Joint Venture Property Development Finance Explained
Have you wondered about learning what you need to know about joint venture property development finance? If so, you’re in the right place.
We have been exposed to Joint Ventures for many years, so we are very familiar with how they work.
In this helpful article, we’re going to explain what a joint venture is, as well as dig into the pros and cons of undertaking this sort of arrangement to finance your development project.
Very simply, a joint venture only works if there are no greedy parties. While we’re all in this to make a buck, greed will kill a joint venture in the water.
As soon as a joint venture property development finance party gets greedy, agreeing on terms will become an issue and fast.
Of course, everyone needs to make money. But you need to decide on how the role and expectations and liabilities of each party and stick to it.
Unfortunately, in our experience, either one or all parties have high expectations.
And high expectations often lead to disappointment.
Why Risk it Then?
You may be reading this and wondering why anyone bothers with a joint venture if it can get messy.
One of the benefits of a joint venture is that it can be a genuinely legitimate path to complete a development project. Especially when other options are not available to you.
This means that you may need to give up a piece of the final pie. But at least you’ll have some pie when all is said and done. The alternative is no pie for anyone.
We say this a lot, but it’s worth a repeat – it’s better to have 50% of something than 100% of nothing at all.
You might do a joint venture for your first project, use it to strengthen your position and shore up your capital and then you can undertake the next project on your own.
Some Risks to Consider
Remember, townhouse development is a high risk yet high reward game. With no risk, there is no reward.
A joint venture, like any investment, carries risk. A lot of people don’t understand this about investing. They invest in property or shares and then scratch their heads when they end up with a loss.
When investing, you’ve always got to be prepared for a loss.
The risk involved in a joint venture is that they require people to undertake, and people have lives, and lives can change, sometimes very quickly.
A legitimate example that occurred to us a while ago was we undertook a joint venture with a fella who wound up with a pretty serious health condition.
His world was turned upside down rapidly. This was not his fault in the slightest and out of anyone’s control. But it derailed the project and was a very early lesson for us.
The lesson is Murphy’s Law – everyone can come to the table of a joint venture with the right intentions, but if things can go wrong, they will.
How to Mitigate Risk
A fundamental way to mitigate risk in joint venture property development finance situations is to have some fail-safe clauses in your contract with the other party.
A project can run for up to two years sometimes. The world can change rapidly during that time like we are currently witnessing with Coronavirus.
People’s situations can change drastically, too, as we described above.
When you enter into a joint venture, you need to make sure everything has been thought of in terms of what may go wrong.
You’ll need contingency upon contingency to prepare yourself for these random situations.
You don’t want to enter into a joint venture willy nilly. You need to know what you’re getting yourself into and that you have the right advice.
They can become a living and breathing disaster otherwise.
If you’re uncertain and want some advice about this, drop us a line, we’ll leave contact deets at the end of this article.
Let’s look at joint venture property development finance in more detail.
Example: You Have the Money or the Land
Let’s say you have either the money or the land to develop property with or on. But you lack the industry knowledge and know-how to pull it off.
In that case, you may wish to engage a partner to manage the heavy lifting for you. They take a stake in both the risk and the reward.
This partner might manage the following tasks for you:
- Locate great sites in areas that have a high capital growth rate
- Do all your feasibilities and plans
- Do all the networking and relationship building (remember, if you’re not networking you’re not working)
- Take care of the finance application
- Get a great deal on the site, sometimes off-market and below market value
- Lead the design, town planning, plan of subdivision and tender process
- Take on the role of development manager for the build
- Manage the sales or leases once the build is finished
As you can see, this is a lot of work, so it makes sense that a partner in a joint venture doing all these tasks may want a fair slice of the pie.
In this case, you finance the project, and the partner manages the process. This is what we do here at Little Fish.
In this situation, the party funding the project is responsible for the following:
- Paying the deposit for the land/deposit towards the residential development finance
- All funding costs, including design, plans and surveying
- Any and all legal fees, including stamp duty
- Building reports and other enquiry costs
- All rates payable on the property, any taxes and levies on the purchase price
- All insurance costs
It can work the other way around, of course, where you have all the industry knowledge and experience, and you approach a landowner or investor who has the capital. It’s a two-way street.
