Adapting To Market Conditions: Joint-Venture Considerations For The Institutional Real Estate Investor And Its Legal Counsel
In an environment where real estate buyers are increasingly confronted by a market that is either focused on a particular asset type, or geographic area, or some other widely accepted trend or type, many buyers are discovering that they must look beyond their normal “comfort zone” in order to identify, negotiate and close their next deal.
For as many buyers as there are, there are probably as many strategies as to best stretch the parameters of their business model and consummate acquisitions. Exploring new property types, new locations, new tenant mixes, or development opportunities are all approaches that many buyers consider today. And some buyers, often smaller companies, may decide to retrench and to focus on and manage existing assets while waiting for the market to cool down.
However, other companies, particularly larger institutional investors, do not have the luxury of waiting. Many financial institutions in particular, with revenue that must yield dividends or other regular payouts, must locate and close on “product” in order to generate the returns for their clients. Adapting to the current market, some of these larger companies seem to be considering different property classifications and locations, but often, more is needed than a simple change of city or even a change of focus from retail to, say, industrial property. For some larger companies seeking as much maneuverability as may be institutionally tolerated, a joint venture structure may be a necessary and beneficial arrangement.
The joint venture strategy is often a good one in this market in that it may be used in conjunction with other adaptive business strategies. That is, an institutional company may decide to investigate properties in a new trade area at the same time it seeks to enter into a partnership with another company. In fact, the decision to pursue a joint venture is often made specifically in order to facilitate a company’s entrance into a new sub-market or to pursue a new property class or other novel strategy. While it may be profitable for a business to seek new opportunities, companies, especially institutional ones, may be reluctant to do so completely alone, especially during the initial stages.
Thus, a combination of market factors and institutional modes of operation seem to be coming together to cause many companies, particularly the larger financial institutions, to enter into joint venture structures, even when such structures were previously not a consideration by such companies just a short while ago. And with whom are the institutions joining? Very often, the smaller (much smaller, oftentimes) local developer and operator is the chosen partner for this union.
The small real estate owner and operator is often picked because it offers the much larger institution the local knowledge, the off-market leads, the management abilities and possibly the development risk tolerance that the institution perhaps does not possess – but which it may desire in order to adapt to actual market realities. It is this smaller real estate company that, if chosen well and structured correctly, may ultimately prove to be an ideal partner to the institutional investor by complimenting the latter in many various ways and allowing the institution to truly reach for, and realize, new opportunities – precisely when such adaptation by the institution is, given current market conditions, practically a necessity.
At a time when such marriages of institutional clients with smaller owners are increasingly sought and structured, attorneys and law firms that represent the former type of investor would be well advised to make some adaptations of their own. In this something of a new world, it is not only the real estate investor that needs to make adjustments. Law firms must adapt too, of course. Perhaps some sound changes by select legal professionals will allow such advisors to best serve their institutional clients as a great advocate, a careful but practical dealmaker and an indispensible marriage counselor, if needed.
First, law firms, attorneys really, should more seriously think along interdisciplinary lines, and legal teams should be restructured accordingly. Specifically, the real estate and corporate departments should be less distinct and much more integrated. Many real estate attorneys should be far more familiar with the recurring concepts in joint venture negotiations, documentation and transactions. Concepts, to use but one not so minor example, like a “promote,” and the several real ways in which it impacts the corporate union and relationship that is integral to a particular development deal, should be a part of the real estate attorney’s understanding. Conversely, the corporate attorney specializing in these types of venture transactions and steeped in issues of management and control, capital calls, dilution and the general transfer of interests is enormously benefitted by a thorough grasp of leasing and rent roll issues – after all, the essence of the deal.
The old adage that a lawyer must also think as a business person is no longer sufficient. Now, real estate and corporate attorneys must analyze and advise both on legal and business levels, while also across practice group boundaries.
With the law firm practice properly reorganized, a partnership and deal is now identified. The issues only increase in importance as well as immediacy. Dollars are now on the table, and issues of access to capital, with, most likely, a joint venture agreement far from signature, quickly arise. And the dialogue (is trialogue the better word?) among the not-yet partners and the seller soon hinges on exclusivity periods and pursuit costs, maybe even a breakup fee or reimbursement. Are these real estate issues, or corporate concepts perhaps? In such a context, those distinctions are irrelevant.
Perhaps at this time the attorneys, more so the institutional and developer suitors, struggle to integrate the inherently different characteristics, methods and interests of the parties as they increasingly analyze a specific transaction. Maybe even the very right to lead the negotiations, or the authority to terminate further discussions, is debated. The adaptive legal professional now assumes yet another role, a diplomatic one. Having to establish a rapport with both the seller’s team and the minority partner’s group, this attorney must be adept on an interpersonal level, with a considerate yet clear approach and style, in the hope of preserving a deal that is worth making.
But the attorney is also required, in more than most of his tasks, to determine as fast as possible if the deal is not to be made. With multiple parties involved in these joint venture acquisitions, costs are quickly incurred and no one wants to waste money and resources. Potential pitfalls should be promptly identified by the legal team, which must make discoveries regarding such varied topics as may concern title, outstanding leasing commissions, creditworthiness and reputation, and operational and management capability. Staffing the deal properly is not enough, certainly not within traditional disciplinary boxes. The multifaceted legal team, to serve its client well and efficiently, must effectively communicate its various findings internally in order to spot and hopefully resolve the problems that lurk in the shadows of almost all such large deals.
And if the deal is a development one of some kind, even if there is “only” pending construction to be assumed and completed, the financial implications may magnify these issues. The courting companies, disparate in their economic appetite to begin with, must now determine if another potential quarrel can be avoided over newly discovered monetary obligations that affect both the net operating income of the property and the capital contribution obligations of the possible members in the venture.
The deal’s hurdles – both regarding the venture and the acquisition – are now perhaps, if not in the rearview mirror, then in the slow lane and falling behind. The contracts are almost complete for execution. A trust has settled in, one might find. But there is no respite in the real estate, joint venture, acquisition universe, because maybe there is a loan assumption to contend with. Financing issues and the assumption of existing obligations and guaranties are now central to the script, and once again the legal professionals should be ready. It matters not a whit if, for example, an existing loan agreement’s prohibition on subordinate financing is classified as either a real estate dilemma or a corporate impediment to the right of the majority member to make certain loans to the venture company. What matters is the integrated legal team’s ability to catch, if not anticipate, these issues and to find the best way to collectively solve the problem and close both the acquisition and venture aspects of the transaction.
In a real estate market that has forced buyers, especially institutional investors, to adapt beyond its normal parameters, such investors and their value-added legal counsel are together restructuring their previous approaches. The institutional buyer is, quite appropriately, exploring new business strategies and structures. The necessary legal team must be aware of this development and, somewhat symbiotically perhaps, adjust wisely and accordingly. Together in that effort, worthwhile transactions, which may be outside of the mainstream, may be more effectively discovered, vetted and closed to the benefit of all parties.
This article appeared in the May 2012 issue of The Metropolitan Corporate Counsel.
The views and opinions expressed in this article are those of the author and do not necessarily reflect those of Sills Cummis & Gross P.C.