Partnership Split on Commercial Land

[REInvestors888]

Hi REINation,

If Mr X owns a commercial land to be contributed to a JV partnership with Mr Y who will finance the construction of small commercial plaza, what's the best formula to get a reasonable split?

Option 1 - Mr X's assessed land value (or market value?) (eg., $4M) + Mr Y's estimated project costs ($6M) = total investment ($10M), so the split is 40% (Mr X) and 60% (Mr Y). Is this approach reasonable?

Option 2 - Mr X gets 25% for his land contribution and 75% for Mr Y who will finance the project and manage the operations.

Any suggestions please? Thank you.

 

[Thomas Beyer]

It depends on the fees. If Mr Y takes a massive project management fee, mortgage arrangement fee, mortgage personal guarantee fee and a sales commission on asset sale then the JV % is somewhat irrelevant as the fees could easily wipe out all the profits. Ideally the land seller get his land value plus x % of asset value on sale or z% interest on his land to keep the math simple and the incentive in line. Land seller needs to secure his interest on the land as a mortgage as construction is risky and costs and fees all over the place.

 

[REInvestors888]

Very good point on fees. Thanks, Thomas.

Just a follow up question:
If X and Y have initially agreed on specific % split of net profit, should there be % split adjustment as asset value increases in course of business operations?

 

[Matt Crowley]

Is this a hold or development project?

With two professional, experienced partners you split pro-rata based on equity contribution. Two parts to equity: cash equity and land equity. Typically capped around 70% construction debt of project cost then often will want a take out loan 70 - 75% of value. That is your equity required. Look at land equity vs cash equity requirements. Development manager usually charges a fee 3 - 6% of construction costs. That will cover overhead for developer.

 

[REInvestors888]

Thanks, Matt.

Say a development project.

Just trying to clarify:
So, for Mr X, his Land equity would be valued at assessed value (or market value?) of his land at the time of JV agreement assuming the land is cleared, no liens and encumbrances or he'd be responsible to clear any liens or encumbrances or to pay the mortgage/s, if any. (Q: Can Mr Y ask Mr X to clear all liens, encumbrances or mortgage/s prior to contributing the land to the partnership?)

For Mr Y, his Cash equity would be money to finance the whole project plus any agreed development fee. (Q: Can Mr Y charge the JV partnership for the cost of his money? If so, is it the norm?)

So, in summary, % split would be Option 1 pro-rata as per original post above(?).

Now, supposing one party or they both run into some issue during the progress of development, what's the best remedy? Amicable take over by whoever is interested to continue the project and has the capacity? I would think this matter should be spelled out clearly in the JV agreement, right?

Thank you all.

 

[Thomas Beyer]

.. Development manager usually charges a fee 3 - 6% of construction costs.

That might be true for large projects. A cost plus small project is usually higher that that, more like 15-18%.

As such profit sharing is OK as long as one knows what the fees are as 20% or so on cash invested are the profit targets. Per year.

 

[Thomas Beyer]

If X and Y have initially agreed on specific % split of net profit, should there be % split adjustment as asset value increases in course of business operations?

Why would there be ? Both take risks. Land owner get no cash upfront and a share of profits in lieu.

 

[Thomas Beyer]

..
Now, supposing one party or they both run into some issue during the progress of development, what's the best remedy? Amicable take over by whoever is interested to continue the project and has the capacity? I would think this matter should be spelled out clearly in the JV agreement, right?

Thank you all.

As MANY things can go wrong in a development project, and that is why the profit potential is so high. The land owner has to judge forfeiting cash upfront for potentially (but not necessarily) more cash later. In most cases the land owner would want a charge on title, perhaps postponable into second position behind construction financing. However, if project is in trouble almost always the first position bank takes it all and second position guy gets nothing.

More common is to get X $s upfront, say 50% of land value and 50% plus interest in the future, say after asset sale or each condo sale. So if 20 condos are being built land owner would get 5% of his money owed per condo sold.

 

[REInvestors888]

Thanks, Thomas.

It seems things are getting more complicated as we go deeper to details===)))

If you are Mr. X, the landowner, who wants uncomplicated and less risky business with Mr Y, what would you choose:
Option 1 - Lease of land to Mr Y and let him build the supposed to be partnership project e.i., build and rent out small commercial plaza.
Option 2 - Outright selling of land to Mr Y

If you are Mr Y, would you prefer to lease or outright buy?

Any other options or business arrangements available for Mr X the landowner to maximize income and use of his land?

Thanks all.

 

[Thomas Beyer]

If you lease the land construction financing is extremely difficult to get.

Of course getting all $s now is best but as stated above 50% now plus 50% plus interest or X% of assets sold would work too.

If you envision a long term hold I would try to get 50% upfront AND a pro-rata interest in the asset owning entity, say 33% if it costs 2X to build ( plus your X for land value) and of that 50% ie 1.5X is borrowed. [The math: you still have half of X invested and 1/2 X over 1.5X is 33% ]

 

[REInvestors888]

If you lease the land construction financing is extremely difficult to get.

