Strategies For Successful Joint Ventures
Strategies for a successful courtship and marriage in the real estate world.
Gary T. Saykaly and George A. Schmidt, Esq.

Over the past few years, sponsors (investors, operators, developers) have had no difficulty executing on acquisitions, new developments and redevelopments on their own. In fact, even less qualified sponsors with speculative projects were able to minimize capital investments through high leverage. As a result, many sponsors avoided diluting their ownership position via a joint venture structure and pursued financially engineered solutions to meet their capital needs. However, with the current credit market correction and its resulting impact on the real estate market (conservative underwriting, increased equity and balance sheet requirements, focus on experienced sponsors and sound projects) together with increased deal complexity, we expect to see an increase in the volume of joint ventures being completed in the market.

What Is A Joint Venture?

A joint venture is not a conventional partnership, but rather an agreement by two or more parties to carry out specified responsibilities and obligations to achieve certain objectives. It is a legal organization that takes the form of a short-term partnership in which the persons jointly undertake a transaction for mutual profit. Distinguishable from a partnership by narrowness of purpose and scope, joint ventures can be for a specific project or for a continuing business relationship. Typical reasons for the formation of joint ventures include:

Capital Partner — the most common joint venture structure is that in which a sponsor secures a money partner that puts up the entire cost of development or acquisition (debt and/or equity) and in return receives a preferred return and an ownership position. Structures range from 50/50 arrangements to those with cash flow/capital event sharing based on a pari passu structure with the developer receiving a promoted interest. Depending on the characteristics and risk/return profile of the asset, capital partners will range from institutional and offshore core focused investors to entities that can assume a higher degree of risk (REITs, hedge/opportunistic funds, other developers and private investment groups). While preferred equity investment structures can provide required equity on a more passive basis with less upside participation, a joint venture partner can accept more risk (guarantees/liabilities, leasing, pre-development, construction, etc.) in exchange for shared control and ownership.

Development Partner  —  two common uses are where: 1) a smaller developer (pursuing a larger project) brings in a larger developer to provide development expertise, tenant relationships, a required resume/balance sheet and/or capital, or 2) a property type focused developer brings in one or more outside developers to develop the alternative property types for a mixed- or multi-use project. Given the independent nature of most developers, a joint venture arrangement between two different property type developers poses its own set of challenges.

Land/Project Partners — to limit upfront project acquisition costs or high sale price expectations, a sponsor will enter into a joint venture with an existing land or building owner (redevelopment projects) where the project is contributed or sold to the joint venture at an economically viable basis in exchange for an ownership stake in the venture. This structure is sometimes the best option for sellers who cannot achieve their targeted pricing in the current market. The sponsor secures the required financing (with or without the contributing entities’ balance sheet) and develops/redevelops the project.

Credit Enhancement — situations where a JV partner puts up its financial strength and credit rating in the form of a standby commitment, loan guarantee or other form of credit enhancement and in return receives a share of cash flow and capital event proceeds.

Whatever the reason for a joint venture, there are a variety of factors to consider.

Joint Venture Partner Considerations

Joint ventures are complicated transactions that may take an inordinate amount of time to negotiate and complete. This is a key consideration when dealing with a time sensitive deal. Joint ventures are not appropriate for all sponsors and typically involve complex documentation and sharing of profits/ownership/control. In determining a joint venture strategy, the sponsor/developer should first analyze the following:

• Sponsor Self-Assessment — what is the primary need for a joint venture partner and what are the alternatives to a joint venture structure. In addition, what are the sponsor’s exact goals and objectives? The most important aspect of a joint venture is procuring a partner with similar goals and objectives.

• Project characteristics (deal size, location, asset type, investment strategy, etc.) and risk/return thresholds will determine what type of partner would be the most appropriate and most interested for the given opportunity.

• Risk/Return thresholds — investors each have different return thresholds based on the risk they are willing to take. Understanding the project’s risk/return profile will help narrow the search and help determine whether there is adequate profit potential for the sponsor and partner. With the increase in exit cap rates, the profit margins have compressed and the project might not be financially viable in the current market.

• Timing (initial reaction time and anticipated hold) — if the viability of a project depends on quick execution, a private market/entrepreneurial entity (as opposed to an institution) might be the best choice. In addition, a longer investment period might lessen potential interest.

• Control Requirements — What level of control is the sponsor willing to share? If it is unwilling to be share control and decision making, a joint venture arrangement might not be the best option.

• Contribution — What is the contribution to the joint venture (capital, unique expertise, relationships, services, financing, below market acquisition costs, etc.)? The JV partner will want to determine whether the sponsor’s staff is adequate and is sufficiently experienced. In addition, the partner will want to know that the developer has the financial strength to cover any cost overruns.

• Value-Add — To secure the best terms, a sponsor needs to gain as much leverage as possible prior to looking for a JV partner by reducing the project’s risk profile (e.g., completed entitlements, pre-leasing), thereby gaining more deal control, and bringing more to the table.

After analyzing the foregoing considerations, the sponsor is better prepared to secure the right partner and the best terms.

The Negotiating Process

There is no set structure for a joint venture and each is negotiated based on the specifics of the transaction. Obviously, sponsors improve their position by increasing deal control and reducing the perceived deal risk. Before negotiating an agreement, it is important to understand that both sides have opposing viewpoints and see their position as superior to and more valuable than the other’s.

To be successful, the parties must agree on a proper balancing of the risk and benefits for both sides. Each party should approach the JV with specific objectives, a focused negotiating strategy, and operating flexibility. In addition, they should each have an economic incentive for seeing that the project reaches a successful completion. One of the most overlooked areas of a joint venture is the fit of the relationship (see chart on opposite page) as it is a marriage of personalities and interests. Success depends on agreeing on the accountability for the various responsibilities (development/construction, operation, financial), establishing performance criteria and having an understanding of what procedures will be followed if unexpected problems arise. Negotiations typically start with the execution of a basic term sheet followed by a more detailed operating agreement covering the points shown in this chart.

Conclusion

Joint ventures pose numerous challenges and benefits to sponsors. Too often, an entrepreneur’s decision to enter into a joint venture arrangement and the procurement of a partner is an expedient rather than a strategic move – done without thorough analysis of the transaction. As mentioned above, joint ventures are complex to structure and anyone considering a joint venture should engage an outside advisor that can not only determine the optimal structure and “best fit” partners but also assist in negotiating the best terms and reviewing the after tax considerations of alternative structures and terms. While many joint ventures begin with a specific project, they can lead to more of a programmatic relationship.

George Schmidt, Esq. is the chief investment officer for Glimcher Realty Trust, a Columbus, Ohio-based real estate investment trust. Gary Saykaly is a managing partner of BridgePointe Advisors, an Atlanta-based firm providing investment banking solutions to the real estate industry.