Disclaimer: The below information is general only in nature. It is not intended to act as financial advice. Individual circumstances and outcome will vary, and each person should assess their own appetite for risk and gain their own independent financial and legal advice.
Joint ventures are a fantastic way for two or more people to come together to achieve a property project which neither party could achieve without the other.
They offer up more flexibility than traditional financing and open up property development to more than just the wealthy. They make it possible for some people to invest in, and manufacture equity in property without having any available $’s.
There are typically 3 roles in a joint venture. The roles are:
Working party – this is usually the person who does all the initial research, will assess the projects’ viability, will keep a project budget, manage the builder, tradespeople and consultants. Decide on build materials, floor plan and finishes. They will generally manage the project through to completion, the sale at the end of the project.
Finance or Equity Party – this is the person who will provide the funds for the project. Funds can be provided by one party, both parties or a third person.
Servicing party – This is the person who will be on the land title of the property. Generally, the person who already owns the property, or, if it is a new purchase, then they will be the one who gets a mortgage from a bank, and therefore be named on the land title.
That doesn’t mean that only 3 people can be involved. Any of these roles can be held individually, as a couple, or in a company. Also, each party can take one, two, or even three of the roles. However, in most cases the servicing party will be held singularly (by one party which may also be a couple or company). The reason for this is that a bank, funding a mortgage on a property, usually demands a first mortgage. That means that should the property need to be sold; the bank will be paid first over all other interested parties.
There are many ways a joint venture can work – here’s a common example:
Let’s say that John has a house that he owns, and that he would like to develop, but doesn’t have the skills, knowledge or money to fund the development. He would like to knock down his house and build three new ones.
Samantha has the skills and experience having done many of these projects previously, but doesn’t own the property. However, she does have the money required to complete the project.
John already has a mortgage on his property of 80% of loan to value ratio (LVR). What that means is that if the properties’ value is $800k, he will have a mortgage of 80% of that amount assuming he hasn’t already paid any of it off. His mortgage will therefore be $640k, being 80% of the value.
Let’s say that the total project will cost a total of $2,400,000. Depending on the funding model (how the bank chooses to assess and fund the project) the bank may be willing to allow John to borrow up to 80% of the gross realisation value (GRV) of the completed price of the project. That is the amount the three new properties will be worth once built. In this case, let’s say that each house will be worth $1million, the GRV therefore, is $3 million.
They agree to work together to complete the project. First, they fill out a ‘heads of agreement’, this is a fairly simple document that sets out which each persons role and responsibility within the joint venture, it is not legally binding, but will form the basis for a formal legal document – their joint venture agreement.
They will be considering things like:
- Who will manage the money?
- What protection does each person have?
- Who will pay the mortgage and other bills?
- Who will decide which builder they will use?
- Who decides on the type of property they will build, what size, style and finishes they will have?
- What will they do if something goes wrong, or if they can’t sell the properties at the end of the project?
- Will they rent them instead?
They may even choose to keep one house each, and just sell the remaining one, or any number of possibilities that they can agree on. There is no right or wrong way here, but a vital part of this early agreement is to consider how they will manage if the parties don’t see eye to eye on a particular issue. Who will handle dispute resolution in case they can’t agree? Does one party have the final vote? Or do they appoint another person to decide on a sticking point? It’s important to nut our all the different scenarios early on and try to foresee any potential problems that you may encounter down the track. Every project has some complexity and / or something that doesn’t go quite to plan, being able to work together to resolve issues quickly is the key.
Once they have agreed, John and Samantha decide that;
John will be the servicing partner and he will be using equity in his house, also making him an equity partner. Samantha will also have two roles, that of the working partner and the finance partner.
John will contribute his servicing to the project (his bank loan of $2,100,000) his house will be used as equity. Samantha will contribute all the additional money and bring the skills and experience to the table.
They decide to split the profit at 40% for John and 60% for Samantha after all costs and taxes* of the project are paid.
Once the properties are sold, they will each share in the profit of $600,000.
John will receive $240,000 and Samantha will receive $360,000 of the profit.
Note *Both John and Samantha will still have to pay their own individual personal tax liability on their income.
Typically, these types of projects take around 18 months to complete. It’d be hard to try to save that amount of money in the same timeframe!
This is a simplistic example, there are many ways a joint venture can work, for example sometimes a 3-way joint venture is more appropriate. One servicing partner, one working partner and an equity partner. Sometimes people share the financing party role… The skies the limit in terms of negotiating how many people can be involved and who is responsible for which element. The most important thing is that you choose to joint venture with people you can trust and have experience in joint ventures.
We’ve personally partnered with many different joint venture partners from all walks of life for the mutual benefit of ALL parties. Working closely with each other for a set period of time, builds some great financial gains, but also builds great relationships with like-minded people. That’s arguably one of the most beautiful benefits of these types of arrangements.
Happy joint venturing!
Nicola