agree to share in the profits, losses, and operating costs that result from the partnership.
Real Estate Joint Venture Structure
That said, the joint venture nearly always exists independently of the business interests of the two partners as a whole. Usually the joint venture is set up as its own LLC, with both parties signing and creating an entirely new entity. The agreement that makes the joint venture official will outline the terms and requirements of the venture, including contributions, distribution of profits, responsibilities as delegated between the members of the joint venture, and other parameters.
However, LLCs are not the only form that joint ventures take. They can take the form of partnerships, corporations, and other arrangements depending on the specific circumstances and the capital provider/developers involved. LLCs are the most common form because they allow for the limiting of liability in the event of anything going wrong over the course of the agreement. If you want to learn more about the specific advantages and disadvantages of types of joint venture, you should contact Clopton Capital directly for more info.
What partners look for in joint venture real estate deals.
Generally, many capital providers look for a distinct list of unique criteria when deciding whether to enter a joint partnership or not. These include:
- A record of success with other real estate development ventures
- Project sizes that will be worth the initial time and money investment, often larger than $10 million
- Enough cash on the real estate developer side of the deal to make the joint partnership equitable
- A level of expertise specific to the project, market, and location on the part of the real estate developer’s end of the partnership.
How joint venture lenders differ from traditional commercial property lenders
Joint ventures hold a few distinct advantages over traditional commercial property loans. First of all, having a capital provider invested in the project makes them more likely to leverage their expertise and ongoing support. The structure of a joint partnership, especially one set up as an LLC, allows for sharp limits on liability between the two parties in case the partnership is ultimately liquidated, as many of them are either at the conclusion of a project or beforehand.
Joint ventures carry other benefits as well, and if you’d like to learn more you can reach out to a commercial mortgage broker at Clopton Capital directly for more information.
Writing a real estate joint venture agreement
When it comes to putting together a real estate joint venture agreement, there are some key sections you’ll want to
discuss, nail down, and outline in clear terms within the agreement itself. This list is not designed to include everything you’ll want in your real estate joint venture agreement, only the most vital elements that tend to be generalized across most if not all joint venture agreements in real estate.
- Capital Contributions- You’ll want to specify exactly how much each partner is contributing to the partnership. Not only that, you’ll also want to make explicit exactly when certain amounts of funds are due to be contributed. For example, 50% might be due upon execution of the agreement and the rest due upon completion of the project.
- Profit Distribution- One of the most important considerations is how profits resulting from the joint venture will be distributed to the involved parties. This figure is often not entirely equal between parties. For example, if one party is much more actively involved with the day-to-day process of the real estate project, they may be entitled to a larger share of its profits.
- Management Outline- It’s not just financial contributions that have to be outlined and made explicit—you also want to make clear exactly who will be making ongoing decisions for the partnership’s interests. Will both parties have decision making power? Or will the capital provider be excluded from major decision making? These parameters must all be outlined within your real estate joint venture agreement.
- Exit Parameters- Make sure that you clearly detail how the joint venture will conclude when the project is complete, or if it’s not completed. Not only will this help avoid awkward complications, it can also help both parties save on expensive legal fees and other costs—particularly if the joint venture is dissolved before the project is completed. The more exist mechanisms are made as clear as possible, the less chance there is for ambiguity or disputes when the joint venture ends.
Reading a real estate joint venture term sheet
A joint venture term sheet is a non-binding legal document designed to outline the primary terms of the agreement before it. Becomes legally binding. This sheet will feature specific information designed to clarify the terms of the partnership. These include:
- Entity name, which simply describes what the joint venture will be legally called
- Type, which describes the type of venture being entered into by the two parties
- Size, which is the monetary amount of funds being directed into the joint venture
- Governance, which determines how decisions will be made and dictated within the venture
- Guidelines, which outline how investments should be handled
- Restrictions, which place limits on what is and is not permitted within the venture
- Other information about the structure, terms, length, and exist strategies of the joint venture
No two term sheets are the same, but it’s important to know that they’re an initial outline of terms rather than a legally binding document. The creation of a term sheet does not lock in any of the terms or make them official, and it does not make you a legal partner with your proposed partner in the real estate joint venture agreement.
Understanding real estate joint venture calculations
When it comes to deciding how or whether to enter a real estate joint venture partnership, there are some key questions you want to make sure you ask before moving forward. Asking these pointed questions will help to ensure that the partnership will be profitable for both parties moving forward—even if unexpected conditions arise.
- What will be the anticipated rate of return for the venture?
- Will profits be double-counted in calculations?
- Will the venture use “waterfall” distributions, meaning a method of splitting profits that follows an uneven distribution?
These are all factors that you and your potential capital partner should be considering at every step of the way.
Key metrics in joint venture development
Once you’ve entered into a joint venture partnership in real estate, how do you measure its success? There are some very key metrics you’ll want to track to determine how your partnership is going—and they all reflect distinct areas of success or failure. Here are some of the most important metrics
- Cash flow from joint venture earnings
- Total value of cash flows
- Contributions from parent company
- Direct value creation from joint venture
- Value of royalties and fees
Keep figures like these in mind to ensure that your venture is operating at a sustainable rate.
Mistakes to avoid when entering a joint venture real estate partnership
While joint venture partnerships can be extremely lucrative and successful opportunities for real estate developers in need of capital, they don’t come without their risks if handled correctly. Here are some key tips to avoid making costly mistakes in a joint venture partnership.
- Know the operational risks.
- Ensure that partnership duties are clearly defined and explicitly stated in legal documentation
- Get to know your partner before initiating the deal
- Treat partners with respect, honesty, and integrity
By keeping these key tips in mind, you’ll be able to enter into a rewarding, lucrative, and successful real estate joint venture partnership with a capital provider that will help you reach your real estate goals.