3 Major Types of Real Estate Joint Ventures | Difference Explained

Understanding different types of real estate joint ventures between builders & landowners and the current trend of percentage shares

How does this article help you?

• How many shares do the landowners and builders get in different types of real estate joint ventures?
• What aspects can landowners and builders consider before entering joint ventures?

Different Types of Joint Ventures

Which are the different types of joint ventures?

Overall, there can be multiple types of agreements that can be formed for a real estate project, including joint development agreements, joint venture agreements, development management agreements, or even outright sale and development of the project individually.

As the scope of this article is limited to the joint venture between a developer and a landowner, the different types of models include revenue sharing, area sharing and profit sharing. In all these cases, the asset contributed by the landowner as the land for the project and the responsibility of the developer to bring in equity as well as the construction, management and sale of the project remains the same.

The basic difference between these is the manner in which the landowner would be reimbursed for contributing his land for the project. These typologies are explained in detail below –

1. Revenue Sharing Model

• In the Revenue Sharing Model, the landowner is reimbursed for the land through a share of the revenue earned by the project. The revenue will come in at different stages of the project and will be distributed at every stage between the landowner and developer based on a pre-decided percentage.
• Generally, an escrow account is set up to ensure transparency in the process and it has details of both partners so that the revenue that comes in will get distributed in adherence to the agreement.
• In some cases, the landowner is given his share after the subtraction of the marketing charges, in other cases, the percentage is decided to keep this in mind beforehand.
• The returns of both parties will be affected by the profits generated by the project, and hence, their interest will tend to be aligned.
• This model is beneficial to the landowner as the risk of an increase in construction cost or such will not affect his returns. Due to the lower risk on the landowner, his share will also be comparatively lesser.

2. Area Sharing Model

• The Area Sharing Model is wherein the developer gives units of the project to the landowner as a reimbursement for his land. The percentage of the units to be provided, and the typology and location of the units within the project are suggested to be pre-decided during the negotiations themselves and mentioned in the agreement.
• As expected, the landowner gets his share of the units once the project is constructed, or in case the project undergoes phased construction, the timeline of the surrender of the units can also be negotiated.
• In this model, if the landowner wishes to liquidate the asset, he can either consult the developer to sell the flats or he may do so himself. If the developer is asked to sell the units, he may charge a marketing fee for the same.
• Assuming the units of both parties are being sold in the market together, then they may face competition from one another, and either party may adopt means to ensure their units get sold quicker. On the other hand, the landowner may decide to hold on to the units and sell them when the market is on an upward trajectory, and to minimize the competition to ensure maximum returns.
• In most cases, the difference in the share of landowners and developers for the same project in both the area sharing and revenue sharing model will be minimal.

3. Profit Sharing Model

• In the Profit Sharing Model, the reimbursement to the landowner comes in the form of a pre-decided percentage share of the profit generated by the project. The profit will be arrived at only once the project is complete, and the accounts have been recognized in the books.
• The calculation of profit for deciding the returns to each party can be tricky and the parties may attempt to skew the calculations to their advantage. For example, the costs of land charges, operation, and corporate costs, etc. may or may not be considered.
• Since the landowner’s return come at a much later stage in this model, it is often observed that an upfront advance or deposit is required to be paid by the developer to the landowner.
• In this model, both the landowner and developer bear the risks and hence, the share of profits being split is more towards the equivalent side.
• Increasing construction costs affects the profit negatively, just as increasing sales price positively affects it. As both parties benefit from the profitability of the project, it is a collaborative model with the interests of both parties being aligned.

Overall, the profit-sharing model is not very structured and due to the risks involved, it might be less likely to be opted for by the parties. It might also not be favorable due to the various risks and grey areas involved.

Other than this, both the area sharing model and revenue sharing model are being used in the market. Few landowners may also opt to go for a combination of these in the different projects they are involved in.

For example, in a prime location, they may decide to opt for area share so that they may be able to mortgage the units or sell them at a later stage for higher profits.

And in another location, where he envisions lesser price appreciation, he may prefer revenue sharing. Additionally, if he is looking for a continuous income, he may opt for revenue sharing and if he is only looking to generate assets, he may opt for area sharing.

For each of the above-mentioned typologies of joint ventures between the landowner and developer, the aspects that affect the share of each of the stakeholders in the project have been explained in detail below.

How to Calculate Percentage Share in a Joint Venture?

Which factors determine the percentage share of developers and landowners in a joint venture?

The percentage shares in joint ventures are very subjective and tend to depend on various factors such as the physical site factors, the regulations applicable on the site, the real estate market in the region, and the potential for price appreciation.

Post the understanding of all these aspects and setting assumptions on the value of the property as well as the sales assumptions, along with all the costs they have to incur, the financial modeling may be formed.

Further, by existing knowledge of the market or a hit and trial method, the percentage split will be determined to arrive at something beneficial to both parties through negotiation. As a thumb rule, the developer will look to cover his costs and generate a reasonable profit through his share and the landowner will look to recover his land price along with appreciation through his share.

