I'm interested in partnering with someone on new construction for a multi-unit facility. My question is, he owns the land already and I am just going to be providing a capital investment into the construction itself. What is the best way to structure a deal like this?
Put together what we call a Land Joint Venture, or Land JV.
1. Negotiate the deal terms in a letter of intent, keep it dead simple, you want to negotiate the deals terms, without lawyers, principcal to principal on all major buiness points.
2. Run a proforma based on the deal terms (you should really do this upfront, but you won't know his exact land value until you fully negotiate that part), make sure the deal works, paying particular attention and grounding assessments on rents, operating expenses, construction costs, financing costs, and values upon sale of the asset.
2. Sign that LOI assuming the proforma works for the deal.
3. Send that signed LOI to an attorney to draw up an LLC operating agreement based on the LOI terms, with the following general JV structure:
A. Land owner will transfer land into the LLC at the value based on you proforma and negotiations.
B. You will put your capital up, to the extent it's needed. I say this, because you will be able to claim equity credit with the lender for the value of the land that will be in the LLC once you close the deal and transfer the land. Your capital should only fill the equity gap, and should be available to backstop the liquidity requirements of the lender to make the loan if you do the loan guarantee. Usually, we see the cash equity partner pay for predevelopment activities, such as entitlement processing, architectural construction drawings, plan check fees, soils engineering, etc. These all require payment before the construction loan closes.
C. Who will provide the construction loan guarantees, you or him, or both of you. Most land JV's we have been involved in, the "seller" or land partner, does not want to put up financials for a loan guarantee.
D. Preferred return that will be paid for invested equity - the land equity, and your cash equity.
E. The back end or profit splits based on paid-in equity. If you provide the loan guarantees, I would not go any less than 50% of the back end. Normal market value for the loan guarantee by itself it 20-25% of the back end. You also will put the entire deal together, so that has value.
F. Agreement on who will manage the project and the general contractor during the build process.
4. Sign the LLC, close the deal, transfer the land, complete entitlements, complete working drawings, pull permits, build, lease, season the rental stream.
5. Sell the project, pay the lender back, pay the invested equity back - the land value and your cash equity, pay the preferred return, pay the back end profits. Done, do the next one.
Thanks Scott - if he wants to leave the land in his LLC, would it be best for him to "lease" the land to the JV?
Owner would need to put the land into the new LLC.
This will be required by the lender, as they will want to know the land is in the deal level LLC, so that they can encumber the value of the land, and to know that the land is available to build the new buildings on. They wouldn't want to finance a new build on someone else's land. As importantly, you also want this, to protect against him yanking the land out of the deal altogether after you put your money in.
Likely a ground lease structure on a residential development project would be too complicated for most lenders. The brain damage and complexity would likely be a burden on the deal.
If it were my deal, I would require the land to be transferred into the new LLC, or walk away.
Land JV's are a hard sell to most land owners, You usually get hung up when the seller realizes they have to put their land value at risk (as the "investor"), and once you tell them they will subordinate to the new construction loan, that's normally where we lose most people. Land sellers are generally not developers, and the risk of investing and subordinating is usually too complicated for most non-sophisticated land owners.
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