It might be intimidating to invest in commercial real estate. The entrance obstacles can seem insurmountable because of the financing needed, the industry-specific lingo, and the sheer magnitude. Fortunately, joint ventures let you share resources like money, time, and expertise to participate in business initiatives. As a result, we’ll utilize this page to describe a real estate joint venture.
We’ll discuss the following subjects in further detail:
- Definition of a joint venture
- Benefits of Joint Ventures
- Potential negatives
- Creating a Joint Venture for Real Estate
- Final Reflections
Definition of a joint venture
Overview
A corporation can only provide so many resources, which are needed for many business opportunities. Partnerships provide a solution. A joint venture allows two or more businesses to pool their resources to collaborate on a single project.
Take the case of a well-known manufacturing company that wants to enter a foreign market but is unable to do so since it has access to a local distribution network. Despite having a robust distribution network, a logistics company seeks to expand its clientele in this new market. The two companies could collaborate to form a new company that is separate from the original firms. In this configuration, the two businesses work together as a joint venture to create and sell goods in this new market. While the logistics firm would help with local distribution, the manufacturing company would provide production expertise and plant management.
The two parties would probably both give an accepted sum of capital, subject to the operating agreement of the joint venture. Similar to that, this agreement would specify how the joint venture’s revenues and losses would be divided.
It’s crucial to keep in mind that joint ventures are not formally categorized as a sort of tax by the IRS. As an alternative, businesses engaging in joint ventures frequently create distinct legal corporations (e.g. corporation or LLC). This separate entity would subsequently be subject to taxation in accordance with IRS laws. Partnerships or corporations are frequently used to tax joint projects.
Real Estate Partnerships
Similar to the manufacturing/distribution scenario from above, a real estate joint venture functions similarly. Single enterprises lack the resources or experience necessary to carry out a deal on their own, particularly with really big real estate deals. Instead, a joint venture is created by two or more businesses to pool resources and expertise to pursue a single contract.
Let’s take the case of Lifestyle at Midtown, a new mixed-use neighborhood that is being planned by a real estate development company. But the developer discovers that it doesn’t have the required finances as it is funding the deal. Instead of taking on too much debt, the developer contacts a building company and a private equity organization and proposes a joint venture.
The agreement among the three parties to create a joint venture, Lifestyle at Midtown, LLC. The construction company supplies its services at cost, the developer plans and manages the project, and the private equity group provides the required funding. The joint enterprise is owned equally by all three parties, who also participate in its revenues and losses.
All three of these organizations would continue operating as separate companies inside the joint venture. In other words, they are not combining operations. Instead, they are combining their efforts in support of a single project that will be carried out under the direction of a joint venture called Lifestyle at Midtown, LLC.
Benefits of Joint Ventures
Pool Money
A real estate joint venture’s main benefit is its capacity to pool funds. Costs for significant business transactions can range from tens to hundreds of millions of dollars. The majority of ordinary investors will find it difficult to get the funds necessary for these kinds of projects. However, with a joint venture, several businesses can combine their resources to satisfy the funding needs of a certain contract.
Utilize the Expertise of Others
Joint ventures provide you the chance to benefit from someone else’s experience in addition to pooling funds. There aren’t many companies that are experts in every facet of a deal in commercial real estate. A developer can join forces in a joint venture with design studios, private equity firms, building businesses, etc. to benefit from each other’s expertise and experience in the pursuit of a single project.
Cut Back on Time Commitments
The daily management of a project, whether it is in the construction or stabilized phases, is something that many developers and investors don’t want to deal with. A development business might organize a transaction while enabling a construction company to run the daily operations of the construction site by creating a joint venture. Similar to this, a real estate corporation with a property management division may form a joint venture to assume management of the stabilized property. By concentrating efforts where they may provide the greatest value, this method enables organizations to make the most use of their time.
Potential disadvantages
Reduced Deal Control
Joint ventures automatically give you less control over a transaction. You own complete control if you enter a transaction as the lone equity participant. However, when you create a joint venture, you give each new member of the business a percentage of your power.
Possibility of Conflict
A real estate joint venture that has an improperly written operating agreement may suffer serious dispute. Conflicts are likely to arise if each venture participant does not fully comprehend their respective rights and obligations. Therefore, a well-written operating agreement is a need in every joint venture — it is always preferable to address possible points of contention before closing a contract than after.
Lower Returns
Your pro rata returns are decreased when you create a joint venture. In other words, since you won’t provide all of the cash for a business, you won’t obtain the entire return on equity. However, by combining resources, a joint venture may also provide you access to far bigger transactions than you would be able to close on your own. In this way, you risk losing a pro rata portion of a deal but gain larger overall profits because of deal size and economies of scale.
Creating a Joint Venture for Real Estate
Step 1: Find a Partner and/or a Deal
This initial action might take place in any order in a joint venture in real estate. Multiple parties may choose to form a joint venture in certain circumstances before looking for a transaction (for example, a developer and a construction business). As an alternative, one party may discover a bargain and then approach other organizations to create a joint venture.
Step 2: Verify Your Operating Agreement and Legal Structure
After choosing to establish a joint venture in principle, the parties must come to an operating agreement and legal structure. Although most joint ventures operate as corporations or limited liability firms, as was previously stated, there are alternative options. The operational agreement then serves as the legal document outlining the joint venture’s operational procedures. Without limiting the list, the following are some of the most important elements of any operating agreement:
- Individuals involved in the joint venture (basic info and equity percentages)
- Organizational framework
- Members’ obligations
- Required capital contributions
- Distributing money
- Gains and losses are allocated
- Accounting procedures and obligations
- Broader aims of the joint venture
Step 3: Seal the Deal
The contract is finally finished, whatever it may be, by the joint venture. Some joint ventures in real estate intend to create a project from the ground up and then sell it right away. A property’s long-term management and holding might be the venture’s main objectives instead. The operational agreement must expressly state the ultimate transaction purpose, regardless of what it may be.
Final Thoughts
Joint ventures are only briefly discussed in this page’s material.
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