A common consensus of the stakeholders interviewed for the purpose of this article is compiled to summarise the factors determining the percentage share in joint ventures, which include –

1. Location

• Location describes the place at which the land parcel is located, with reference to the city’s economic centres, as well as the administrative boundaries. It is important to study the development that has taken place in the surroundings as well as any proposed development,
  which will help us understand the prices of the property and the expected appreciation in the property rates that can occur leading to the revenue that can be generated by a project in that region.
• Hence, the location determines the capitalization rates by providing the idea of the real estate market in the region. In addition to this, the study of real estate at the location gives us the valuation of the land as well.
• The closer the land parcel is to the economic centres, the more developed the region is, the higher will be the real estate prices as well as the value of land hence in such a case, to ensure the reimbursement of the value of land, the landowner’s share in the project will tend to increase.
• On the other hand, if the land parcel is located at the peripheries with minimal development taking place, the value of land and property prices will both be lesser, and the landowner’s share will be lesser as well.

2. Development Regulations

• Through the development regulations, one can gain an understanding of the permissible FSI that can be built on the land, the heights that can be achieved, the margins that will need to be left out between the buildings, etc. which would in turn help us estimate the amount of construction that can happen in the given land parcel.
• The development regulations also specify the proposed land use of the parcel that indicates the activities that can take place on it. The changing of land use involves an official procedure that will need to be conducted if there are any discrepancies.
• The development regulations help us in interpreting the volume that can be constructed on-site, the typology of development that can take place, and the land use that can be adopted.
• As expected, the greater the construction that can happen, the typology will move towards denser units, with an increased cost of construction. Other than this, higher heights also mean more constructed units. While the revenue will be higher, but the developer’s share in the joint venture will also increase as his investment will be higher.
• However, lower FSI or restrictions in the typology may mean hindrances in constructing more units, in such a scenario, the units will be less dense. With a lesser amount to be constructed, the developer will also be incurring lesser construction costs, and his share in the project will be lower.

3. Typology of Development

• Depending on the permissible land use, the maximum FSI that can be constructed on the land parcel, and the micro market demand, the typology of the units will be determined. They may either be villas, apartments, row houses or any other typologies.
• The typology generated affects the number of units generated, the construction costs, sales prices and the generated revenue. In different typologies, the share of the landowner and developer will also vary.
• In the case of apartments, it is expected that the larger share goes to the developer, due to the higher cost incurred by him.
• However, in the case of villas and rowhouses, the landowner tends to have a larger share.

4. Physical Features of the Land Parcel

• Physical Features of the land parcel include the aspects such as the topology of the site, size of the said land parcel, the shape of the site, the number of sides with road access and road width, and the connectivity to the site, etc. All these aspects determine the potential of the land parcel concerning the land value, amount of construction that can be done on the site and revenue it will generate.
• While the physical features of the land parcel may not directly impact the shares of the developer and landowner, they surely have an impact on the saleability of the land parcel, the ease of construction, and help in estimating the amount of construction that can be carried out on the site. If the physical features of the site are not favorable, there are lesser chances that it might be taken up for development in the first place.
• In different contexts, the importance of the physical features of the land parcel will vary. For a region with varying topography, a comparatively flat land might hold greater importance. In another place, having smaller roads, a corner site adjacent to a wider road may lead to an increase in permissible heights, and hence, hold superiority over the other sites in the region.
• Understanding the context and market of the region will help both parties estimate which features of the site are unique and what kind of impact they may have on the land valuation and the share of each of the stakeholders.

5. Scale of Developer

• The developer’s experience in the market or his scale of functioning will have a huge impact on the type of deals he is willing to enter into and the share he will give the landowner.
• In the case of a large-scale or tier one developer, his goodwill, experience and assurance precede the negotiation and due to the lesser risk involved in a deal with such a builder, the landowner will tend to have a comparatively lesser share.
• On the other hand, a developer who is new to the market, or has been functioning in the market for a smaller scale of projects will need to provide a larger share to the landowner, as the risk taken by the landowner is greater.
• Additionally, while smaller developers may agree to provide a deposit to the landowners, the larger developers may only concede to paying an advance of the value of about 10 percent of the land cost.

As mentioned above, after the consideration of all these aspects, the financial modeling is carried out. A seasoned developer in a market is likely to know his fixed costs in terms of operational costs, marketing costs, construction costs (per sqft rate), and any miscellaneous charges. He is also likely to understand the real estate micro market before making a project proposal.

In that case, inserting the variables of the volume of construction possible expected revenue, and estimated land value, he will be able to carve out a range that he finds feasible to be paid to the landowner, keeping aside the recovery of his costs and his profit margin.

Through the market study, he will also determine which type of joint venture would be beneficial to him. Studying the project’s construction and financial phasing will assist him in understanding the schedule of payment that he might be able to provide to the landowner.

On the other side of the deal, the landowner will first attempt to understand his land value and the real estate micro market to be able to judge a range of reasonable shares that he can demand from the developer. He may also examine the calculations that the developer may draw, to understand the other side of the feasibility. Additionally, he may consider his own financial status and preference to decide the typology of joint venture he wishes to enter and the schedule of payments preferable.

