In this guide, our commercial property solicitors explain how joint ventures work in commercial property and the benefits of entering into such a property arrangement. We highlight some of the key due diligence checks to perform before committing to a joint venture, explore the various financing options available, and provide an overview of the structure and terms of joint venture agreements. We finish off by considering exit strategies, and what to do in the event of a dispute.
Contents:
- What is a joint venture in commercial property?
- How does a joint venture differ from other property arrangements?
- What are the key benefits of entering into a joint venture?
- What due diligence should be conducted before entering a joint venture agreement for commercial property?
- How is financing typically arranged in a joint venture for commercial property development?
- How do I set up a joint venture?
- Deciding how to structure the joint venture
- Key terms of the joint venture agreement:
- Can a joint venture agreement be modified during the course of a project, and how?
- Exit strategies in commercial property joint ventures?
- Can a joint venture be terminated prematurely, and what are the implications?
- How are disputes typically resolved in a joint venture for commercial property?
- Summary
What is a joint venture in commercial property?
A joint venture refers to a business arrangement where two or more parties collaborate to purchase, own, develop and/or manage a real estate project. This could involve the acquisition of land, development of buildings, management of existing commercial premises, and eventual sale of the properties. Joint ventures have been successfully utilised in a range of projects, such as the purchase and development of office buildings, retail centres, industrial facilities, hotels and leisure sites and more.
The idea is that each party contributes its capital, expertise, and any other valuable resources to the joint venture, and the profits and risks are shared in proportion to their investment. The terms of the joint venture, including decision-making, responsibilities and profit-sharing, are typically outlined in a legally binding, joint venture agreement.
How does a joint venture differ from other property arrangements?
Ownership Structure: joint ventures allow multiple unconnected parties to come together to own and control a commercial property project. The parties involved can retain their separate legal identities, while working together towards a common goal.
Limited Duration: joint ventures are typically formed for a specific purpose and limited duration, coming to an end once the project is complete and objectives achieved. In most cases, the parties agree on a planned exit strategy, providing the flexibility and freedom to move onto their next project. Other property arrangements may have a longer-term or indefinite duration.
Shared Risk and Reward: in a joint venture, the parties share both the risks and rewards. This means that if the venture is successful, the profits are shared among the parties according to their agreed-upon ownership interests. If the venture incurs losses or liabilities, these are also shared among the parties. In other property arrangements, the owner(s) bears the full risk and reward of the property.
Separate Legal Entity: joint ventures can be structured as a separate legal entity, such as a limited company. This provides a level of legal protection and allows the joint venture to enter into contracts, own property, and assume liabilities in its own name. Other property arrangements, such as sole ownership or partnerships, do not afford the same levels of protection.
What are the key benefits of entering into a joint venture?
Shared Resources and Expertise: Each party to a joint venture brings its own unique expertise, experiences and insights to the table, which in turn can lead to a more efficient, resourceful and ultimately successful real estate project.
Risk Sharing and Diversification: the financial and operational risks associated with larger, more complex real estate projects are shared among multiple parties in a joint venture. This in turn helps reduce individual exposure where high stakes are involved. There is also the opportunity to diversify your portfolio across multiple property types, market segments and locations.
Increased Access to Capital and Finances: joining forces with other investors often provides access to additional capital or lending options that may not have been available to individual investors. This can help fund larger scale and more lucrative projects.
Expanded Networks: collaborating and connecting with other investors, developers and industry stakeholders through joint ventures can expand your professional network, facilitating deal-making and business development.
Market Reach: joint ventures can provide access or entrance routes to new territories by partnering with local developers or landowners with the local knowledge to help you navigate unfamiliar markets.
Improved Profitability: by sharing costs and expenses, and reducing the financial burden on individual investors, this can lead to improved profitability for each party involved in the long run.
Shared Responsibilities: when working together as part of a joint venture, parties can share the workload and allocate responsibilities based on their strengths and expertise, leading to more efficient project management and decision-making.
What due diligence should be conducted before entering a joint venture agreement for commercial property?
Financial due diligence: It is sensible to assess the financial stability, standing and track record of your potential project partners before committing to a longterm business relationship. This typically involves identifying factors such as creditworthiness, liquidity, any outstanding litigation, debts or liabilities that may impact a party’s ability to perform its obligations and commitments in the future.
Partnership Alignment: the project is more likely to succeed if the parties involved are compatible, with shared goals, values and vision for the project. Identifying and ironing out any potential issues or conflicts of interest before getting started can mean a smoother project for all parties.
Legal and tax implications: it is essential to seek specialist advice and input to determine the ideal structure of the joint venture, ensure compliance with any tax liabilities triggered by the property arrangement, and ultimately protect your legal and commercial interests in the deal.
Feasibility: although joint ventures involve sharing the risks and rewards, it’s important to conduct individual feasibility analyses to ensure the opportunity is viable for you based on the proposed financial contributions, costs and profit-sharing arrangements and ultimate exit strategy.
