13/12/2024
Real Estate Joint Ventures: Overview
Published in December, 2024This Back to Basics note follows our key concepts briefings, which intend to provide high-level insights regarding funds fundamentals, funds vehicles and operational considerations, available here. Introduction This Back to Basics briefing focuses on joint ventures (“JVs”) and particularly those used for real estate investment. It covers key topics including:a high-level summary of what a real estate JV is;typical structures used; andthings to consider when establishing a JV. It is important from the outset that the parties identify what they want to achieve and the terms for their relationship. Our second Back to Basics briefing will then look at governance, controls, day-to-day management, exiting and the end of a JV. Real Estate JVs JVs are a long standing and an increasingly popular way of investing in commercial real estate in the UK, Europe and elsewhere. They are used for many reasons, including allowing more than one party to acquire an asset or portfolio or to carry out a development together. The benefits of a JV structure include:combining land interests for a project or scaling up a portfolio;accessing new markets, skills and resources (for example the expertise of a local developer, sector or regional or country specialist); andcombining and raising equity in larger amounts than doing so individually (such as a developer or local authority joint venturing with an institutional investor).A JV structure also enables sharing the risk between the parties. Structuring considerations JV Structuring A JV can be structured in many ways as it is a generic term. Relevant considerations will include where the parties are based and their investment requirements, tax, accounting and the practicalities and costs of management of a structure. However, there are a number of options. These can include:contractual arrangements at the property level (such as co-ownership or lease arrangements; orsetting up an investment vehicle. Having a standalone vehicle is often an attractive option because it allows the parties to agree the terms of their arrangement for an entity that has separate limited liability and can be separately financed and managed. It also provides an opportunity to sell the vehicle, to sell down a share in it or bring in a further joint venture partner later. JV vehicles The options also include a variety of investment vehicles or even a mixture of them:mediumThey may be UK, European or offshore vehicles depending on the structuring needs of the parties. 50/50 and other arrangements A JV does not necessarily have to be a 50/50 structure. This can be negotiated between the parties to cater for their specific requirements and contributions. For example, one party may have a majority, there may be more than two parties or one party may receive a greater share of profits if certain returns are achieved. However, the split in the interests held in the JV will have an impact on other aspects such as accounting (the JV may become a subsidiary), the levels of control and management of the JV, risk and liability and potential returns. This is discussed further in our second Joint Ventures Back to Basics briefing. Limited Companies Assuming that the parties do not want to use a contractual arrangement (a lease structure or co-ownership are examples), a company is a frequent choice due to its legal personality, limited liability and relative flexibility for managing, financing and owning. Parties should decide where they want to incorporate the JV entity, including for practicalities of management, the location of the parties and the JV activities and any potential tax implications. For example, an English limited liability company will typically be taxed in the UK on its profits and gains but there may be exceptions such as where a UK real estate investment trust (REIT) election is available. An offshore company or European company may also be liable to UK tax unless certain exemptions to be treated as exempt or tax transparent are available. Similar tax points will need to be considered for other jurisdictions where the company is set up (eg offshore, Luxembourg, the Netherlands or elsewhere) or investment made (eg into another European country). Applicable solvency rules will also need to be considered when determining how the parties will finance the JV. Avoiding cash traps, in particular in respect of the distribution of periodic incomes, may command the use a mix of equity and debt instruments, or of hybrid instruments, such as participating loans. Sample corporate structuremedium Limited Partnerships A limited partnership is a frequent alternative due to its potential tax transparency (look through treatment to the parties). This allows the JV to preserve a particular tax status of a party such as for a pension fund.A limited partnership combines elements of limited liability protection for its investors (the limited partners) and contracting and governance arrangements through its general partner(s).A limited partnership may also have corporate personality depending on where it is established. A limited partnership established in England and Wales does not have separate legal personality but the structure can still operate in practice with the assets being held by nominees or with a nominee and the general partner. Legal personality may be possible elsewhere, such as Jersey, Scotland or Luxembourg if that is otherwise suitable. Sample structure of a UK limited partnershipmedium Other structures These include offshore unit trusts or a mixture of vehicles including the different types mentioned above and different jurisdictions especially where cross border elements feature. Further Considerations Whichever structure that the parties decide upon, additional considerations include:Costs: Running a more complex structure, or management and decision-making taking place in certain jurisdictions may incur more costs, particularly, if the vehicle is not where the parties are based. Tax: The tax efficiency of a JV structure is critical. For example, a limited partnership is tax transparent or an offshore unit trust can be structured such that (rental) income is attributed directly to investors or a company may be able to become a UK REIT. Taxation of capital gains will depend on the circumstances and relevant tax rules, elections exemptions and treaties. Tax treatment is a continually evolving or changing subject. Transfer Taxes: Taxes that arise on transfers of interests in the JV may differ from the interests on a transfer of the property but this will depend on the vehicle, jurisdiction and assets. There are also provisions which may look through the vehicles or treat a transfer of a JV interest as a direct property transfer where certain conditions are met. The ownership of vehicles investing in German assets are one example. Regulatory: The EU's Alternative Investment Fund Managers Directive (AIFMD) generally does not apply to JVs. However, because they are not expressly exempt (despite a declaration in the Directive's recitals that joint ventures "should" not be covered), it is important for JVs to fall outside the definition of an alternative investment fund (AIF). This is usually achieved by giving all the JV parties a share in key decisions, the JV a product of how the parties wish to invest rather than one which has gone to them to raise capital and it may not have a “defined investment strategy”. A similar analysis applies in the UK.A limited partnership JV could still be treated as a collective investment scheme (CIS) for UK regulatory purposes unless it takes advantage of one of the available exemptions, most likely the "group" exemption or the "existing business" exemption. If the JV is classified as a CIS, it will need to appoint an operator authorised by the UK Financial Conduct Authority (FCA), which typically increases the time, cost and administrative burden. Competition: This will depend on the relevant merger and competition controls. These may look at the autonomy of the joint venture, any change of control, the parties and their turnovers (such as in the EU or particular countries), their current market shares, areas of expertise and the proposed venture. The parties should assess whether any there is any risk of falling with the remit of the merger control. There are EU and national rules. The UK has its own rules. Foreign investment control rules: These are also relevant for particular types of assets of national importance. The National Security and Investment Act 2021 is a specific example for the UK. The information contained in this publication is for general purposes and guidance only and does not purport to constitute legal or professional advice.
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