UNDERSTANDING JOINT VENTURES IN REAL ESTATE
A joint venture (JV) involves two or more businesses pooling their resources and expertise to achieve a particular goal.
The risks and rewards of the enterprise are also shared. Typically, a joint venture in real estate entails a partnership between a landowner and a developer.
Each party in a JV usually makes a substantial contribution to resources:
i) Raising capital which can be in the form of land or equity (cash)
ii) availing labor, and
iii) providing services, which may include project management, marketing, distribution, fund-raising, etc.
Thus the partnership is a symbiotic business alliance between partners where the complimentary resources are mutually shared and put to us. Key to note, the venture can be for one specific project only or a continuing business relationship. A joint venture may be structured as a corporation, limited liability company partnership or other legal structure depending on tax and tort liability.
The partnership requires an agreement to establish the contractual terms for business operation, usually known as a Joint Venture Agreement (JVA), which is signed by both the landowner and the developer. The JVA outlines the terms and conditions of the partnership and addresses issues such as capital obligations, management structure, rights and responsibilities of each party, profit-sharing mechanism and also outlines the decision-making procedures.
Below are the different types of joint ventures:
i) Partnerships – Partnerships are formed when parties come together and make a contribution towards funding the development and can take two forms:
- an unlimited liability partnership, where the partners incur unlimited liability for the debts of the development. LLPs are not subjected to corporation tax in their individual capacities as they are not considered taxable persons under the Income Tax Act. Instead, their income is taxed on the individual partners after the distribution of profits. However, unlimited liability obligates the owners to forgo their personal assets to cover the liabilities of the organization.
- a limited liability partnership – here the only parties taxed are the partners who are solely responsible for the payment of their own tax liabilities. This thus necessitates that the parties have separate accounts where each will be taxed according to their share of the partnership.
ii) Corporation – A corporation is owned by shareholders and has a corporate structure thus managed by the Board of Directors. The main disadvantage of this type of joint venture is that the corporations suffer double taxation as both the corporation’s profits and shareholder dividends are taxed separately.
iii) Limited Liability Company (LLC) – This type of joint venture is usually structured as a separate jointly owned entity and is owned by its members. The partners enjoy limited liability which means that the members of the company cannot be held personally liable for the company’s debts or liabilities. According to Kenyan law, an LLC is treated as a “pass-through” entity thus single taxation.
Real estate projects of any size can use joint ventures to enhance development. However, just like any other business structure, joint ventures have booth an upside and downside.
Some of the benefits of the structure include
- Increased capital base – In a real estate joint venture, partners contribute capital into the project in the form of land or cash. This is beneficial considering the capital intensive nature of real estate development.
- Shared risks and gains – A successful joint venture generates the expected high returns for both partners. The partnership also enables the spreading of economic and other market risks that would otherwise be borne by one party.
- Development expertise – The developer in a joint venture provides development expertise in terms of concept development, design, project management and oversees the project to completion. With the right partner, the landowner is relieved of the day-to-day hustle of supervising a project and is assured of professional workmanship;
- Access to market distribution channels – Partnering with a reputable real estate firm that understands the market ensures the real estate product reaches its suited, market and thus enhancing easier and faster exit either through renting or selling. The faster exit also facilitates reaping of the returns faster.
- Can provide partial liquidity for landowner without having to sell the entire land – Through the structure of a joint venture, the landowner can get some cash exit for their land to meet their liquidity needs and also maintain interest in the development.
- Outlining of the preferred return – Landowners should insist on either preferred or guaranteed minimum returns during the signing of the joint venture agreement. This ensures that in the event that the project does not materialize, they do not lose the value of their land. On the other hand, and similar to any other partnership, joint venture partnerships are not always smooth and the following are the main expected challenges
- Double Taxation – In the case where the joint ventures have not been listed as a limited liability partnership, it may attract double taxation where both the partnership gets taxed as well as each of the partner’s profits. Therefore, investors interested in joint ventures ought to consult and know the pros and cons of different partnership structures before committing.
- Conflicts – Joint Ventures are prone to conflicts that could threaten the success of a project, and these arise due to unmet expectations or if any one of the parties fails to deliver on their end. Therefore, it is important to outline clearly how any manner of conflict will be resolved during the signing of the agreements, in addition to putting in place a proper management/governance structure that could include neutral parties that fail to deliver on their end. Therefore, it is important to outline clearly how any manner of conflict will be resolved during the signing of the agreements, in addition to putting in place a proper management/governance structure that could include neutral parties to help in decision-making during times of conflict.
- Slow Decision Making – With a joint venture structure, all parties must be involved in decision making. This could, therefore, slow down the process especially in the case where parties are in contention or are unavailable for meetings. Success in a real estate joint venture depends on thorough research and analysis of aims and objectives, and proper planning. It is a noble way to match capital needed or desired for a real estate acquisition or development by an operating party with a real estate capital provider. For the structure to achieve its objectives, the parties to a joint venture agreement should take great care at the beginning of the business transaction to carefully layout and draft operating agreements that clearly reflect the parties’ obligations and rights with a partner, joint ventures have been a time-honored vehicle to real estate success
Wacu Mbugua is a Real Estate Research Analyst at Cytonn Investments