Market research: even if you are tapping into the geographical expertise of local property partners, it is important to make your own assessment of the market dynamics and potential for return. This may involve a comprehensive analysis of local market conditions, trends and competition, the property’s accessibility, potential for growth and demand for similar properties in the area.
How is financing typically arranged in a joint venture for commercial property development?
Financing is typically arranged through a combination of equity and debt financing. Each party contributes a certain amount of equity capital, which can be in the form of cash, land, or other assets. In most cases, the equity capital determines the ownership share and the distribution of profits and losses.
Debt financing, such as bank loans or mezzanine financing, helps to leverage the equity investment and provides additional capital to fund the development project. The terms of the debt financing, including interest rates, repayment schedules, and collateral requirements, are negotiated amongst the joint venture parties and lenders.
How do I set up a joint venture?
The specific steps and timeframes from conception to completion can vary depending on the number of parties involved in the joint venture, complexity and scale of the proposed commercial property project.
Arranging the joint venture typically involves the following steps:
- Identifying Parties: the first step is to identify potential parties who are interested in forming a joint venture for a commercial property project. This may involve networking, research, or reaching out to potential partners who have complementary skills, resources, or expertise.
- Preliminary Discussions: once potential parties are identified, preliminary discussions take place to gauge their interest and ensure that there is alignment in terms of objectives, goals, and expectations for the joint venture. This may involve sharing information about the commercial property project, discussing potential contributions, and exploring compatibility between the parties.
- Due Diligence: before moving forward with the deal, it is important for all parties to conduct background checks on each other to have a clear understanding of the risks, opportunities, and potential challenges involved.
- Negotiating Terms: once there is a mutual interest in moving forward, the parties enter into negotiations to determine the terms of the joint venture agreement. This involves discussing and agreeing upon various aspects, such as ownership structure, equity contributions, decision-making processes, management and operation, funding arrangements, dispute resolution mechanisms, and the duration of the joint venture.
- Drafting the Agreement: based on the negotiated terms, a joint venture agreement is drafted outlining the rights, responsibilities, and obligations of each party in the joint venture. It is crucial to involve legal professionals experienced in commercial property joint ventures to ensure that the agreement accurately reflects the intentions and protects the interests of all parties involved.
- Execution and Completion: after the agreement is approved, it is signed by all parties involved, making it legally binding. The completion of the joint venture agreement may also involve additional administrative tasks, such as registering the joint venture entity or obtaining any board approvals etc.
- Land and Property Acquisition: once the joint venture parties have the protection of a legally binding agreement in place, legal advisors can focus on the due diligence and legal paperwork relating to the purchase/acquisition of the commercial property or land development itself.
Deciding how to structure the joint venture
The two main structures to decide between when entering into a joint venture are:
Special-Purpose Vehicle (SPV): here, the parties specifically set up a limited company, which then owns and operates the commercial property development. The joint venture investors/partners become the shareholders of that company, agreeing ownership, voting rights, financial contributions etc.
As with any other limited company, the key benefit of the SPV structure is that it offers liability protection as a separate legal entity. The downside is that the administrative costs and burdens may outweigh the benefits especially with smaller-scale, quick turnaround projects.
Contractual: the other option is to simply agree all the terms in a fully loaded joint venture agreement. The contract itself specifies and outlines the levels of control, profit distribution and risk-sharing. These can be customised in various ways to meet the specific needs and goals of the parties involved:
Equity joint ventures - each party contributes equity capital to the project in exchange for ownership interest. The parties share the profits and losses based on their ownership percentage.
Development agreements – this is common in new construction projects where one party who owns the land (landowner), joins forces with other parties who have the expertise and resources to develop it (usually developers and investors).
Profit-sharing structures: parties agree to share the profits from the development based on a predetermined formula or arrangement.
Key terms of the joint venture agreement:
Purpose and Scope: the agreement usually starts off by clearly outlining the purpose of the joint venture, including the specific goals, objectives, and scope of the collaboration. This helps in setting expectations and defining the responsibilities of each party.
Ownership and Management: the agreement will specify the ownership structure of the joint venture, including the percentage of ownership held by each party, together with the agreed position relating to its management structure, decision-making processes, and applicable governance.
Contributions and Responsibilities: next, the agreement details the contributions and responsibilities of each party, including financial contributions, assets, resources, intellectual property rights, and other obligations.
Profit Sharing and Liabilities: with the ultimate aim being to make a return on investment, of utmost importance to the joint venture parties is how profits and losses will be shared among those involved.
Term and Termination: the duration of the joint venture, including termination provisions, conditions for dissolution and exit strategies should be considered and set out in detail.
Confidentiality and Non-compete: clauses relating to confidentiality, non-disclosure of proprietary information, and non-compete agreements to protect the interests of the parties involved must not be overlooked.
