Land is the most fundamental building block of any real estate development. However, there is a fragmentation which exists in the market between landowners ‘LO’ and those with development expertise and finances. Ironically, many LO’s tend not to have the next two essentials of development: finances and development expertise.
On the other hand, those with development expertise and finances tend to be limited in terms of suitable land for development. Consequently, a win-win solution is to bridge that fragmentation in the market by LO’s seeking development expertise and finances partnering with institutions that possess development expertise, and can access financing from investors.
The partnership can usually take any form, but the most optimal form we recommend is to enter into a Joint Venture Agreement (JVA), where the roles of each party are clearly laid out. The land owner duty is to contribute land, and the development partner’s duty is to source financing and take responsibility for all that pertains to executing the development from start to finish.
However, several JVA’s have run into trouble, with some making news headlines. Below we highlight 7 issues for LOs and developers to keenly consider when evaluating a JV partner:
1. Shared Vision
Is there a shared vision between the LO and developer? If one party desires an aspirational master-planned development and another desires a simple parcelling and selling project, then there is no shared vision. It is important to spend time and get on the same page with regards the goal of the development.
2. Counterparty Risks
How is the potential partner likely to behave in difficult situations? What is their history and standing in the community? Are they litigious? What do people who have had previous deals with the potential partner say about them? Avoid dealing with a partner with a history of trouble making, as it saves a lot of headache and heartache.
3. Rights and Obligations
The rights and obligations of each party should be clearly spelt.
4. Management and Control
It should be clear how decisions would be made. Especially, issues that require approval of all parties and those that can be left to the managing party should be clearly defined.
5. Profit Sharing: The participants’ share in any cash flows arising from the development should be clearly specified, and even clearly illustrated.
6. Exit Mechanism: A device or a procedure for liquidating an investment in the JV and ending a venture’s involvement should be clear.
7. Dispute Resolution: It should be clear how disputes are resolved. Most development projects, once started, have to be finished to preserve value because development involves a lot of upfront expense, such as legal expenses and stamp duty, which consume huge amounts of capital upfront. These expenses can only be recovered upon exit or renting the development.
For example, stamp duty alone costs 4 percent, and for a piece of land valued at Sh1 billion, the stamp duty is Sh40 million; which means the moment land is transferred to a JV, the liabilities are going to outweigh the assets by Sh40 million. Hence, if the land does not proceed to create value through development, unwinding the JV will leave a Sh40 million hole. We recommend that the first course of dispute resolution is to seek mediation, which is aimed at assisting the partners attain the original intention that brought them together. Should mediation fail, we recommend arbitration; however only where significant amounts are involved.
By Shiv Annop Arora
Investment Associate : Cytonn Investments