Joint ventures in real estate development are strategic partnerships where parties come together with the purpose of developing a particular project and share in the risks and rewards. Joint ventures often bring together parties with complimenting strengths and expertise. A developer may bring the property, understand the local market and have connections with consultants and subcontractors to complete the project while an investor may bring the majority of the capital to fund the project.
As attorneys experienced in commercial real estate, we prepare joint venture agreements to protect the investment of real estate investors and developers.
Joint ventures are often structured by forming a limited liability company (LLC). A well-drafted joint venture operating agreement prepared by an experienced commercial real estate attorney will define the parties’ roles, rights, responsibilities, contributions, and allocation of profits and losses. Key terms to address in a joint venture operating agreement include:
Contributions
The operating agreement should define the project, include the contributions provided by each partner, whether undeveloped land, services or cash contributions. The agreement should include a schedule of the value of all non-cash contributions, such as land and intellectual property. The agreement should also include provisions on whether the parties are required to provide additional capital contributions in the future and the consequences of a partner’s failure to provide the additional contribution. A partner who fails to make a required contribution can be considered to be in default. Contributions by other members to cover the defaulting member’s contribution can be treated as a loan to the defaulting member. A real estate development attorney will carefully prepare the terms relating to the parties’ contribution obligations.
Governance and Management
The operating agreement should outline the various roles of all of the partners. It is important to identify which partner will be in charge of permitting and construction and which partner will manage all operations and administrative duties. An LLC may be member-managed or manager-managed. The agreement should define the management structure and appoint a project manager and development or construction manager. The operating agreement should address which partner is responsible for obtaining all zoning approvals, entitlements, permitting (including a site plan) and all other governmental approvals for the project and who will provide the funds needed to obtain the approvals.
Financing
The agreement should address details of the anticipated financing of the project, whether construction loans, private money loans and/or equity contributions, and which partners will personally guarantee the loans. It is important that a commercial real estate attorney include these provisions to avoid disputes later on if the project requires additional capital to be completed.
Development Process
A description of the project and the development timeline should be included in an operating agreement. The parties should provide for a process for approval of the budget, change orders, cost overruns and changes in the schedule of work. Authority of the construction or development manager in approving such items should be clear.
Ownership and Voting Percentages
The voting percentages of the partners in a joint venture LLC will be tied to the ownership percentages. Major decisions such as financing or sale of the project, or changes in the Site Plan may require unanimous or majority approval of the members.
Profit and Loss Allocation
The agreement should address allocation of profits and losses of the project between the partners, the timing of distributions to the partners according to their ownership percentages (whether quarterly, annually or after meeting certain milestones) and whether there are preferred returns of cash flow or profits to certain partners. The managing partners may choose to issue distributions to all partners to cover the partners’ tax liabilities even if no profit distributions are made. An experienced commercial real estate attorney specializing in real estate development will prepare profit and loss allocations taking into account any preferred returns on profits.
Transfers and Exit Strategies
Joint venture agreements can contain certain restrictions on partners transferring ownership interests. These restrictions include:
- Right of First Refusal (ROFR) by the joint venture and by the other partners
- Buyout of a partner by other partners in the event of a divorce, bankruptcy or other legal event
- Drag-along or Tag-along Rights
Exit strategies such as the sale of the project or dissolution of the LLC upon the sale of the property or mutual agreement of the members should also be addressed. Upon dissolution, there will be a liquidation process and distribution of proceeds which determines the order and percentages of each member’s cash distributions after payment of the company’s debts and liabilities.
Final Thoughts
Entering into a joint venture to develop real property can yield high returns but only if done strategically with the right business partners and the right legal guidance.
Contact Lotus Law today to schedule a consultation with a knowledgeable commercial real estate attorney.