The art of the joint venture
Changes in the market and increasing foreign capital mean conditions are ripe for joint ventures. Theo Andrew speaks to experts who highlight the points to consider before entering into a partnership
There are a lot of things to consider when entering into any new relationship: common interests, likes and dislikes; likemindedness and understanding; and, ultimately, the degree of willingness to make it work.
In business, as in life, often the best partners are those who complement and challenge each other in the pursuit of a common goal. Of course, such relationships also require a certain level of commitment and trust if they’re to get off the ground.
Joint ventures, as we know them, have been around for a number of decades, but the evolving global economy, the movement of foreign money and the structural changes in the real estate market mean that, now more than ever, capital and knowledge are being shared to bare the fruits of collaboration.
According to EY’s 2016 report, JVs Changing the US Real Estate Market, overseas investment into US real estate topped $93 billion in 2015, creating a massive opportunity for those looking to gain attractive returns while minimising management requirements from further afield.
For Philip Churchill, founder of 90 North, a global real estate investment advisor that prides itself on striking longstanding partnerships, there are a number of key drivers for undertaking a joint venture.
“Firstly, the key thing is access to transactions in a cross-border investment, or even a cross-region investment if you are looking at the US,” he says.
In June, 90 North acquired the 368,477-square foot Mercey Health headquarters in Cincinnati, Ohio, for $84.5 million, in partnership with Saudi Arabia-based Sidra Capital.
Churchill says: “Where it is different is when we are considering new joint venture partners from different parts of the world. There are so many different cultures, which means different approaches to business, so you have to understand who you can trust within particular markets.”
“A lot of our equity partners tell us they want to work with us for our local knowledge. If you are sitting in Jeddah with a desire to invest in Chicago you have a few barriers to entry, but a local team on the ground can help massively.”
Churchill believes that a fruitful partnership can often start in one geography and end up somewhere totally different, but due diligence is essential.
“It is vital to know everything you can about your partner, from its ambitions to its thought process when investing in a particular transaction, in order to stay out of trouble,” warns Churchill.
“One of the main challenges is different motivations. If you can both do what you say you can do, and you have a similar mindset on how to operate these transactions, then that is key.”
“Our hope is that you end up having fairly lengthy relationship with our equity partners. The time with investors upfront is rewarded with
He adds: “It is important that you have a process in case there is a disagreement between the partners, in which case a decision can be made, often an orderly sale of a property.”
With a joint venture investment there runs an increased risk that one partner could cut and run, or simply manage the deal badly.
It’s therefore imperative to ensure that measures are in place should the unthinkable happen.
When working with an operating partner, there is a carrot-and-stick relationship, according to Iain Morpeth, a partner in the Ropes & Gray real estate team.
He explains: “The stick is that he is usually required to put some hurt money in. At least 2 percent on a co-investment basis, so the operating partner is going to lose money if it isn’t going well.”
“On the other hand, if it goes well and capital is returned plus a 15 percent return on an opportunistic deal, for example, then the return is normally split proportionally to equity, so if it was 95 percent to 5 percent, then returns might be split 80 percent to 20 percent.”
Another viable reason for entering into a joint venture is the old adage of safety in numbers.
Sharing risk can be attractive when entering a new market, but it also gives a second or even third opinion on the viability of an investment.
Churchill says: “Bluntly, investors can ask themselves whether they are the only idiot going for this. Hence 90 North’s co-investment is important. Is there someone else doing their own due diligence?”
According to the EY report, longer-term capital providers such as insurance companies, pension funds and sovereign wealth companies have been particularly interested in joint ventures.
Much of this can be attributed to the attraction of investing in high-quality assets. However, in recent years the changing nature of the market, along with companies’ needs to diversify their assets, means investors are willing to look further afield in a sector that they previously wouldn’t have considered.
Take, as an example, the Canada Pension Plan Investment Board’s (CPPIB) recent partnership with IndoSpace Capital Asia, India’s largest developer of modern industrial and logistics real estate. The pension fund committed $500 million in a majority stake in the joint venture worth $700 million, in a market and a sector that they have traditionally stayed away from in the past.
IndoSpace Capital Asia will manage the partnership, which has acquired 13 industrial and logistics parks spanning more than 14 million feet in Chennai, Mumbai and Delhi.
At the time of the announcement, Andrea Orlandi, head of real estate investments for Europe at CPPIB, said: “This joint venture gives us immediate scale and access to a significant development pipeline in a rapidly growing sector. IndoSpace is the leading industrial platform in India and we look forward to building a long-term partnership and its sponsors through this joint venture.”
In addition to diversification, there is an increasing number of incentives being offered to lure foreign investment into the US that might otherwise have had trepidations.
Foreign pension funds looking to invest into the states are benefiting from a change in the Foreign Investment in Real Property Tax Act, which allows them to invest in the US without having to pay tax on exit from these investments, according to the report.
Churchill says: “Depending on the jurisdictions, there can be some tax advantages to joint ventures, particularly for sovereign wealth funds going into the US. If they remain below 50 percent they will get pretty favourable tax terms and it’s similar in other jurisdictions.”
There may be many advantages to embarking on a joint venture relationship, but, as Morpeth warns, it’s important to make sure that it’s with the right partner.
He advises: “Do your due diligence, structure your tax, ownership and exit plan right, and make sure the terms of your relationship with your capital partner give you the means to trigger your exit when you want to. You cannot be stuck in a position where you are held to a long-term commitment when investment horizons change.”