Key Points to Consider in Negotiating a Commercial Real Estate Joint Venture

Commercial real estate joint ventures (JVs) offer a way for parties to pool resources, share risks, and leverage combined expertise to achieve mutual investment goals. However, negotiating a successful joint venture involves careful planning and clear agreements on various critical aspects. Here are a few key points to keep in mind when considering entering into a joint venture.

Capital Contributions

One of the first and most crucial steps in forming a joint venture is determining how much money each party will contribute. Contributions can vary widely, and the structure of these contributions often depends on the roles each party will play within the venture. Typically, joint ventures can be categorized into:

1. Equity Partners and Operating Partners: In many ventures, one partner (the equity partner) contributes the majority of the capital but takes a less active role in day-to-day operations. The other partner (the operating partner) contributes less capital but takes on the responsibility of managing and operating the property.
2. Equal Partners: Alternatively some ventures are structured so that both partners contribute equally to the capital and share operational responsibilities.
   It is essential to ensure that the terms of capital contributions are fair and reflect the value each partner brings to the venture. Clear documentation and agreement on these terms can help prevent disputes down the line.

Division of Proceeds

Allocation of Profits and Losses
Another critical aspect of negotiating a joint venture is determining how the proceeds from the venture, such as rental income or profits from the sale of the property, will be divided. This division is often proportional to the capital contributions but can also include preferential returns or promotes for certain partners to compensate them for their efforts in operating the property.

Promote Structure
A promote, or carried interest, is a common feature in real estate joint ventures where the operating partner receives a disproportionate share of the profits after achieving specific performance benchmarks. This incentive structure aligns the interests of the operating partner with the overall success of the venture, motivating them to maximize the property’s performance.

Waterfall Structure
If one of the parties will be entitled to a promote, the parties should agree on a “waterfall” structure, which dictates the order in which distributions are made. This structure often includes:

1. Return of Capital: Returning initial capital contributions to the partners.
2. Preferred Return: Providing a preferred return on the contributed capital.
3. Profit Sharing: Distributing remaining profits according to the agreed-upon percentages, including a promote for the operating partner.

Decision-Making Process

Major Decisions
Joint ventures require clear mechanisms for making major decisions to avoid conflicts and ensure smooth operations. The parties should determine at the outset how these decisions will be made between the parties. These decisions often include:

• Property Acquisition and Sale: Deciding when and on what terms to buy or sell the property.
• Financing: Determining how to finance the property, including taking on debt or raising additional equity.
• Admitting New Members: Setting criteria and procedures for admitting new members into the venture.
• Significant Contracts or Leases: Approving major contracts, such as lease agreements with key tenants.
• Budgeting: Establishing budgets for property operations and any development projects.
• Legal Issues: Deciding on strategies for resolving lawsuits or other significant legal matters. The parties may elect to allocate responsibility for these decisions in a variety of ways including:
  • Unanimous Consent: Requiring unanimous consent for major decisions to ensure all parties agree on critical issues.
  • Majority Vote: Allowing decisions to be made by a majority vote, which can speed up the process but may lead to disagreements.
  • Veto Rights: Granting veto rights to specific partners for particular decisions, ensuring that crucial stakeholders have a say in critical matters.
    

Dispute Resolution

Handling Disagreements
Even with clear agreements in place, disputes can arise. It is important to have mechanisms for resolving these disputes to prevent them from escalating and disrupting the venture or preventing the venture from taking a needed action. Common methods for dispute resolution include:

1. Formal Dispute Resolution: Establishing a formal dispute resolution process, such as mediation or arbitration, to address conflicts impartially and efficiently.
2. Buy-Sell Agreement: Including a buy-sell agreement that allows one partner to buy out the other under predefined terms if they reach an impasse. This can provide a clear exit strategy and help prevent deadlock situations.

Legal Considerations

Legal Framework
Drafting a comprehensive joint venture agreement is essential to formalize the partnership and protect the interests of all parties involved. This agreement should cover all aspects mentioned above and be tailored to the specific needs and goals of the venture.

Working with a Commercial Real Estate Attorney
Engaging a commercial real estate attorney can provide valuable assistance in negotiating and drafting the joint venture agreement. An attorney can ensure that the agreement complies with all legal requirements, addresses potential risks, and protects the rights of each partner.