Many real estate investors have been turning to joint ventures and strategic alliances in order to develop large-scale, capital-intensive projects.
Several years ago, Dr Martin Matu partnered with a friend to purchase a piece of land, which the two parties agreed to subdivide and sell or develop residential units on later, once the land appreciated in value.
The collaboration enabled Dr Matu to purchase a large, prime piece of land which the real estate developer wouldn’t have been able to alone; however, it taught him a hard lesson about joint real estate ventures.
“Every time I needed to make a quick decision regarding the property, I could not because I had to consult the other party. The same applied if I got stuck somewhere,” posed Dr Matu, a director at Cherd Africa.
Transactions would also stall because once the property began appreciating in value, one of the parties began to ask for a larger percentage of the total selling price than what was agreed upon initially.
These disagreements prevented both parties from earning a return on their joint investment in the land, a majority of which, to date, still lies idle, despite having significantly appreciated in value.
“Since then, even though we have been receiving several expressions of interest to partner from people offering land or money for our gated community projects, we have deliberately decided not to engage in joint ventures, due to the potential complications,” stated Dr Matu.
Over the last decade, the rising cost of construction materials, scarcity or high cost of urban land, as well as tightening of finance, have made it difficult for real estate investors to implement projects individually.
Joint ventures
As a result, a lot of real estate investors have been turning to joint ventures and strategic alliances in order to develop large-scale, capital-intensive projects, amidst these increasingly complex market conditions.
For instance, developers who lack land but have the networks and expertise to implement large-scale projects have been partnering with land-selling firms that have idle land to actualise their projects.
Similarly, these developers have been partnering with financial institutions that offer affordable credit, such as SACCOS, to free their returns from the high interest rates attached to commercial borrowing.
Meanwhile, landowners and financial institutions looking to earn revenue from their resources without going through the hustle of supervising projects or getting approvals, have been partnering with seasoned developers, who have the networks, expertise and access to better markets.
According to market analysis, a significant number of major mixed-use developments launched in the past five years, particularly in major cities such as Nairobi and Mombasa, involved some form of joint venture.
“75 percent of Nairobi’s major developments have succeeded because partners share the load. Well-defined joint ventures can help to cut down on project costs by up to 40 percent,” says Akuku Felix, E-Commerce and Value-Added Services Lead, SIC Investment Cooperative.
Well-defined agreement
As these partnerships have increased, however, so too have the number of court cases involving disagreements on how ownership is structured, how risk and profits are distributed, among other issues.
"When investing with others, most of the decisions about the property, including management, sales, as well as major improvements, must be agreed upon by all parties involved," explains Akuku.
This dilutes individual decision-making power, and one may have to compromise to align with other investors, even when whatever is agreed upon is not in their best interest or in alignment with their goals.
Without clear communication and a well-defined agreement, the parties in a joint venture may come into conflict due to different expectations about their roles, responsibilities, and potential returns.
Investing with others also means that you are tied to them financially, and any disagreements over property management, financial decisions, or investment strategies can strain relationships that were once cordial.
If a joint project requires additional funds, perhaps because something that was not in the initial plan came up, investors may be subjected to capital calls, which require them to contribute more money.
If one of the investors is unable or unwilling to meet these capital calls, their stake in the project may be diluted, whereas the ownership percentages of other investors could increase.
Developers who lack land but have the networks and expertise to implement large-scale projects have been partnering with land-selling firms that have idle land to actualise their projects.
This can create financial strain on some of the investors, who may be forced to make difficult decisions about their involvement in the project. It could also lead to disagreements and conflicts among investors.
Jacob Omondi, a conveyancing practitioner, observes that managing tax obligations in a joint venture is also something that many investors, particularly those who do not have much experience in joint ventures, often struggle with.
Tax liabilities associated with the income or sale of a jointly owned property are supposed to be shared among the investors, but sometimes, one party may fail to meet their obligations, exposing the other to legal risks.