Hoping Y and his investors have deep pockets. What's the norm in this case? Is the landowner expected to be a partner in a construction project? I would think so.

If you envision a long term hold I would try to get 50% upfront an an interest in the asset owning entity, say 20% if it costs 2X to build.

Yes it should be long term hold and this is probably the best for X.

Thanks, Thomas

 

[Thomas Beyer]

The norm is: Selling land for cash or a 50% vtb with at 5-8% interest over say 3-4 years is quite common.

JVs not so common as developers can be a pushy, fickle and sometimes unreliable bunch.

Also common is that land owner is or becomes the developer by arranging construction financing and hiring architects, engineers and construction manager that manages subtrades.

 

[REInvestors888]

JVs not so common as developers can be a pushy, fickle and sometimes unreliable bunch.

JV in construction project maybe too much to swallow

Also common is that land owner is or becomes the developer by arranging construction financing and hiring architects, engineers and construction manager that manages subtrades.

Same observation here as we talked to land owners turned developers.

 

[Thomas Beyer]

Ask yourself "who is driving the bus ? " And secondly: "do you trust the bus driver to not steer the bus off the road ?"

The bus driver maybe you, or the developer / partner.

 

[REInvestors888]

Noted. Great posts Thomas. Thanks for sharing your thoughts and expertise.

 

[Thomas Beyer]

Consider doing the development yourself

You need a good

• Realtor to lease
• Architect to design
• Planner / Engineering firm to coordinate with city ( or do it yourself )
• Engineer to design water/sewer/gas/electric lines underground
  
• Construction firm to build
• Mortgage broker to get financing

All doable.

Just drive the bus slowly so it doesn't crash .. but you'll get there, maybe a bit more slowly and a bit more expensively than an experienced bus driver but you will likely get there. I encourage you to try it if you own the land already and you see demand for a commercial building on it.

 

[REInvestors888]

Consider doing the development yourself

Fully support this as JV issues (big or small) may arise down the road and jeopardize the entire project.

You need a good
Realtor to lease
Architect to design
Planner to coordinate with city ( or do it yourself )
Construction firm to build
Mortgage broker to get financing

All doable.

Wow you simply sum it up

Just drive the bus slowly soot doesn't crash .. but you'll get there, maybe a bit more slowly and a bit more expensively than an experienced bus driver but you will likely get there.

You are right Mr X should take this role and drive slowly and carefully to get there.

Thanks many times over Thomas.

 

[REInvestors888]

Mortgage broker to get financing

Any recommendations on good mortgage broker who deals with Construction Financing?

 

[REInvestors888]

Is 50-50 split fair and reasonable for X (the landowner and managing partner) and for incoming money partner Z willing to finance the entire project without mentioning any $$$ value? Z was just saying that he will put whatever money is needed.

A JV lawyer will be hired eventually to prepare all documents necessary. Meantime, your thoughts, experience and expertise on the questions/concerns below would be highly appreciated:
1 - Isn't it that $$$ value of incoming money partners must spelled out in the JV agreement for clarity?
2 - How could X (he's on title and mortgage) and Z interests be protected?
3 - Aside from clauses on:
- Protection of investment re: JV registration on title, caveats, etc.
- Release and indemnification of managing partner
- Managing partner's duties and responsibilities, entitlements and others (what's the norm in this role?)
- Financing the Joint Venture, initial contribution, any possible cash calls, etc.
- Profit (Loss) sharing and distribution, 50-50 at year end/anniversary,
- Exit strategy, selling-buying out partners
what other important points that need to be spelled out / clarified in the agreement?

Thanks in advance for sharing............

 

[Thomas Beyer]

Is 50-50 split fair and reasonable for X (the landowner and managing partner) and for incoming money partner Z willing to finance the entire project without mentioning any $$$ value? Z was just saying that he will put whatever money is needed.

A JV lawyer will be hired eventually to prepare all documents necessary. Meantime, your thoughts, experience and expertise on the questions/concerns below would be highly appreciated:
1 - Isn't it that $$$ value of incoming money partners must spelled out in the JV agreement for clarity?
2 - How could X (he's on title and mortgage) and Z interests be protected?
3 - Aside from clauses on:
- Protection of investment re: JV registration on title, caveats, etc.
- Release and indemnification of managing partner
- Managing partner's duties and responsibilities, entitlements and others (what's the norm in this role?)
- Financing the Joint Venture, initial contribution, any possible cash calls, etc.
- Profit (Loss) sharing and distribution, 50-50 at year end/anniversary,
- Exit strategy, selling-buying out partners
what other important points that need to be spelled out / clarified in the agreement?

Thanks in advance for sharing............

50/50 makes sense ONLY if land owner and manager contributes real $s and material or if investor gets a hurdle rate on the money, say 8% - 10% per year.

Yes much can go wrong. Investors gets shares usually and a shareholder or JV agreement. This agreement should spell out all the details you mention.