Guide to Real Estate Joint Ventures between Landowner and Developer

Section 1: Understanding Joint Ventures in Real Estate Projects

What are joint ventures in the context of real estate projects?

• A joint Venture is an agreement by two or more parties to pool their resources to develop a real estate project
• The purpose of joint ventures is to share investments, risks, and losses
• Parties come with different assets which are contributed to the project- capital, assets, experience, credit potential
• A Joint Venture can be formed by any combination of landowners and developers- but they must have the resources required for the project
• It is not a partnership, as the business identities of individual partners are retained

Who can participate in a joint venture?

Scenario if the developer or landowner does the project individually-

Developer’s side-

The developer will need to purchase land, for which large capital will be required. At the initial stage of the project with no cash inflow, it is difficult to arrange such finances. In case any problems are encountered at this stage, the capital will be stuck, and it would affect the developer’s returns.

Landowner’s side–

While the landowner might already own land with immense real estate potential, he would still require the expertise and experience to develop the land. However, even if he decides to go ahead on his own, arrangement of the cost of construction, management, operation, etc. will still be needed. Additionally, any external borrowing will require interest payments. He might also not have the knowledge or skills to bring the project to success.

Instead, both parties can come together to contribute their respective assets and resources. However, in a scenario where the developer has capital for land purchase or if a landowner has the experience and access to some capital, they may even do the project themselves without forming the joint venture, with the benefit of keeping all profits to themselves.

In summary, a Joint Venture can be formed by two or more parties with the contribution of assets like experience and expertise in the real estate market, capital needed to start a project or good credit to access required capital from external sources or land to develop the project.

In most types of Joint Ventures, there will be two types of members, the operating member, who typically has expertise in real estate, and the capital member who would be financing the project.

What are the benefits of forming a joint venture?

• Allows leveraging of each party’s resources throughout the project cycle with greater efficiency
• Capital savings, with the possibility of reallocation of that capital elsewhere
• The efficiency with project delivery and customer service
• Possibility of entering a new market without a lot of capital investment
• Possibility of taking on more projects, with less capital requirement for each
• In the case of a market slowdown, less capital will be locked, and losses will be shared
• Retains individual business identities
• For smaller developers- redirection of capital investment to the other costs required for the project
• For large-scale developers- the tweaking of the process for efficiency, paring down of expenses, enhancing projects

What are the disadvantages of forming a joint venture?

• Sharing of decision-making power with the risk of conflicts
• While losses will be shared, so would the profits
• Responsibilities are divided amongst the partners, so if a partner fails to deliver, it can lead to delays and problems, with investments being stuck

Section 2: Negotiations in the Formation and Drafting of Joint Venture Agreements

Which are the aspects that need to be negotiated upon during the formation of joint ventures?

Each party will conduct its own financial analysis to make the deal beneficial to both parties after which negotiation will take place

Aspects that should be negotiated upon

• Terms and conditions of the agreement
• Deposit or advance to be paid by the developer
• Investment in the project by each of the partners
• External funding, if required and how it will be arranged
• Sharing the responsibility of management and operation of the project
• Shares of each member in the project
• Responsibilities in sharing of losses, if they occur
• Process for termination of the Joint Venture
• Ownership, Development, etc. rights of the project at different stages of the project

In some cases, penalty clauses may also be included and negotiated in the joint venture to safeguard the interest of the landowner

The parties need to prepare their financial analysis keeping in mind all these factors as well as the profit they are expecting out of the project. An accurate calculation and understanding of all aspects mentioned above will help the parties in arriving at a deal beneficial to both of them.

What should joint venture agreements contain?

• All aspects negotiated and agreed upon must be clearly written in the joint venture agreement
• Few aspects that the agreement may contain include – the objective of the agreement, contributions of all members, duties and responsibilities, rights of each member, sharing of revenue, profit or area, etc
• Unclear or incomplete drafting of the agreement is one of the reasons for the failure of joint ventures, it is crucial to have it drafted properly (Links for examples of Joint Venture Agreements can be attached here)

Section 3: Why do Joint Ventures tend to fail and the aspects to consider before entering into one

Why do joint ventures tend to fail?

• In the drafting phase, if the negotiations don’t come to a fruitful conclusion, the joint venture may not be formed at all In the operation phase, there can be non-adherence to agreement by the parties, disloyalty or non-disclosure by any of the parties
• Additional cash flow can also be required for the project which parties were not prepared for
• Due to some external contingency, there might be a need to reconsider certain clauses of the agreement

What are the aspects to look out for before entering a joint venture?

Aspects to be considered by the Developer

• Rights and legalities related to the land need to be clear and verified. It is important to note that there will be a difference in the case of purchased land and inherited land. The owner is likely to have all the rights in the case of purchased land, while in the case of inherited land, consent from relatives might be required
• Upcoming proposals and regulations surrounding the concerned land parcel should be verified by referring to development plans, local area plans and other records. This is necessary to avoid restrictions in construction and to be aware of the acquisition of land that may happen in the future
• Consideration of any deposit or advance that needs to be paid to the landowner, and if it is refundable or not

Aspects to be considered by the Landowner

• There may be delays due to the developer’s partial interest, and to safeguard against this, a deposit can be asked
• Understanding project phasing and financing is necessary to avoid ignorance in the scenario where the allocated finances are siphoned off elsewhere
• In profit sharing model, understanding the financial modeling done by the developer is important, to be aware of how profit will be calculated because there are a lot of grey areas related to the same
• In the area sharing model, typology and location of units to be allocated should be discussed beforehand, to avoid discrepancies at a later stage
• In the revenue sharing model, an escrow account can be set up to ensure that the finances due are paid transparently
• It is advisable to stay weary of situations where the developer is giving much more shares than expected, since if it is due to an upside in the market, the market situation may change over the project timeline
• All real estate projects are affected by ongoing economic conditions and there may be delays due to the same

Aspects to be considered by both parties

• It is advisable to verify the credibility and trustworthiness of the partners by checking their identities and looking up past projects and deals and capabilities. A landowner can verify the builder’s track record, goodwill, advance he is willing to pay, etc. A developer may check past deals of the landowner, the rights and legalities of the plot, etc.
• The parties must recheck if there are any additional taxes, fees or charges or legal clauses that may stall the project as it will result in locking of the capital at the beginning of the project itself
• It is noteworthy that in the area sharing model, the selling of units simultaneously by the developer and landowner may lead to competition between the two, which can be discussed beforehand to avoid any disputes later.