Post their individual financial modeling is done, both parties will have a basic idea of the offer they are willing to put forth and accept. At this stage, they may meet and negotiate the deal until the terms are acceptable to both. In case they fail to come to a favorable conclusion, the deal may not go forth. However, if they can accept the terms and decide to go ahead with the deal, the joint venture agreement is then drafted and signed.

In conclusion, it basically comes down to the valuation of land, the amount of construction, and the revenue that the project is expected to generate. During financial modeling, these are the only factors that change, and through the tweaking of which, the individual share can be arrived at. However, it has been noted by all the stakeholders interviewed, that there exists no exact percentage or even a range that is present for the split of shares between the landowner and developer.

The percentage entirely depends on the abovementioned factors for each land parcel and the individual negotiations between the developer and landowner.

Current Trends for Percentage Share for Joint Ventures

An estimate of the current trends for percentage share for the different types of joint ventures between developer and landowner have been inquired from the stakeholder working in the real estate sector of Bangalore and they have been compiled below –

1. Revenue Sharing Model

• Within the Revenue Sharing Model, a certain percentage of the revenue earned by the project is given as payment to the landowner for his land. Within this model, the general share of revenue offered to landowners ranges from 20-45 percent.
• Under the condition that the project is located within the CBD area, the share of revenue going to the landowner may be as high as 30-40 percent, but moving towards the outskirts, it may reduce to the range of 20-30 percent.
• In very unique cases when the land is located in a premium location, with high potential and property prices, there are chances of the ratio going up to 45 or 50 percent for the landowner.
• Additionally, it may vary with the typology of units, the development potential, and other aspects mentioned above.
• In case a deposit is requested by the developer as safekeeping, it is generally noted to lie around 10-15 percent of the land value.

2. Area Sharing Model

• The Area Sharing Model allows the landowner to be reimbursed for his land through the allocation of certain units from the project to him. Within this model as well, the general share remains approximately the same as the revenue share, with a minimal variation that is, 20-40 percent going to the landowner.
• In regions with prime real estate or with a typology other than apartments, the percentage may even go up to a 45 percent share.
• The shares in this model for the same land parcel and with negotiation with the same developer will vary very minimally from the revenue sharing model, as the revenue earned, and units sold are proportional in the financial modeling as well. A 2-3 percent valuation may be noticed due to the addition of marketing fees or some additional costs.
• Sometimes, even in area sharing, a deposit may be charged by the landowner which will again the range between 10 to 15 percent of the land value.

3. Profit Sharing Model

• In the Profit Sharing Model, post the project is complete and the profit is recognized, it is split between the developer and landowner. The general trend of share to the landowner may vary anywhere between 30-60 percent.
• As discussed earlier, the risk to the landowner is higher and the costs to the developer have already been accounted for. Further, is also not a popularly adopted model. Hence, the range of profit shared to the landowner is higher. That too will be in addition to the deposit that may be charged by the landowner at the time of formation of the joint venture.
• In this model, the trust between the partners and the goodwill of the developer also plays a role, since there are a lot of grey areas involved to arrive at the profit and if these calculations are not acceptable to the landowner, discrepancies may arise at a later stage.

As mentioned earlier, these percentage ranges are very subjective and may vary drastically from what is mentioned above, the numbers mentioned above are only for an indicative purpose and are estimated for the city of Bangalore.

Disclaimer

It is important to understand that each deal and agreement is unique and must be treated so, there is no exact percentage or even range for that matter that would apply to all. The agreements are always negotiated based on the various aspects mentioned in the article, in addition to the specific financial conditions and the risk appetite of each of the parties, and hence, discretion, legal advice and negotiation are suggested while making the deal.

Earthfields Contribution

• Earthfields actively assists both developers and landowners to ensure that the opposing party is genuine and that the land parcels listed are verified. To assure this, there is a verification process that every stakeholder is required to go through while creating an account on the portal.
• Further, it is also working toward providing an option for the landowners or agents to upload legal documents, site photographs and other details related to the site so that the developer can have all the necessary information before going ahead with the deal. There is also an option of drone site surveys to gain a deeper understanding of the site’s surroundings.
• The developer will also be able to analyze the development regulations, master plans, zoning regulations, etc. for the related site to calculate the development potential that the site can offer. This data will make the calculation of financial feasibility much easier and quicker.
• The developers can look into a test mode feature that allows them to check the legal health index of the land parcel which will be calculated by the inputs regarding legal documents given by the landowner. This can help them match their risk appetite to that of the land parcel they are willing to construct on.
• The landowners themselves can also benefit from the various features available on the portal which will allow them to locate their parcel on the map, identify any future proposals and understand the potential of the land parcel. In the coming future, there will also be options to verify land boundaries and social infrastructure. These features will assist them in the accurate valuation of their land and calculation of their share in the joint venture. Another feature that will assist them in the calculation of the land value is the ideal land market price range (ILMPR), which will provide an additional check on the calculations.