Looking for joint venture equity can be a really hard thing. However, that’s actually a good thing. After all, if it’s really easy, then everyone would be able to raise their own capital and start their own business. In the realm of commercial real estate, this can make the competition a lot fiercer and ferocious.
However, in the event that you managed to find joint venture equity, there lies yet another question: how can you use it for funding a commercial real estate project?
That’s exactly what we’re going to talk about in this article. But first, let’s have a look at how joint ventures work when it comes to commercial real estate.
Structure of a Real Estate Joint Venture
Real estate joint ventures are often made of two parties: the capital member and the operating member. The capital member is basically the one who finances a huge part of the project, though in some cases, even the whole project. On the other hand, the operating member is responsible for managing the project as well as the daily operations.
In a venture, each of the members will be liable for any profits and losses related to commercial real estate. Often, both members will set up the project as an independent LLC (limited liability company), though various setups can also be used, such as partnerships, corporations, etc.
How to Use a Joint Venture Equity
Now that you’ve learned about how a real estate joint venture works, let’s now talk about how you can use it for a commercial real estate development project. Basically, here are the essential steps you should follow:
1. Conduct Due Diligence on Your Potential Joint Venture Partner
Due to how complex it is to manage a commercial real estate project, you have to make sure that you come into an agreement with your potential joint partner and discuss the responsibilities and liabilities that come along with it.
However, before you even form an agreement with another party, it’s best to conduct due diligence first and think through the contingencies and eventualities that are related to it. In the event that your potential partner doesn’t have a pre-existing business relationship with you, conducting due diligence is important to make sure that you can ascertain whether he’s capable of doing his obligations to the joint venture.
Parties involved should also talk about their expectations before entering into any agreement, such as the allocation of profits and losses, decision-making, responsibilities, and more.
2. Determine the Role of Each Partner
You have to keep in mind that each partner that’s part of a joint venture has his own important role. In most cases, however, it often involves a sweat equity partner and a dollar equity partner. The sweat equity partner is basically the one responsible for coordinating the project’s management development. Meanwhile, the dollar equity partner is the one to provide capital contribution amounts, basically, the one primarily handling the financial return of the project. The sweat equity partner also focuses on generating financial returns while ensuring access to the capital by the dollar equity partner.
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3. Create a Term Sheet
Most real estate partners tend to come to an agreement with a handshake. However, it’s highly recommended to first come up with a term sheet that outlines the main terms involved in the joint venture deal. The choice of whether the term sheet is binding or not will depend on the parties involved.
However, what matters is to identify any sticking points early in to avoid losing resources in the event that parties can’t come to an agreement. Ideally, the term sheet should involve the following:
- Third-party lending and financing options
- Capital contributions
- Identity of the project
- Dispute resolution
- Other aspects of the deal
4. Determine the Structure of the Joint Venture Entity
Once both parties have come to an agreement, they should then start creating the joint venture entity. Even though it’s not really required by law, it’s still highly recommended to create a separate legal entity in order to reduce any possible complications as well as isolate any potential liabilities.
During this step, potential partners should determine the type of entity they’re going to create. LLC (limited liability companies) are often the most preferred choice since they’re quite easy to create, are fairly flexible, and have limited liability for the members.
However, do keep in mind that there’s really no optimal type of entity for all commercial real estate joint ventures. Also, depending on where the project is going to be developed, you will have to deal with a number of taxes that require the use of a general partnership or any other form of business entity. Therefore, it’s recommended to discuss with a tax attorney before creating a business entity to make sure you can pick the best type of entity depending on the current situation.
After determining the type of business entity, next is to determine where it will be created. Instead of just choosing the state where most partners are located, parties should consider choosing the location of the project as well as the requirements that a lender might have.
With this, it will be a lot easier, even cost-effective, to organize within that state instead of coming up with a merger or a property transfer before a loan agreement.
Joint ventures, especially when it comes to a commercial real estate project, can be a really good means of combining the strengths of an equity source and a real estate developer. However, its failure or success will depend on the proper preparation of the agreement, which will determine the relationships of all parties.
Nowadays, funding a commercial real estate project in a joint venture is made a lot quicker and easier. This is mostly thanks to the presence of financial intermediaries, such as Clopton Capital, that will help not just in arranging joint venture equity but also in financing them.