A Guide to Joint Ventures in Property Development
16 min read
If you think investing in property is beyond your reach, then it might be time to think about joint ventures.
Picture yourself in this scenario… you’re now in your 50s and your kids are all grown up and left home.
You see them battling out there in the jungle and you wonder how they’re going to get ahead.
You lament to yourself:
How are they ever going to save the deposit for their first home?
You will understand how hard that is as it has taken you more than 30 years in the workforce to get to the financial position you’re now in.
That is, your house is paid off and you’re diligently making payments into your super fund, balancing that up with the cost of your new life (travelling overseas for the first time in your life) and a new car.
If your health and job hold out you should find yourself financially independent in 10 years’ time.
You often think you’d like to help your kids get ahead, but what can you do?
Perhaps you’re the adult child in this scenario.
The excitement of moving out of the home has been numbered now by the realities of life.
How am I going to save the deposit to get into my first property deal? – you ask.
After you pay the rent, car payments, and private health fund contributions there’s precious little left.
Mum and Dad have often said that they’d love to give you a “leg up” if they could, but, how can they?
Well, have any of you ever thought about a joint venture?
As a parent, your maturity and assets/money (the great thing about having money is that it keeps you close to your children) together with their youth and energy are a great combination.
The way it usually works is that mum and dad put up the equity in their home as security for a loan which will fund the purchase and development (or renovation) of a property for a profit.
Mum and Dad provide the line of credit over their house along with their maturity and education, and the kids do all the work.
The profit is then split 50/50.
You all need to educate yourselves, however, about joint ventures and how they work.
If you, the parent, are anxious about this proposal, then look at it this way: who are you going to leave your assets to anyway?
Isn’t it better to give now with a warm hand rather than a cold hand, in circumstances where you can guide them?
So, let me help you get educated on joint ventures.
Are you an asset or cash flow rich, but without the time or the expertise to get into a real estate deal?
Or do you have a lot of building, real estate, or project management experience but are too cash-flow or asset-poor to venture into the real estate market?
Are you an asset or cash flow rich, but without the time or the expertise to get into a real estate deal?
Or do you have a lot of building, real estate, or project management experience but are too cash-flow or asset-poor to venture into the real estate market?
Ever thought about joining with someone who has the “other half of the equation” and using your combined skills, capital, expertise, and cash flow to make money from a real estate transaction?
Note: There is much upside to a joint venture between people of like minds with different skill sets or contributions.
The risk of “having a go” is also spread.
The breadth of your experience would widen too in a joint venture.
On your own, you might only be able to undertake a small duplex development at best, but in conjunction with others, a three-story walk-up or a small commercial or industrial strip development comprising ten shops/factories may now be possible.
How you will grow!
The world can be your oyster now.
There are downsides too (and you must document this arrangement in a joint Venture Agreement) but if well-structured and properly managed, these can be minimized.
The range of joint ventures is broad.
Tips: You can start at one end of the scale with a simple contractual arrangement between two people to buy a house, renovate it, and on-sell for a profit.
At the other end of the spectrum, the venture may be between a solicitor, architect, builder, town planner, and real estate agent who join their skills and expertise for the development of a project to build and run a shopping centre or even construct a high-rise unit building.
The salient features of a typical joint venture, whether small or grand, are similar.
Let’s look at the features of a humble joint for a small real estate development between one man who has capital assets and strong cash flow and a woman who is cash flow capital-poor, but has a lifetime of real estate, trading, and marketing experience.
Join these two together in a joint venture and, as I said earlier, the world is their oyster.
A typical joint venture agreement for property investment
One investor (let’s call them “the first investor”) is able to contribute substantial funds and cash flow towards a small project to purchase a house, renovate it, and then sell it for a profit.
The second investor will contribute their skills to acquire the right property, renovate it appropriately, manage that process and then effect a sale of the property for a profit.
HOW DOES IT WORK?
The second investor will identify property suitable for the project and obtain approval for its purchase from the first investor.
The first investor will fund the acquisition of the property (usually in their name only).
The second investor will offer suggestions and submit a proposal to the first investor for the renovation of the property and its eventual sale for a profit to be shared equally between the two (i.e. the overall scheme of things with a simple joint venture).
Let’s look more carefully at the specific contributions of each of the investors.
FIRST INVESTOR’S CONTRIBUTIONS
The first investor will acquire the property in their name and provide all of the funds necessary to do so together with funds necessary for its renovation or development including:
- The deposit and purchase price;
- All Funding costs;
- All legal fees and stamp duty, including any building and building reports, survey reports, town planning searches, and the costs of any other inquiries;
- Payment of all rates, taxes, and levies on the purchase of the property;
- All insurances for the property.
This contribution by the first investor will be typically called the “Initial Contribution”.
All other continuing costs (called the “Continuing Contribution) during the ownership, development, and sale of the property, including payment of interest and loan expenses, renovation works, and sale costs will typically be met by this first investor.
In short, all purchase costs and expenses, development costs, and sale costs are met by the first investor and are commonly called “Join Venture Expenses”.
