Joint ventures are enjoying a surge in popularity. A lot of the appeal lies in the numbers: It’s common to secure a loan for up to 70% of the value of the desired property.
Investing is not unlike gambling. Just as most people don’t want to go to the casino alone, joint ventures rose in popularity in part because they are set up to allow their members to share in both risk and reward.
What is a joint venture?
A joint venture (JV) is a contract between two or more investing parties who agree to share both the responsibilities and rewards of the arrangement. In a JV agreement, all profits, losses, and costs between real estate investors are split. Typically, these are one-time arrangements crafted to secure a relatively quick profit and tend to be short-term investments.
Sometimes, however, investors are in joint ventures for the long haul. This is particularly true if the parties have enjoyed a successful joint venture in the past. In this scenario, the parties will form a new company to operate, own, and manage the investment to minimize risk.
What real estate joint ventures look like: a common example
To understand how joint ventures and their operating agreements work, let’s look at an example transaction. Johnny loves joint ventures and has had both successes and failures. His first joint venture involved a property that he purchased with his existing LLC. The plan was to spruce it up and resell it quickly.
Johnny couldn’t afford the property’s full value on his own, so he talked his pal Phil into a joint venture. They drafted an agreement, signed on the dotted line, and got to work. They later shared the profits earned from the project.
Advantages of joint ventures
Joint ventures allow multiple entities to participate in a mutually beneficial deal. The entities can work together to reach deals that each one may not have reached on their own. That requires them to give up some equity, but that’s often a sensible choice given it allows the entities to grow their real estate portfolio and earn a profit ultimately.
In a joint venture, everything is shared, from resources to risk. A team approach lessens the load on one entity’s shoulders and spreads out the profits accordingly. Each entity can come to the table with its own set of resources, capital, and expertise to share with the other. That brings a lot of power to the deal.
In summary, the advantages include:
- Combined expertise
- Combined capital
- Shared resources
- Shared risk
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Disadvantages of joint ventures
However, no real estate investment method is perfect, and each comes with its own set of pros and cons. We have already gone over the benefits of joint ventures; now, let’s talk about its downsides.
While resources and skills are shared, so are negative traits. If one entity is greedy, lazy, or controlling, they are bringing that to the deal. That could hamper the situation and cause disagreements among entities. Be wary of who you choose as your partner in a joint venture, as disagreements could risk the deal. Before going into a joint venture, each entity should sit down with a business lawyer to make sure everyone is on the same page.
In a joint venture, you also have to commit to sharing profits. That means a smaller piece of the pie for you. As you go into joint venture real estate, keep this in mind. To reach your monetary goals, you may need to weigh whether a joint venture is right for you.
In summary, the disadvantages include:
- Shared profits
- Possibility of disagreements
- Shared control over the project
- Potential for uneven efforts
Common joint venture structures
Although nothing bad happened to Johnny, it sure could have if Phil had gotten greedy, and the law very well could have sided with Phil. Let’s consider a better method for negotiating joint venture agreements.
A venture-specific limited liability company (LLC) allows for the same profit and cost-sharing in for the JV partners but doesn’t bleed into your other investments. Because of this, the parties also get some liability protection out of the arrangement that might not have been available if using an existing company.
An additional benefit is that it’s easier to leave the company alone if things don’t go well. While things turned out alright for Johnny, he could have landed himself in hot water if he had decided to partner with someone less trustworthy than Phil.
Venture-specific LLCs have one final benefit: asset protection. Let’s say the venture doesn’t go well and fails so miserably that you don’t just lose money. You also get sued. If you have used a venture-specific LLC, any liability issues or lawsuits arising from the property can’t seep into your other assets. Your separate properties (and their profits) stay separate and can’t be touched.
In a corporation, multiple owners collectively operate as one entity. That will allow you to partner with another business entity in a joint venture for a real estate deal.
In complex joint venture situations involving a large sum of money, use a corporation. Apply with your state to establish an S Corporation or C Corporation. Either one works as both will offer liability protection.
Corporations have similar rights and responsibilities as individual business owners, but a corporation owner has significantly less liability. With a joint venture, two separate corporations can work together on a project that will ultimately benefit both. Establishing a corporation will protect each entity as they move forward in the project.
Each partner can hammer out the details of the joint venture agreement in the corporation’s bylaws, where you can spell out shares and other specifics. Once signed, that agreement will protect both parties in the case of a dispute down the road.
Alternatively, you can form a partnership to move forward on a joint venture. Typically, partnerships are less of a commitment compared to corporations, and they aren’t used that often. Corporations are fairly permanent (at least until it sells or goes bankrupt), whereas partnerships can be temporary. Choose between these options depending on your specific goals.
Partnerships can be general or limited, and which type you choose will depend on the type of joint venture you want to pursue and the responsibilities of each partner. If both partners are actively involved in the project, a general partnership works well. If one of the parties is a passive investor, they should use a limited partnership.
In general, partnerships are usually less expensive to form than corporations or LLCs and require less paperwork.
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Important parts of a joint venture agreement
A solid agreement is essential for any joint venture project, whether it’s in real estate or not. Both parties must agree and sign off on it before moving forward to avoid potential disputes. Signed agreements can save you money and headaches down the road.
Break down, in percentages, how much profit each entity will get from the joint venture. If both parties agree on a certain amount, this should prevent problems with profit sharing once the project is complete. An agreement that spells out profit distribution in excruciating detail will benefit everyone.
Make sure to spell out which entity will contribute what in detail. That way, neither can backpedal and get away with contributing less than they initially committed to. You can include a designated bank where contributed funds will go and where any additional funds will come from if needed.
Management and control
Choose how much control each entity should have moving forward. One can have most of the control while the other takes more of a back seat, or you can share management equally. Either way, agreeing on amounts of management and control will avoid conflicts over workload.
How to exit the agreement
There are multiple reasons a party may decide to end a joint venture agreement, including bankruptcy or illness. Your joint venture agreement should detail how each party can exit. This may involve written notice but can also involve insurance and defaults. However complicated this may be, addressing an exit strategy in your initial agreement is essential. If such an incident is necessary, the agreement will ensure the process goes smoothly.
Finding joint venture partners
Depending on your personal situation, you may decide you want to jump into joint venture real estate. But where do you start? First, you need to find a partner to work with. There are several ways you can find a partner that meets your needs. Look within your personal network and work out from there. You can ask around to determine if anyone is interested. If you hit a dead end, head online and use market research tools to find interested partners.
- Search social media
- Look online
- Market research
How should you conduct your joint venture?
What you choose to do with your joint venture depends on the size of the deal. If you’re commanding armies of contractors to the tune of millions, you really might need the protection of a venture-specific LLC. However, the joint venture agreement worked out okay for Johnny and Phil because they were trying to make a quick profit.
The agreement alone is ideal for investors who are in the business of rehabbing and flipping properties like single-family homes.
While no two partnerships or agreements are the same, the most important feature of these deals is working with someone you have reason to trust. That way, even if the project ends up being a one-time deal, you are still growing your business network and building relationships in the industry. There will always be more deals to pursue in the future if you treat your partners well and leave the door open for collaborating again down the line.