Additionally, if one of the investors has been exposed to a legal tax dispute before, this could complicate the tax filing process and potentially lead to unfavourable tax outcomes for other investors.
Real estate investment
Exiting a joint real estate investment is another challenge that many investors often encounter. Unlike individual ownership, selling your share in a jointly owned property is often more complex.
“You typically need the agreement of all other investors to sell the entire property, which can be difficult if some partners want to hold onto the investment,” says Omondi.
Finding a buyer for just your share can also be challenging, as it may require the other investors' approval or a specific buyer willing to buy a partial interest.
Furthermore, the terms of the partnership agreement can dictate the exit process, potentially restricting your ability to sell or impose penalties. This lack of flexibility can be a significant disadvantage if you need to liquidate your investment quickly or if the partnership dynamics change.
In shared ownership, each party may be jointly and severally liable for any credit taken against the property, regardless of their individual stake in the property. This means that if one party decides to default on the loan, the other party could be exposed to great financial risk.
Additionally, the creditworthiness of each investor can impact others’ ability to secure funding. If a co-investor has a poor credit rating, one may be unable to secure funding against a property.
Estate planning and inheritance is also an issue that often comes up in joint real estate investments. If an investor passes away, their share of the property doesn't transfer to their heirs automatically.
Often, the deceased's share must go through probate, a lengthy and costly process of reviewing the assets of a deceased person, which can create uncertainties for the surviving investors and the deceased's heirs.
If the legal structure of the partnership agreement and local laws do not align with how the deceased would have wanted his share to be handled, disputes may arise among heirs and surviving investors.
“That is why it is very important for one to carefully evaluate the kind of joint venture they are getting into, as well as the character of the partners they are looking to work with,” says Omondi.
Do your due diligence and conduct background checks to identify partners who will not only complement your skills and add value to the venture, but who will also remain trustworthy and reliable.
Partners should be willing to share documents such as financial statements, inspection reports, and other relevant documents to enhance trust and promote a culture of transparency.
“Conducting due diligence on the land upon which you will be implementing your project is also crucial to verify ownership, identify encumbrances, detect fraud and indeed avoid future issues,” says Omondi.
In addition, maintaining open communication with other partners, regularly updating them on the progress of the investment and promptly responding to their questions or concerns can also enhance collaboration.
Plan promptly
“Implement systems that can regularly monitor the performance of the joint venture, including key performance indicators to assess progress and address any deviations from the agreed-upon plan promptly,” Omondi posed.
Partnerships and joint ventures can have complex legal and tax implications that, if treated with indifference, can have major repercussions on the parties involved.
Michael Kiruti, a partner at Kiruti and Company Advocates, says that consulting an attorney and a financial advisor about the legal and financial implications of joint ventures can help investors to avoid the common issues that arise out of joint partnerships.
An attorney will help partners to draft detailed joint venture agreements that clearly outline things such as what the venture intends to achieve, how decisions shall be made, who will make decisions and what level of authority each party has.
“A detailed joint venture agreement sets clear expectations, defines roles and responsibilities, and provides a roadmap for resolving disputes, thus ensuring a successful partnership,” said Kiruti.
The agreement should also outline what each party is to contribute, how the profits and losses will be shared based on the contributions of each party and how regularly profits will be distributed.
Should one party fail to meet their end of the bargain, a good joint venture agreement should also outline how disputes shall be resolved or what actions shall be taken against the party at fault.
If the partnership can no longer hold because one party has defaulted on their obligation, or if one party wants to sell their interest, the agreement should include provisions for how the joint venture will be dissolved.
Partners may also consider drafting a will or trust that specifies who will inherit their shares or what will happen to their interest in the property if something unfortunate, such as death, occurs, to ensure seamless continuation of projects.
“By vetting the character of partners, understanding the legal and financial implications of partnerships, consulting experts and communicating openly, investors can unlock value in joint ventures which they may otherwise not be able to as individuals,” posed Kiruti.