THE SECOND INVESTOR’S CONTRIBUTION
The contribution of the second investor to the project will usually be as follows:
- Identification of an appropriate property to buy for the development project, including negotiating the terms of the purchase, arranging for the appointment of lawyers, and engagement of any others to carry out due diligence inquiries before the settlement of the purchase.
- Selection of builders required the preparation of plans, and obtaining approvals and quotes for renovation and development work.
- If requested by the first investor, assistance with sourcing appropriate finance to fund the development.
- Payment of all project expenses incurred in relation to the property’s development and sale.
Typically, there’ll be no charge by the second investor for providing their contribution to the project, as it’s understood that they are to be remunerated from their share of the net profits on the eventual sale of the property.
So, what if there’s some disagreement or dispute between the two investors about whether the property should be sold after it’s developed, and if so, at what price?
As this issue falls within the province of the contribution of the second investor, they will usually determine these issues after consultation with the first investor.
That is, the second investor will decide the matter, but in making such a determination, the Joint Venture Agreement between the parties will usually provide that the second investor must act reasonably and with a view to achieving a net profit for both parties.
THE NET PROFIT
When the property is sold, the sale proceeds are usually paid as follows:
- repayment to the first investor of their Initial Contribution;
- repayment to the first investor of their Continuing Contribution (i.e. investment project expenses); and
- sharing of the balance (i.e. any rental received from the property during its ownership and renovation equally between the parties as “net profits”).
TERM OF THE JOINT VENTURE
The typical term for a joint venture of the style outlined above is a maximum of 12 months unless the property is sourced, purchased, renovated, and sold earlier, in which case the term comes to an end on the settlement of the sale of the property, the repayment of the first investor’s contributions and division of the net profits between the parties.
The risk of joint venture partnership
Although it’s expected at the time of entry into the agreement that a profit will be made, the reality is that sometimes there’s a loss.
Note: Even though the property is purchased in the name of the first investor, the Joint Venture Agreement will provide that the losses are shared equally between the parties.
A common joint Venture Agreement will also provide that although the first investor owns the property, they grant to the second investor the right to lodge a caveat (a freeze on the title to the property) in order to protect the interests of the second investor.
If the property isn’t sold at the expiration of the year, The Joint Venture Agreement will usually provide that either party shall have the right to offer or sell their interest in the property to the other at a price nominated as being the anticipated net profit of the project, or if there’s some disagreement about this amount, at an amount set by an independent valuer.
Tips: Schedule regular meetings, even if there appears to be little to discuss.
This is especially important when there are more than two parties to the joint venture.
These meetings ensure that everyone is kept up to speed and communication channels are open.
Record in writing everything that’s discussed and agreed upon in the meeting and, as soon as possible after the meeting, circulate a copy of the minutes to all parties of that meeting.
If there’s some misunderstanding about an issue on the agenda as recorded in the minutes, it will very quickly be flushed out and can be dealt with sooner rather than later.
Confidentiality in joint ventures
This is particularly important in joint ventures with family members.
The relationship with your family is a precious one and the joint venture experience should foster this relationship, not undermine or destroy it.
Particular care needs to be taken with these types of joint ventures.
Tips: You must agree at the outset about how private the project is to be.
That is, are all parties free to share with all and sundry details of the development, or is it only to be made known to their professional advisers and lenders in the transaction?
I recently received a call from a distressed client.
She was at a party on a Saturday night before and was horrified when a friend revealed to her full details of a development my client was undertaking with a local builder.
My client was mortified when her friend disclosed what she thought until then was a private arrangement between her and the builder.
Her friend told her and everyone else in the group at the party full details of how much money they were borrowing, the estimated profit from the transaction, and other personal information which would have been protected by the Privacy Act if you had provided it to a real estate agent or lender.
What could have been a series of successful developments with this builder had now turned sour and had basically ended before it had even started?
9 questions to ask before entering a property joint venture
Let’s explore some of the issues potential joint venturers frequently encounter when they give their time, money or expertise to a property deal that involves other investors.
1. WHAT ARE INDUSTRY ACCEPTED STANDARDS?
There are no generally accepted industry standards or commercial terms that you should offer your potential joint venture partners.
Each joint venture is different, although there are some common elements.
What, for example then, should the active joint venturer in a project offer to the party injecting all of the cash but taking no active involvement?
If, for example, there are three partners and two of them are active and the other one is passive but providing all of the capital, would an equal profit share between the three be appropriate and reasonable?
Yes, it would in most circumstances, so that answers the most common question I’m asked.
2. WHAT SECURITY SHOULD BE OFFERED TO CASH CONTRIBUTORS?
The next frequently asked question I’m asked is what security should be provided to the party that provides all of the cash.
It would be appropriate, in my opinion, to offer them a first mortgage over the property, as they’ll no doubt be funding the acquisition of the site and start-up costs of obtaining development approvals etc.
Once construction starts, though, the lender to the project will require a first mortgage and the cash contributor will have to step back to a position of a second mortgage, which is also reasonable in the circumstances.
