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Real Estate Joint Ventures: 10 Red Flags You Shouldn’t Ignore | Antonio DiMinno

Overview

Toronto real estate lawyer, Antonio DiMinno, of DiMinno Rizzi Lawyers, shares some general red flags that investors should look out for when doing a joint venture.

What is a Real Estate Joint Venture?

A joint venture (JV) is a business arrangement where two or more companies (or people) collaborate to achieve a specific goal or undertake a project. It involves sharing resources, risks, and profits, and allows companies to leverage each other’s strengths and expertise for mutual benefit. Joint ventures are a common structure used for those investing and developing real estate (see here for more on JVs). However, JVs can be used for any commercial venture.

 

Do I Need a Joint Venture Agreement?

Not documenting JV agreements can be a major red flag and a recipe for disaster. Failing to put agreed-upon terms in writing during the pre-JV phase can lead to miscommunication, legal risks, and a lack of trust. Written agreements ensure clarity, prevent conflicts, and provide legal protection for all parties involved in a JV.

For this reason, we always recommend that our clients have a joint venture agreement prepared, no matter how small the project.

 

Joint Venture Red Flags

1. Nothing on Paper or Very Short Contracts

This is one of the most common red flags with beginner investors. Not having a written  agreement is a recipe for disaster. Even if the parties do not have malicious motives, the parties may forget certain terms or have selective memories, resulting in disputes later on. 

Similarly, a very short, bare bones agreement, while better than nothing, will lack the comprehensiveness required and raise issues. It is important to ensure that all aspects of the JV partnership are clearly outlined and agreed upon to foster a successful and mutually beneficial collaboration.

 

2. An Unreviewed Contract is a Bad Contract

When presented with a JV agreement but given no explanation or opportunity for discussion, it is crucial to exercise caution. JVs, particularly aspects involving financial contributions, can be complex. It is advisable to review any agreement with a lawyer to ensure understanding and protection. A partner dismissing legal review raises red flags.

                    

3. No Independent Legal Advice

Access to expertise is a significant advantage of real estate joint ventures, particularly for new investors. Instead of spending a significant amount of money on expensive courses or mentorship programs, partnering with experienced individuals in a JV allows new investors to gain practical knowledge and guidance directly from those with a proven track record. This hands-on learning experience can be invaluable, as it not only helps investors avoid costly mistakes but also provides them with real-world insights and strategies to succeed in the industry. By investing their capital in a JV, new investors can simultaneously earn returns on their investment while gaining a valuable education that may surpass what they could obtain through traditional educational programs or courses.

 

4. Family Joint Ventures

Family JVs have both advantages and disadvantages. They offer a higher level of trust and can be beneficial for newbie investors to gain experience. However, they can also be problematic due to lack of written documentation, different assumptions, and reluctance to take legal action against family members. It is crucial to have a JV agreement with family members to ensure clarity, especially for unsophisticated parties. Parties should thoroughly explain and emphasize key clauses to avoid misunderstandings.

 

5. Incomplete, Inaccurate, Unorganized Pro Formas

When considering a JV, it is important to carefully analyze the pro forma presented by the active partner. A messy or incomplete pro forma can indicate a red flag. Money partners should have a general understanding of pro forma analysis to identify discrepancies. It is crucial to compare numbers with industry standards, such as vacancy rates, property management fees, and maintenance costs. Suspiciously low numbers, especially for expenses, should raise concerns. Additionally, accounting and legal costs specific to corporate structures should be factored into the overall costs of the venture.

 

6. A Lack of Communication

A lack of communication from the active partner(s) in a JV is a significant red flag. When promised reports are not provided or sudden cash calls are made without notice, it raises concerns. To address this, include a reporting clause in the JV agreement specifying how and when the active partner will provide updates. This clause ensures accountability and enables the passive partner to hold the active partner responsible. Clear communication channels and reporting timelines are essential for maintaining transparency and fostering a successful JV partnership.

 

7. No Plan for Exit Strategy or Renewal

Another major red flag in JVs is the absence of an exit strategy. It is crucial to determine the active partner’s or other venturers’ preferred exit strategy. Will the venturers be selling the property and sharing the profits of the sale? Will there be a cash-out refinance, where the passive investors are paid out? If so, will the passives have the option to keep equity in the property?  A replacement clause or shot gun clause allows for early exits if suitable replacements are found. Additionally, having multiple money partners on the roster provides flexibility and mitigates risks in the JV partnership.

 

8. No Plan for Cash Calls

In a JV, it is important to address the possibility of cash calls for unforeseen expenses beyond the reserve fund. The JV agreement should specify how cash calls are paid, typically based on ownership percentages. Establishing a reserve fund (contingency fund) is crucial, usually around 3-4 months of expenses, to cover unforeseen costs. The JV agreement should outline the threshold for cash call triggers and the consequences for non-payment, such as reduced ownership percentage or penalties. If the active partners and JV agreement do not address the above items, this is a big red flag.

 

9. No Plan for Death, Incapacity of a Venturer

It is important to address what happens if a venturer passes away and how the estate settles with the venture. The JV agreement should specify whether the estate of the money partner or active partner assumes the role. Insurance considerations, such as business interruption insurance, should also be addressed. If the JV agreement does not cover these scenarios, it may be necessary to consult with a new lawyer. It is crucial for real estate investors, regardless of JVs, to plan for contingencies like the “hit by the bus” scenario to ensure smooth management and transition of their investments. If these scenarios aren’t contemplated by the JV agreement, that is a red flag.

 

10. The Active Venturers are Reluctant to Retainer Professional Advice

A red flag in joint ventures (JVs) occurs when parties avoid investing in professional advice, including architects, engineers, development consultants, tax accountants, lawyers, and contractors. This is common among cash-strapped beginner investors attempting a DIY approach and even intermediate investors with relevant professional backgrounds. Even if one has a stellar background in a relevant area, being personally involved in the project can hinder objective assessments of the project, despite technical expertise. It is important to recognize the need for objective external advice to mitigate risks, ensure comprehensive evaluations, and make informed decisions. Investing in professional guidance is essential for successful JVs, regardless of experience level or technical expertise.

How an Ontario Joint Venture Lawyer Can Help

When considering a real estate joint venture, whatever the size, a crucial first step is to speak to a joint venture lawyer. Your joint venture lawyer will uncover red flags, hidden landmines, and protect you from unforeseen consequences.

Your joint venture lawyer will work closely with your team to protect your interests and be your trusted strategic advisor as you grow your portfolio.

 

Antonio DiMinno

647-205-9128

antonio@drlawyers.ca

Contact us today for a free strategy session!

 

Disclaimer: All number figures are approximate only and may be subject to change. Like all material on this website, this is not financial, legal, or tax advice. Contact a professional for your specific situation. 

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