Key Takeaways:
- Real Estate Development projects are often done as Joint Venture Partnerships between an equity provider (or fund) and a development company (or individual sponsor/developer).
- Time value of money and intersection of risk/reward drive choices to invest as equity or manage the development as the general partner.
- Often, equity investors have made their money in other industries or are funded elsewhere, but seek to take advantage of real estate as an investment medium.
- Critical that the partners communicate early and often about shared project goals and metrics for success.
In this article, we will explore the relationship between an equity source (limited partner) and a development company or sponsor (general partner) in a joint venture partnership for real estate development. A primary concern is the question of what each partner brings to the table and how their roles differ from one another.
I can best answer this question through reflections on life experience. I have worked with equity investors, as the development partner, in the ground-up development of residential real estate in Boise, Idaho. The partners I have taken on have been similar in their need to have a professional spearheading the development, who has intimate knowledge of the local market and the development process itself. These investors have all been highly intelligent people who work in industries other than real estate. They have been doctors, accountants, and people who own large shipping companies. If they really wanted to, or had the time, they could probably be very effective at directing the development of a real estate project. However, that is not their expertise and that is not where they wish to spend most their time. Instead, they wish to put their capital to work on their behalf, and partner with someone who does make it their business to move a parcel through the process of adding value. The equity investors I have partnered with are all a little bit different in terms of how much they want to be involved in the details of the development process. However, at the end of the day, all of them had full time occupation elsewhere. It was up to me, as the local expert, to ensure that the project was a success and their equity investment earned the return we established as a goal. In theory, it is no different than any other investment of capital with the expectation of a reasonable return. When the capital is being invested outside the principle’s area of expertise, they should seek to partner with an expert in that field.
I believe that at the core of a joint venture, you will find the forces of Specialization and Time Value of Money, at play. Most equity investors earn a higher return on their time, by placing focus on their specialty outside of real estate, than they would placing much of their focus on a real estate project. Similarly, experts in real estate development earn a far greater return by focusing on their specialty, real estate, than they would by working in areas which they were unfamiliar. This is what keeps the equity investor from simply learning the skills necessary to do the project themselves, without the development partner. Could they? Probably. Would they wind up losing money and time by doing so (learning a new craft)? Likely. Would they be in the position of having equity to invest, in the first place, if they made poor decisions with how and where they invest their time? Nope.
My perspective is mostly centered around individual equity investors and individual or small development companies because that has been my experience. However, I feel my statements hold even greater weight in evaluations of the relationship between large private equity funds and large development companies. They tend to operate under guidelines and time restrictions which are even more stringent than do their smaller counterparts.
Although they have different roles in the development process, the investor and developer should have similar targets for success. It is critical that the equity partner and development partner reach an early understanding as to the goals, duration, returns, and outcomes which they are seeking. These objectives should be formalized into an agreement and made actionable through a systematic cash flow waterfall that brings returns in an equitable fashion, based on the goals set out by the joint venture.
Questions?
Should you, or anyone that you know, have any questions related to this post, please do not hesitate to reach out via phone, email, or text. I am passionate about helping others along their real estate journey.
— Nick Schlekeway