WITH THE RISE IN MARKET UNCERTAINTY AND investor hesitancy, value-added equity joint ventures (EJVs) between private real estate operating companies and institutional investors can be a better investment vehicle than real estate opportunity funds. At a time when investors are having difficulty assessing risk and value, properly structured EJVs — joint ventures that focus either on development or asset repositioning — can offer investors and sponsors flexibility and help resolve this uncertainty.
Compared with opportunity funds, EJVs are less risky because they provide transparency and greater control over major management decisions. In addition, value-added EJVs can deliver returns to the investor that are more attractive than opportunity funds on a risk-adjusted basis.
Equity joint ventures often are structured to include some seed properties that the sponsor contributes. These properties, whose value typically represents a portion of the total EJV target value, initially fund when the joint venture closes. Seeds may comprise either entitled land to be developed later or existing properties. The venture invests the remainder of the targeted capital funds over 18 to 24 months as opportunities emerge. Although the joint venture may either hold or flip individual properties, typically the life of the joint venture is four to seven years.
In two of the EJVs that Colliers Apogee closed last year — one for Erwin L. Greenberg and Associates, a developer of grocery-anchored shopping centers, and the other for The Creaney and Smith Group (CSG), an industrial developer — about 25% of the venture consisted of pre-specified opportunities. In fact, the CSG transaction was designed to fund the recapitalization of a portfolio of properties that CSG had purchased with opportunistic capital several years earlier.
The seed properties provide investors and sponsors with an early opportunity — before consummation of the joint venture — to negotiate price, governance, strategy, markets and operating procedures, including items requiring investor approval. The seed properties are literally a concrete reference point that demonstrate the spirit and purpose of the joint venture. The seed properties help provide transparency and avoid the uncertainty of a fully unspecified transaction.
The investor has the right to participate in all future transactions during the life of the venture. The strategy typically focuses only a subset of the sponsor's business or a collection of markets. And should the sponsor pass on any specific transaction within the joint venture, the operating partner retains the right to seek capital elsewhere.
The right to approve significant capital transactions provides the institutional investor with important control rights not customarily offered by opportunity funds. In return, the sponsor receives a soft equity commitment from the institutional capital partner to pursue a focused strategy over time. When development is involved, this commitment is often sufficient to obtain 90% to 100% construction financing. Both the operating partner and the investor obtain valuable flexibility.
A basket of options
Perhaps the most important right in a joint venture is the investor's option to pass on a prospective investment — a right of first offer. The advantage of a joint venture program that includes yet-to-be identified opportunities for development over an extended time horizon, perhaps in different markets, is that the institutional investor has the flexibility of “toggling” between markets depending on supply and demand balance. While predicting which market will be in favor at any one time is difficult, a program that includes multiple markets is tantamount to a basket of options that positions both the institution and the operating partner to pursue opportunistically favorable market movements as they arise.
EJVs are an alternative for investors seeking value-added returns, good governance and the option to exercise constructive control. They also are an excellent way to pursue a sustained and focused strategy with talented and seasoned organizations. While the market is currently in some disarray, investors should pick thorough bred horses — the best strategy and sponsor — and then be prepared for the opening bell when GDP growth begins to accelerate.
Bart Steinfeld and Randall Zisler are both principals at Colliers Apogee International, a New York-based investment banking firm. Since early 2001, the company has closed approximately $1.3 billion in EJVs.