Dispute Resolution: the agreement should carefully outline the mechanisms and processes for resolving any disputes that arise during its course to help parties navigate and overcome disagreements relating to the project.
Can a joint venture agreement be modified during the course of a project, and how?
In most cases, a joint venture agreement can be modified while the project is live if all parties involved agree to and signify the proposed changes. Modifications to the agreement can be made through drafting and executing a formal document in the form of an amendment, addendum or supplemental agreement that outlines the agreed-upon changes to the original contract. This may include specifying additional terms or making modifications to existing terms. All parties must sign the document for it to be valid.
It is important to note that any modifications to a joint venture agreement should be made in accordance with the terms outlined in the original contract. It is essential to consult with experienced legal advisors to understand the potential impact of any modifications on your particular rights, obligations, and financial interests under the joint venture agreement, and to ensure that any changes made are properly executed and legally binding.
Exit strategies in commercial property joint ventures?
Sale of the Property: One of the most straightforward exit strategies to realise your investment is to sell the completed property development. The joint venture may be structured to sell the property when certain conditions are met, such as achieving a specific return on investment or after a certain period of time. In some cases, partners may wish to hold onto and let out the property to generate rental income, then sell after it has appreciated in value to a certain level. The proceeds from the sale are then distributed among the partners according to their ownership interests.
Buyout or Sale to a Third Party: Instead of selling the entire property, one party may choose to buy out the other partner(s) or sell their stake to a third party. This can occur when one party wants to exit the joint venture while the others wish to continue.
Refinancing: If the property has appreciated in value and the joint venture has sufficient equity, the partners may choose to refinance the property. This involves securing a new loan to pay off the existing debt and potentially providing cash-out to the partners. Refinancing can provide liquidity for the partners without having to sell the property.
Partition or Division of the Property: This involves physically dividing the property or assigning specific portions to each partner. This strategy is more common when the property consists of multiple units or parcels.
Can a joint venture be terminated prematurely, and what are the implications?
In short, the answer is yes, and the implications very much depend on the circumstances leading up to the termination. There may be several reasons for a joint venture to come to an end earlier, both contentious and non-contentious. There may be legal and or financial implications in the event of premature termination, as well as practical considerations. The first place to turn to is the terms of the agreement itself, which should include detailed termination provisions and procedures. Some examples of reasons and their implications include:
By Mutual Agreement: If all parties involved mutually agree to terminate the joint venture, they can do so by following the termination procedures outlined in the agreement. This would typically involve winding down the project and dividing any remaining assets or liabilities between the parties to include settling any outstanding financial obligations.
Breach of Contract: If one or more parties fail to fulfil their obligations or if there is a breach of the joint venture agreement, the non-breaching party usually has the right to terminate the joint venture and seek compensation in the form of damages.
Force Majeure: External factors may stifle the continuity of the project. Depending on the nature and extent of the impact, as well as any insurance in place, it may be the case that the parties must simply accept their losses (including initial capital contributions, time and resources).
Insolvency: If one or more parties become insolvent or bankrupt, this may trigger a termination clause resulting in the winding down of the joint venture, assets liquidated, and liabilities settled. The remaining parties should seek legal advice regarding rights or claims to recover their losses.
How are disputes typically resolved in a joint venture for commercial property?
Dispute resolution mechanisms are crucial in joint ventures to address any conflicts or disagreements that may arise during the course of the project. These mechanisms are designed to provide a structured and impartial process for resolving conflicts and can help avoid costly and time-consuming litigation. Depending on the terms of the joint venture agreement and the preferences of the parties involved, common methods include:
Negotiation: The parties may first attempt to resolve the dispute through direct negotiation. This involves discussing the issues and attempting to reach a mutually acceptable solution without the need for formal intervention. Negotiation allows the parties to maintain control over the outcome and can be more cost-effective and time-efficient compared to other methods.
Mediation: Mediation involves the use of a neutral third party, the mediator, who facilitates discussions between the parties and helps them find a mutually acceptable solution. The mediator does not make a decision but assists in the negotiation process.
Arbitration: If the joint venture agreement includes an arbitration clause, the parties may be required to submit their dispute to arbitration. Arbitration is a private and binding process where a neutral third party, the arbitrator, reviews the evidence and arguments presented by the parties and issues a decision. The decision is usually final and enforceable.
Litigation: Starting formal court proceedings in the event of a dispute should ideally of last resort. Litigation can be a lengthy and costly process, but it may be the only option if alternative forms of dispute resolution have been unsuccessful or exhausted. .
Summary
Joint ventures in commercial property offer a collaborative and flexible approach to property development and ownership, allowing parties to leverage each other's strengths and resources for mutual benefit. Thorough due diligence should be conducted before entering into a joint venture agreement to assess the viability and compatibility of the venture. Financing arrangements, structuring the joint venture and agreeing key terms, are all crucial aspects of the deal that necessitate expert input.
