How To Structure A Real Estate Investment
How To Structure A Real Estate Investment - Real estate joint ventures allow financiers more control over strategic decisions about how the property is managed, while property managers may seek a share of the JV's profits in addition to their fees. Victoria Landsbart, Peeta Menon and James Pullen of international law firm White & Case explain the key steps to success
James Pullen, Peita Menon and Victoria Landsbart highlight how joint ventures give financiers more control over strategic decisions about how assets are managed.
Victoria Landsbert explains which parties form a joint venture in real estate, how their relationship is governed, and how such a joint venture can be formed.
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Peita Menon discusses some of the key tax considerations that investors should keep in mind before entering into joint ventures
Victoria Landsbert explains the role of an asset manager in joint ventures and why it is important for an investor to find the right partner for the role.
James Pullen talks about the different governing bodies in real estate joint ventures and why it's important to understand how decision-making authority is delegated.
Victoria Landsbert discusses the various financing models commonly used in real estate joint ventures and highlights some of the more favorable structures.
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James Pullenandpita Menon explains why exit preparation is an important part of any real estate joint venture plan from the start.
Victoria Landsbert explains different IRR expectations based on investor type, asset class and tenant profile.
Real estate has always appealed to investors. Property yields have outperformed eurozone and UK bond equivalents over the past ten years, allowing investors to gain exposure to attractive sectors with stable returns.
Traditionally, those looking to invest money in the sector have taken a passive role, simply putting capital into a property project or listed property company - with little - or no - say in how the property is managed.
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But forming a joint venture (JV) between an investor and an asset manager can actually be a better option for both parties.
A real estate joint venture differs from a typical JV structure in terms of the equity share of invested capital. Most JV structures typically involve a relatively equal 50/50 or 60/40 equity split between the JV partners.
In a real estate pool, however, it's much more common for the property manager — who provides the real estate expertise — to have a much smaller equity stake, typically 2 to 10 percent, while the financier will contribute 90 to 98 percent. Equity
Direct investment in real estate through JVs benefits both financiers and managers. This allows the investor to have more control over important and strategic decisions related to the property while leveraging the skills of an asset manager with expertise in real estate portfolio management. Equally important, an equity stock gives the asset manager enough "skin in the game" to be passionate about maximizing the asset's return and ensuring that the asset is managed in the best possible way.
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A real estate joint venture (see diagram below) will involve a capital provider providing the largest share of equity and an asset manager investing the remaining equity, typically between 2 and 10 percent.
The "investor" will generally be structured as a limited liability company controlled by a general partner or other tax-advantaged vehicle. The investment company will enter into an agreement with the asset manager – owned by the operator of the investment company – to form the combined company.
The conglomerate will then enter into an asset management agreement (AMA) with the asset manager, directly or through a subsidiary, and often enter into a property management agreement (PMA) with the third-party asset manager.
The merger will consist of one or more series of SPVs that will sit directly below the joint venture in the capital structure. The seller of the assets or portfolio will then enter into an agreement with one of these SPVs to transfer the assets to the Propco vehicle.
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Investments will often be leveraged with bank loans or other lenders. That third party debt is typically invested at the Propco level or at the level of the corporate entity that sits directly above the Propco. The lending bank will enter into a duty of care agreement with both the property manager and the property manager.
+/-5% common capital contribution of a property manager to a real estate joint venture +/-95% common capital contribution of a financier to a real estate joint venture
Tax considerations are important and important business decisions for the success of a real estate partnership.
From a cash flow perspective, any unexpected tax leakage or liability reduces the return an investor can make on the underlying investment. As a result, real estate investing typically has taxes as a primary focus, specifically how to best maintain the tax efficiency of the structure.
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But this is a fluid situation. Gone are the days when a single framework would serve a medium-term objective. Every consolidation framework needs to be reviewed over a short period of time, say 3 to 5 years, because the tax landscape is changing rapidly around the world and any framework must be able to adapt to those changes.
From the outset, tax should also be a key component of exit planning to allow for an efficient and cost-effective exit if a joint venture is dissolved or terminated.
In a real estate company, the manager plays a key role, so choosing the right partner is especially important for the investor. The portfolio manager's objective is to provide planning and strategic advice to joint ventures related to the portfolio. This will include looking at the letting strategy to ensure it attracts the best possible quality of tenants and quality of leases in the portfolio.
This role contrasts with the property manager, who is responsible for ensuring the property is managed in a more property-specific manner and for day-to-day communication with tenants regarding their needs.
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Getting the manager's perks and commission structure right is important. Asset managers can usually expect an acquisition or arrangement fee for bringing the portfolio to the merging company. They may also expect a recurring or annual fee in return for these structural and strategic services they provide. Importantly, to reward successful performance, the asset manager can expect to receive a referral fee. All these fees and incentives are in addition to any return the asset manager makes as part of the capital contribution to the joint venture.
However, if the asset manager does not meet certain performance criteria under the AMA, the funder may be entitled to terminate the AMA and will often have a series of key performance indicators to inform such decisions.
Tax considerations are important and important business decisions for the success of a real estate partnership
Knowing who controls the key levers of the JV is essential as well as understanding the various governing bodies. In a typical joint venture, the board would be in control. What's different about a real estate joint venture is that the third-party manager will be responsible for making day-to-day decisions regarding the property. While strategic control and investment decisions will rest with the board (which is usually critical to the structure to deliver the intended tax results when the parties are international), the board's decision-making power is usually vested in the investors. Money speaks in terms of oversight and governance, and the investor will usually have the right to nominate all – or at least a majority – of the board. Management protection for certain key decisions will be through a list of reserved matters that require shareholder approval.
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If a partnership is structured as a mutual fund, the decision-making role will be delegated to the partners. In such cases, the general partner will effectively act as the board of that fund and it is important to understand who the various governing bodies are and treat them accordingly.
Typically, each JV arrangement will have one or more key partners or key persons—who are key employees of the manager. That person or persons are often the main reason an investor engages with that manager for that particular investment. The key person will be the most knowledgeable person in the fund manager and will be key to the investor's ongoing investment decisions.
The joint venture agreement will contain various provisions that will be taken into account if the principal leaves the job for any reason. Often they relate to exit options for the investor and rights to replace a key person with an expert of similar experience.
Recently there has been a great growth in other financial providers in the real estate market. Hedge funds, debt funds and even insurance companies are in very tough competition with more traditional bank lenders.
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There is also a growing trend of interfinance, meaning real estate
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