Every aspirational real estate entrepreneur wants to do big deals, even if they don’t have the capital to finance them on their own. For example, taking down a $118MM office asset for repositioning can be done partially with debt, but many times the addition of an equity partner to the venture is needed. Joint ventures allow operators to do much larger deals than they could otherwise do, and employ a structure that provides the operating partner a greater percentage of the upside than the capital they’ve invested – a promoted interest.
This is the ultimate leverage; as deals do better, operators do better. However, from the vantage point of a joint venture equity partner, there is a lot more to consider than just how well a deal could perform. At the outset, the deal is really just numbers on a piece of paper. The strength of the partner behind those numbers is critical as it affects the likelihood that the pro forma becomes reality.
We reached out to several of the top institutional capital partners we work with to get their take on the top things they look for in a partner. As expected, a clear “Top 5” emerged. If you are contemplating a joint venture equity partner, consider the lens these investors employ:
Overwhelmingly, JV equity looks for experience above all else. Operators or developers seeking equity should have experience in the geography, the product type, and the play. As one key executive put it, equity partners are looking for “deep knowledge of local markets, so that sourced opportunities are unique in nature and have a solid business plan.”
Understanding of the Local Market
Equity seeks partners able to utilize their local experience to capitalize on opportunities that others couldn’t. This understanding feels fundamentally deeper than information one could obtain through generic, broadly available research. Ideally, sponsors live and breathe the locale and this develops a material competitive advantage. This is particularly important when it comes to development deals, as JV equity expects “knowledge of local jurisdictions” as well as meaningful contacts with governing bodies that make entitlement and development decisions, and may ultimately make or break a deal.
Product Type and Play
In addition to understanding the local market, partners should have experience in the product type and play. For example, a developer could have experience in repositioning apartments, but not multifamily development. They might have development experience, but have never done a single-family tract project. Product type and play are actually quite distinct areas. Each area requires specific excellences and capital partners are reluctant to want to pay for their partner’s first efforts.
Finally, experience in these areas isn’t enough; you need to have had previous success. Track record comes up again and again as a crucial factor for JV equity’s evaluation of a partner. Equity groups want to understand the status of current projects as well as see a successful track record of similar completed ones. Ideally, this track record identifies achievement in the asset type, business plan, and geography.
In discussing “team” with our partners, we heard things like “We don’t love one man shops” or we desire to have “little to no key-man risk.” JV equity wants a team standing behind the real estate entrepreneur in the driver’s seat. Important factors for evaluating the strength of the team include expertise, capacity, and cohesiveness.
Expertise of Team Members
All of the experience factors discussed above applies to the team as well. Sponsors can use their team to demonstrate their expertise. For example, a company’s president does not need to have entitled something personally if they have a team member responsible for that aspect of the business who has entitled over 15,000 units.
Capacity for Multiple Projects
One man companies increase the risk for equity that a project won’t get completed, but equity isn’t in the business of doing just one deal. They want repeat business. What capacity does the team have to handle multiple projects, conflicting deadlines, and various stages of the deal life span?
Cohesiveness of the team is also very important. “How long have they worked together?” is a common question from capital sources; what’s their “working style/culture/personality” is another. Don’t make the mistake of seeing these inquiries as tangential to the “stick and bricks” of a deal, they are where the rubber meets the road and team is closely evaluated by a prospective partner.
Communication & Transparency
As a side note, JV equity also wants exceptional communication and accounting systems. They are to become a “partner” in every sense of the word. They want a strong working relationship with principals and their team. JV equity doesn’t want to be kept in the dark, and they want clear transparency into how the project is performing.
3) Financial Strength:
JV equity wants a strong financial partner. Probably the most important thing here is “skin in the game;” equity wants the sponsor to materially participate in capital contributions. They want the operating principals to have real money in an amount that’s meaningful to them in the deal, not syndicated dollars (other people’s money) or acquisitions fees rolled into the deal as a co-invest. This epitomizes the expression “put your money where your mouth is.
Does a material co-invest happen every time? No, certainly not. We financed deals with no co-invest, but the funding is a challenging one viewed with a lot more scrutiny by equity. Many institutional shops won’t even look at a deal without a minimum co-invest of 10%.
Beyond the co-invest, partners should have a healthy balance sheet, some liquidity, and a clear financial record free from bankruptcies, foreclosures, and contingent liabilities. JV equity expects their partners to have an “ample enough balance sheets to provide completion and cost overrun guarantees to lenders.” The ability to secure debt financing, which in some cases means providing personal guarantees, is something JV equity looks to their partners to provide. The size of the loan and degree of risk obviously influence how strong the partner needs to be financially to obtain debt.
4) Further Business:
JV equity is looking for access to deal flow through their partners. One of our partners stated “JV equity deals take a considerable amount of time and effort. After we’ve underwritten a sponsor, I’d much rather do three to five deals with them.” Taking the time to evaluate their experience, their team, and their financial strength is a substantial undertaking. Equity investors, like most business want repeat business. The economies of scale improve with every deal; JV docs are negotiated and the investor knows what to expect from a sponsor and their team, everything all gets easier. The lesson: have a deal pipeline or be working to build one.
A sponsor’s reputation depends on more than his or her experience completing successful projects. Is he or she ethical and honest? What is their reputation in the community? In a downturn, did the operator demonstrate integrity of intent? JV equity needs to know that the operator can be trusted, that they say what they mean and they do what they say. While last on the Top 5, this one attribute is the most critical, and the one that won’t be fixed when broken.
For projects where community organizations can greatly impact success, a positive reputation among the local community is important. A negative reputation, on the other hand, can compromise the chances of getting the project approved; JV equity will consider the operator’s public perception carefully.
We often ask our clients, what would a background check reveal about you? This can be a highly personal question, but it’s one that equity investors will ask in their due diligence. Have you been involved in any criminal wrongdoings, even minor ones? Has there been lender or other types of litigation in the past? What will bankers say about you? A litigious or contentious reputation is not one equity groups like to see.
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This isn’t meant to be an exhaustive list of the attributes JV equity seeks. The list does, however, illuminate the aspects of a prospective venture partner that you can expect top investment professionals to scrutinize. Remember, these important factors focus on the sponsor and not the deal. It’s a balancing act; a strong deal can offset some deficiencies in experience and qualifications, but a poor reputation married to even the best economics is very hard to overcome. In evaluating a partner, JV equity values experience, team, financial strength, further business, and reputation above all else.