Your anxiety is that tell-tale sign that there’s a real chance this probably isn’t going to work out.
3. DO WE OFFER THE SILENT JOINT VENTURE PARTNER A POSITION AS A DIRECTOR ON THE MANAGEMENT BOARD?
This is a double-edged sword.
If an investor is to be a silent partner and things go wrong, then you should understand that they won’t be so silent.
Note: Holding a position on the board can mean they cause real grief for, say, the other two investors who are actively involved in managing the project.
The downside for the silent partner is that they’d carry exactly the same legal responsibilities being a silent director as they would if they were an active director and do they want the risk?
At the end of the day, most silent joint partners opt not to be directors as they’re happy to take a passive role and don’t want to assume the risk.
4. WHO SHOULD SIGN PERSONAL GUARANTEES TO THE LENDER FOR THE PROJECT?
Usually, the lender to the project will require all directors of the joint venture company managing the project, or which owns the land, to sign personal guarantees that they’ll repay the loan.
This, too, highlights another benefit of the silent partner not becoming a director – they won’t be required to provide personal guarantees.
Having the active partners assume liability as guarantors and the silent partner who injected the cash funds not doing so goes a long way towards evening up the risk assumed by all of the parties and is, I believe, a fair outcome.
Tips: It’s worth remembering, too, that once people establish a track record in undertaking joint ventures, they’re usually not as willing to offer silent partners injecting cash a mortgage, even a second mortgage, as security for their capital injection.
Instead, they’ll usually offer them, say, shares in a company or units in a unit trust without any mortgage security.
They’ll rely instead on their reputation of completing successful projects as your real “security” if you’re the party injecting the cash.
Once they get a number of complete projects under their belt, you’ll usually find that they’ll withdraw any offers for mortgage security on a ‘take it or leave it’ basis.
5. HOW DO WE VALUE THE CONTRIBUTION OF DIFFERENT PARTIES?
Do you give different percentages of profit, based on the skills of one party being more valuable to the joint venture than another?
For example, a builder is given a greater percentage of the profit for obvious reasons, whereas a lawyer, whose contribution might be perceived to be no more than the preparation of legal documentation, may be given a lesser share.
But is that fair?
Note: If each party’s skills are required to do the joint venture, for example, a town planner, lawyer, real estate agent or builder, then they should all have an equal share of the profit.
Allowances can be made for their greater time and input into the project, where they carry a greater share of the physical load in terms of hours worked.
They can be paid a project management fee or consultancy fee to compensate them for this greater input.
A builder, too, may also be allowed to charge a profit margin on his building contract, for example, cost plus 10 per cent, as well as receive his percentage of the profit.
This is a reasonable way of compensating him for his greater time input to the project.
6. HOW DO WE KEEP EVERYTHING TRANSPARENT?
I’m a firm believer that a successful joint venture must be based on a transparent and open-book process. That is, at any time any of the joint venture partners must have free access to the financial records and books of the venture.
There should also be no hidden expenses, for example varying the definition of ‘expenses’ of the project so that a management fee comes out first as an expense before the profits are split.
It should all be transparent and disclosed upfront to all parties so there are no surprises.
7. WHAT IF I STILL HAVE THAT NIGGLING DOUBT?
If after many meetings with your other joint venturers and thrashing out the terms of a preliminary agreement (more formally called Heads of Agreement) to allow you to move forward with the project you still have reservations about whether you want to do business with these people, then don’t!
Tips: You need to look at it as an opportunity that wouldn’t otherwise be there for you without your other joint venturers.
Likewise, if you’ve followed through after the Heads of Agreement and entered into a formal Joint Venture Agreement you find yourself regularly looking at the terms of the agreement to check what your rights are because you still have a certain level of anxiety, then you should not have undertaken this joint venture.
Your anxiety is that tell-tale sign that there’s a real chance this probably isn’t going to work out.
8. ‘BUT I PUT UP THE CASH SO I’M TAKING ALL OF THE RISK’
You sometimes hear this cry from silent joint partners when they’re the only ones who have contributed cash.
They can wrongly feel that they’re the only ones taking the risk.
This isn’t correct, especially if they aren’t a director of the joint venture company and won’t be required, therefore, to put up personal guarantees to the project’s lender.
If that’s you then you’re probably coming at the project with the wrong mindset.
Tips: You need to look at it as an opportunity that wouldn’t otherwise be there for you without your other joint venturers.
Remember there’s no such thing as a risk-free joint venture.
You’re now someone who’s “running with the ball”, so you will be tackled.
There is risk but if you’ve done your homework properly and have a proper joint venture agreement, then this will probably work out alright for you and be an enjoyable and profitable experience that you can build on to undertake other joint ventures with these same people.
9. HOW DO I SOURCE JOINT VENTURE PARTNERS?
Don’t advertise!
The joint venture parties should be known to you or known to associates, family or friends of yours so that you can check out their reputation with people known to you.
Note: Undertaking a joint venture with people who aren’t known to you or can’t be checked out by your circle of family, friends and business acquaintances really increases the risk of something going wrong and is a big negative on the checklist.
