Here’s everything you always wanted to know about S.D.D’s or JV’s (Structured Development Deals or Joint Ventures) but were too afraid to ask.
Structured Developments Deals or Joint Ventures seem to be more commonplace in these parts as the acquisition costs of the sum parts become more prohibitive for a single individual to assume all the risk.
The concept of these structured partnerships is relatively new, but the syndication of capital and the mitigation of risk is as old as dirt.
Here are the who, what, why, where, when, and how a Structured Development Deal or Joint Venture can takes place.
First off Who or who in their right mind would form such a joint venture? Take any motivated property owner and a reputable builder with a great resume and watch the two attempt to marry their interests.
What? If you take a motivated property owner willing to hold paper or a mortgage, and subordinate their lien to allow a builder to finance his construction loan then it becomes possible for the builder to launch a spec project with the minimal amount of capital expense.
Why would a property owner allow such a plan or take on such a risk? Motivation. The owner is motivated by a full priced sale, and the possibility of added income from the interest earned on the mortgage held during the development or re-development period. And/Or the potential for bonus equity in the project if it sells above the acquisition cost!
So, Where do we see most JV projects? Anywhere there is perceived equity in the property, or an untapped potential in a redevelopment project. Anytime the property holder is debt free and see’s the potential for gain over risk. Perceived equity could be defined as untapped potential in a property with neighborhood values that suggest the property could likely triple in value with a smart rehab or a well planned new construction project. Comparable sales, market trends, with a complete understanding of market cycles should be taken into consideration first and foremost.
When is the best time to enter into a JV or seek out such a partnership? Typically for a property owner, motivation comes when they’ve been through several market or sales cycles to learn that unless the property is re-developed, the property could continue to sit until the economics be such that the market collapses on-top of this diamond in the rough. … or a builder knocks on your door with a bag of cash to redevelop the property into something desirable to the market around the property. Until that time the property, the upkeep, and the tied up capital prevents the owner from other investment opportunities.
So, how then are these mega-projects done and how are they structured in a way that mitigates tax liabilities, risk to it’s partners and maximizes the potential for profitability?
Below is a sample template or blue print for mega- JV.
Typical Development Joint Ventures works as follows:
1) A pre-determined “Land Credit” is given to the owner, say in this case, it’s $7m or full asking price for a property that is Deep-South of the Hwy in a predetermined $15m to $20m neighborhood with ocean views or Direct ocean access.
2) If there’s a mortgage payment, along with property taxes & insurance, the payments are included into the newly formed Joint Venture as payment rest, and negotiated into the partnership agreement as either the responsibility of the new JV or the land owners expense/debit from his share of the profits.
3) a building plan, budget and builder is mutually agreed upon. If the budget were say, $4m. The partners would invest into the new JV at a pre-set rate, typically an 8% coupon ( this is not a mortgage is it’s a capital infusion to a business.)
4) A new LLC is formed , made up of the land owners, the development team and their lending entity. This is not considered a sale or a deed transfer. This is simply the formation of a LLC, and a capital infusion to a business partnership. Typically built into the new LLC operating agreement is a 1031 exchange option allowing the business partners to roll their portion of the profits into their next commercial real estate transaction.
5) The capital infusion by the new partners (for the construction/redevelopment) and fee paid to the referring broker(s) is considered part of the partnership contribution. The fee paid to the brokers is not for a commision in conjunction with a sales transaction, since a sale has not occurred yet. The fee paid to the broker(s) is considered part/parcel of the project procurement costs.
6) Upon forming the new Joint Venture/ LLC, the owners continue to maintain ownership and enjoy a majority stake in the project until a preset expiration date, say 24 months. For example: all purchase offers would be presented to the land owners first. However, after 24 months (or the present time period) the decision making shifts to the majority partner or the lending entity. The lending entity becomes the deciding vote and any/all sales offers will be presented and their decision.
7) A pre-set expiration date, of say 30 months from start to finish is the general length of time for the partnership to begin & end, and is described in the partnership operating agreement.
The following is a typical partnership split of the profits after debt, projects costs and credits are paid.
Capital Infusion for redevelopment : $4m budget at 8% interest for a period of up to 30 months.
Land Holder Credit : $7m
Debt is paid 1st
Land credit is paid 2nd
45% share of the profits to the land holder
35% share to the captial partners
20% share to the builder (as an incentive to build at cost)
HRP, LLC contributed to this article.
This was very informative!