Real Estate Joint Venture
Should I Just Sell My Property?
If you own land that has great potential for real estate development, you may get offers from investors to BUY your property outright or, in some cases, you’ll receive an offer to do a JOINT VENTURE instead.
Joint Venture Meaning
What’s a joint venture? What’s the difference between just selling the property and going into a joint-venture? What are the pros and cons?
Some investment websites define a joint-venture as follows:
A joint venture (JV) is a business arrangement in which two or more parties agree to pool their resources for the purpose of accomplishing a specific task. This task can be a new project or any other business activity. https://www.investopedia.com/terms/j/jointventure.asp
A joint venture is a business entity created by two or more parties, generally characterized by shared ownership, shared returns and risks, and shared governance. Companies typically pursue joint ventures for one of four reasons: to access a new market, particularly emerging markets; to gain scale efficiencies by combining assets and operations; to share risk for major investments or projects; or to access skills and capabilities. https://en.wikipedia.org/wiki/Joint_venture
Simply put, a real estate development joint venture is an undertaking between a landowner and a developer to come up with a real estate project. The landowner contributes the land while the developer contributes the funds, expertise, resources, manpower, etc. to do the project. The landowner and developer will then split the income or saleable units based on their agreed sharing scheme. The sharing is normally based on the parties’ contribution to the project.
For example, let’s assume that the value of the land is P100 Million. The developer estimates the development cost (construction costs, architectural and engineering fees, project management fees, sales & marketing , operations, etc.) at P900 Million. The entire project costs now total P1 Billion. In this case, the typical sharing agreement between the 2 parties is 10/90: the landowner gets 10% and the developer gets 90%.
As a landowner, why do you only get a 10% share – because that’s the value that you contributed to the project cost. If the land value were higher, say at P300 Million, for a total project cost of P1.2 Billion, then the joint venture sharing would be 25% for the landowner and 75% for the developer. Simply put, sharing in the fruits of a joint venture all depends on the cost inputs of the parties involved.
Which is why, if you’re going to do a joint-venture, work with professionals that can guide you through the process. Do you know how the development costs are computed? How do you know that the development costs are really P900 Million? Remember that the value of your land and the value of the developer’s inputs would determine your share. Therefore, it is imperative that you make sure to get it right.
But why would I be happy with just a 25% share or even a 10% share?
Because in most cases, you will end up receiving a higher value compared to if you just sold the property. Allow me to illustrate.
Let’s assume that you own a 2,000 sqm piece of land recently valued at P100k/sqm. That’s a total land value of P200 Million. If you’re able to sell that property at P200 Million less typical closing costs (Capital Gains Taxes or Value Added Taxes & Creditable Withholding Tax plus Broker’s Fees), you’ll probably net about P182 Million at best.
If, on the other hand, you entered into a joint venture agreement with a developer, and let’s say the value of your property was placed at P200 Million. The developer estimated that their development cost for 22,400 sqm of saleable floor area would be P1,945 Million. That’s a total project cost of P2,145 Million. That means your share is about 9.3% and the developer’s share is 90.7%. During negotiations, we can round this off to 10% or a 10/90 split.
Ten percent (10%) of the 22,400 sqm of saleable floor area. Assuming that a typical unit is 30 sqm, and 22,400 sqm of saleable floor area would be equivalent to 746 units, then that’s (A) 10% of either 22,400 sqm of saleable floor area or 2,240 sqm or (B) 10% of 746 units or 75 units.
Assume that the selling price for the units is P180k/sqm, then that 2,240 sqm of saleable floor area that you will receive would be worth P403.2 Million. That amount is more than double of the value of the land that you contributed.
But wait — unless you’re retaining the units because you have 75 relatives whom you want to give out units to, you may want to receive the value of those square meters or units in cash.
In that case, those units need to be sold. What? I need to sell the units?!! You can do that yourself or you can also let the developer sell the units for you, for a fee. Typically, the developer shall charge you a 10% to 14% marketing fee based on the selling price.
Let’s assume that a 14% sales & marketing fee is charged – because Covid-19 just hit and, say, there’s more competition. Even after paying marketing fees, you’ll still get around P346.75 Million sale. Of course, with earning money comes taxes. From this sale, you’ll still need to pay income taxes.
Overall, the cash value of the landowner’s share in the joint venture (P346.75 less income tax) will still be more than the net value of the property if you just sold it (P182M).
Is there a catch?…
Unlike an outright sale, a typical real estate development would take around 3 to 5 years to complete from beginning to end. It involves planning and design, pre-sales, construction, turnover, collection of payments and the balance, etc. Suffice it to say that there really is a waiting period.
What if I just wait? Maybe in 5 years, my P200 Million property would be equal to what I would get in a joint venture?
Assuming the value of your land appreciates 5% per year (capital appreciation), then on the 5th year, the land value would be P255 Million. If you sold the property, the net proceeds less closing cost would be P232 Million.
Comparing the results, your proceeds in the joint venture would still be higher than if you wait years for the property to appreciate and then decide to sell the property later on.
What are the Pros & Cons of a Joint Venture?
You’ll get a higher value compared to the sales value of your land.
If you have a bit of emotional attachment to the property, you can still enjoy being an owner of unit(s) in the development.
You’ll need to wait. Given the typical development timeline explained earlier, you won’t get to enjoy the proceeds immediately.
It’s a more complex deal compared to an outright sale. Make sure that you are properly guided.
Doing a joint venture or an outright sale of your property is a critical decision, one that should be studied and measured. There are some properties that work very well in a joint venture set-up and others that render doing a JV pointless.