What About Disputes?
Like we said above, if things can go wrong, they will. Disputes can come up during a joint venture. Usually, this is about the total value of the dwellings once they are complete or ready to be sold off the plan.
These disputes can typically get solved between the investors, through consultation and mediation. Sometimes lawyers are involved. Hence the need for an airtight contract or agreement.
Contracts will have clauses that state that all parties must be reasonable. Remember, the goal is a net profit for both parties.
Again, don’t get greedy and you should be right – but that applies to the other party as well.
Sometimes a dispute can’t be solved between the parties. In this case, you need to have a procedure for if and when you need to terminate your part in the joint venture.
Typically, a termination without the other parties consent will result in a drawn-out and expensive legal battle.
Your joint venture agreement needs to cover this and should have a clause that allows a party to buy out someone in the case they want to exit the venture.
Or at the very least have the first right of refusal.
How Does Splitting the Profit Work?
Generally, you will split the profit at your agreed-upon rate. If the party who is funding the project has incurred upfront costs (which they always do), these are paid back.
Any net profit is then divided upon the terms of the venture. This can be 50/50, but we’ve seen it done differently, too.
More About Risk
We discussed risk above, but let’s get into some more detail here.
Although a profit is expected, as with any investment, a loss is always possible.
While the property is purchased in the name of the person who is funding the project, the contract (or joint venture agreement) will state that losses are shared between the parties.
An agreement will also usually have a clause that the second party has a legal right to a “caveat” (a freeze on the title of the land) to safeguard their interests.
As with undertaking a development project on your own, you need to do your due diligence when considering a joint venture property development finance.
You need to consider your other party’s reputation, and how it will impact on your own.
The wrong choice of partner can wreck a business or individual reputation and all the goodwill you’ve gathered over the years.
You must check the credentials of your potential partner and write off anyone who disagrees with this.
This can include a police check, credit rating and reviewing their finances and accounting records. They can also do this for you.
If you find any red marks or red flags seriously consider if the risk is worth it.
Seek Legal Advice
When preparing your joint venture agreement, be sure to seek independent legal advice. Your partner should do the same.
You will all have different things to consider, like liability and tax implications.
A good lawyer can advise each party on the best approach and what to include in the agreement.
Then, have each parties legal representative review the agreement. You have to be prepared to go back and forth until you’re happy with it.
This will cost, but it is a step to mitigate risk, which is essential as we described above.
Seek Financial Advice
As well as legal advice, you want to seek some independent financial advice.
We stress this a lot, but we have to. In this game, your numbers need to be airtight. They need to be checked, double-checked and then triple checked.
If your numbers don’t stack up a project will fizzle. You can’t afford to estimate and guess here, working with rubbery numbers is high risk.
A financial advisor will be able to tell you if you can afford to undertake a joint venture and help to inform you of the risks associated with it.
Stay in Touch and Hold Meetings
You should have a dedicated meeting time each fortnight or month, depending on everyone’s schedules.
Even if things are smooth and there appears nothing to discuss, it’s crucial, particularly for when there are more than two of you in the venture.
This is a place where everyone can stay updated and have a regulated space to communicate with each other.
Set an agenda and record minutes and ensure these are sent to all parties afterwards. This way, you have records of agreements and all discussions.
Joint Ventures Can Save You Money
In a joint venture, you split this cost, unless otherwise agreed upon.
A Con – Culture Clashes
This can occur when the parties are two separate companies, rather than individuals. But it is worth noting in case you want to set up your own business.
Different management styles, ways of working and company cultures can make working on a project together tricky.
This is why regular meetings and open lines of communication are super important in this case.
Want to Know More?
We hope this is a comprehensive guide to joint venture property development finance. If you are interested in learning about property development tax deductions go here.
Remember, with any investment, there is a risk, and the possibility of a loss and a joint venture is no different.
Just follow the above advice and don’t underestimate the importance of a solid joint venture agreement.
If you’d like to know more, call our expert development consultants team Little Fish on 1300 799 277. We have done a few joint ventures in our time so we can advise on them.
Or you may wish to partner with us. Either way, get in touch for a chat.