ADVICE: JV Structure
The firm i work at has done a lot of development projects(mainly buy and fix but also a few ground up) and an LP brought us a deal and we are considering a JV for a ground-up, build-to-sell branded residence project and would appreciate views on whether the economics feel balanced as we don’t have much experience with such JVs. We are thinking of the following structure:
Equity is 10% GP / 90% LP. Total project costs are $124.8m (includes a 4% development fee on $120m, with 40% of that fee deferred until after construction and subordinated to on-time/on-budget delivery). Target exit is $180m. The waterfall is MOIC-based with a 10% LP IRR time test (promote turns on only after LP clears 10%): return of capital 10/90 to 1.0×, then 20/80 from 1.0×–1.25×, 27.5/72.5 from 1.25×–1.50×, and 45/55 at ≥1.50×; no catch-up. GP will also fully sign onto the completion guarantee.
What do you think?
Thanks in advance.
Seems typical institutional waterfall, though I'm used to seeing IRR hurdles instead of equity multiple hurdles. I hate 10 prefs because they eat up your participation while you are building, but they can be hard to get away from, especially in this environment.
Since it’s a build to sell project I thought that having EM hurdle would make sense more due to irr being inflated the smaller the jvs life is. Was I wrong on that ? Should I still use irr?
Would not structure a merchant build waterfall off EM because it is a short life for the JV. We only us EM as targeted metric for long/medium-term investments with cashflow.
Could please explain how you would structure it? I could be wrong but I don’t think an IRR based promote structure would be accepted by any LP since the expected IRR for this project would be 60%+, driven by the short hold, and thus they would be giving up much of the upside.
Can't say I've ever had a 60% IRR deal on paper. Maybe EM is right in that case...
One thing to consider in JV negotiations is the sale provision if you are using an EMx waterfall. Outside of your disposition, your main growth of EMx will come with NOI growth, which takes time.
If the LP has outright authority (or majority leverage) to trigger a sale at a certain point, date, or metric, they could trigger it earlier than planned and not let your NOI grow, therefore paying you less promote.
As a merchant developer, we push for an IRR waterfall and look to sell asap if the disposition looks accretive because your IRR will be higher (no IRR drag, more promote).
I think this is a condo development, so NOI isn't really relevant, but maybe I read it wrong.
You are correct
In that case, the return structure seems generally in the range of what I would expect. Not that I've done many condo deals, but the few I was a part of had both equity and MOIC hurdles that needed to be satisfied.
Fully signing onto the completion guarantee is typical, but if I were to try to change anything of what you presented, it would be to remove that.
IMO you can go out more aggressive. What are you proposing on cost overruns--pari passu 90/10 or something else? That is one of the most critical business terms on a development capital term sheet. If 90/10 then deferring some of the fee might make sense; but if 50/50 you shouldn't have to defer any fee at all. Most of the deals we are seeing in core markets are closer to 8-9% pref; it is pretty difficult to get out in front of a 10% pref on a multi-year development deal with entitlements, construction period, lease/sellout period unless you hit a home run with very solid market timing (which you can't control)
Pari passu on cost overruns. I guess you are right on the pref point, but we think it’s a great opportunity and we can easily clear that pref (unless something goes very wrong). Do you think the EM hurdles are what you would expect?
I would still suggest going out with no deferral of the fee and seeing if you can get away with it. All of our deals are IRR hurdle based so it's hard to opine without know the timing but 20% above a 1.0 EM (return of capital) then your next threshold being a 1.275 would correspond to roughly a 10% IRR on a 3 year period which is not much to clear for a second hurdle--I would say it's attractive yes
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