LSI 2010 Real Estate Joint Ventures conference materials.pdf

John W. Hanley, Jr. of Davis Wright Tremaine LLP Speaker 20a: 3
assets. Typically, in the real estate joint venture, the investor approves the selection of the target
asset in advance, and it has a greater voice in development, management, financing and sale of
the property than does an investor in a real estate fund. For the investor, use of a series of singleasset
joint ventures, even if they are all with the same operator, may be more time-consuming
and expensive than a single bulk investment in a multi-asset fund, and that strategy may lead to
less diversification than would be the case if the investor deployed its capital through a largescale
blind pool. For the local operator, the joint venture may provide more attractive economic
terms than those typically found in a fund. Real estate joint ventures can vary widely in
economics, but historically the typical joint venture offered the investor only a preferred return
of 6%-8% (as contrasted with a typical fund’s preferred return of 8%-10%), and the split of
residual profits between developer and investors was as rich as “50-50”(in contrast to a 20%-
25% residual interest for the manager of a fund). However, for the developer, the tradeoff for
better economics in the real estate joint venture was typically greater restrictions on authority and
discretion (e.g., investor voting rights) than in a fund structure.
Another possible alternative for the investor is to invest through a public or private real
estate investment trust, which, like the typical real estate fund and typical joint venture, is a taxadvantaged
form of investment (i.e., no federal income taxation at the asset level). However,
with this alternative the investor will typically have less control than in either a private real estate
fund or joint venture structure. The principal distinguishing benefits to the prospective investor
from use of a public REIT to place its capital in real estate are greater liquidity and more assured
diversification, but at the cost of greater volatility.
Real estate and capital market conditions in the United States have dramatically changed
from those seen between 2001 and late 2008. During those heady times, capital from all corners
rushed into U.S. commercial real estate, and fund sponsors enjoyed the upper hand in setting the
terms for each successive fund. Investors motivated by potential eye-popping investment returns
had little interest in, or little bargaining power to require, protections in governance,
transparency, disclosure, and other measures to limit excess risk or operator abuse. Then the
bubble burst.
Today, real estate investment capital remains relatively scarce, and the dynamics of
negotiating a fund structure may be quite different. Real estate fund terms will be affected by
many considerations, including the prevailing conditions in the capital and real estate markets,
the track record and demonstrated capabilities of the fund sponsor, the stated objectives of the
proposed fund, and the sponsor’s proposed investment guidelines. However, all of the legal
issues implicit in fund formation remain, but perhaps now with different emphases. This paper
will identify and briefly discuss the most important of those legal issues. 2
2 A private equity fund may solicit investments from foreign or domestic entities which have specialized federal and
state tax and reporting requirements. There are at least three categories to be considered:
(a) foreign investors, that is to say, non-U.S. persons. The presence of such investors will trigger
requirements on the fund manager under OFAC, RAFC and, in connection with distributions, “effectively connected
income” and federal tax withholding laws;
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Law Seminars International | Real Estate Joint Ventures and Funds | 02/09/10 in Seattle, WA
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