Owning real estate by an individual that does all management, repairs, marketing, tenant selection, legal structuring, financing, and improving income does not require joint venturing. The problem with ‘the one man show” is that the individual quickly suffers from restricted cash, mortgage financing, time and profit.
The purpose of the joint venture is to allow individual joint venturers to specialize in his role while allowing the business of real estate investing to grow. The business of joint venturing can be scalable to very large money raises, different geographies, and different properties. In simple terms, there are really only two components required for joint ventures. These are time or expertise and the other is money or mortgage qualification.
There are in essence three roles in joint ventures discussed today. The first is the finder, who is the individual that has found the property, has contracted the property, done due diligence and has the expertise to decide the quality of the investment. The finder is usually the deal scout or real estate agent that understands the neighbourhood or type of investment. The finder has expertise in negotiating the contract, negotiating financing and negotiating terms of ownership. The finder usually produces an agreement of purchase and sale for the joint venture to review in addition to market data and financing options for the joint venture to decide on.
The second role is the joint venture manager. The manager is the property manager, or manages the property manager, and the financial manager. The property management is the dealing with tenants by selecting them, collecting rent from them, the procurement of bids for review for repairs and the advertising for new tenants. The financial management includes the creation and reporting of the income and expenses for the joint venture including filing for income taxes and GST. The financial manager deposits rents cheques, reviews the utility bills, property taxes and repair bills and makes sure payment is made.
The third role in a joint venture is the investor. The investor will come up with deposit for the agreement of purchase of sale, the down payment for the purchase and participate on the mortgage qualification. The investor usually plays a more passive role and is dependant on the expertise of the other two parties of the joint venture.
Percentage of contribution, ownership, distribution and responsibility are all negotiable. An example that is on the far side of the spectrum is the assistance of a parent of a child buying his first house. The mother can be the investor providing the down payment and co-signing on the mortgage. The son can be the manager that is responsible for paying all mortgage payment, utility bills, paying for all repairs. Additionally the son is also the finder that is working with his realtor to find the property that he wants to live in. The requirements for cash calls on major repairs may be the full responsibility of the son or the son may make a cash call to Mom to fix the roof or repair the garage because it would be in both of their interests to protect the value of the asset. Both parties may have an arrangement that upon the sale of the house Mom would get her down payment plus half of the profit of the sale. If the son chooses to finish the basement for his enjoyment he may require that the additional $20,000 that he invested in the house be paid back to him upon the sale before the profit is distributed. Mom may require that a separate bank account be kept and funded by both parties 50-50 every year in the amount of $2,000 which will be the repair fund for the property and Mom may require to review the repair quote if more than $2,000 is being paid from or withdrawn from the account for the repairs.
Legal forms of ownership in a Joint Venture:
Joint Tenancy and Tenancy in Common
The parties of a joint venture could both be on title in the form of Joint Tenancy or Tenancy in Common. Joint Tenancy is equal ownership where upon the death of one party, that joint tenant’s interest automatically goes to the other joint tenant. The liability of the mortgage is joint and several meaning that both parties are responsible for the mortgage qualification and the mortgage liability.
Tenants in Common own a property in a percentage of interest and upon the death of a tenant in common, the percentage of ownership goes to their estate. The liability is again joint and several. The percentage of ownership interest can be sold to any third party unless in the joint venture contract the other joint venture party has the first right of refusal.
The above forms of ownership can be done by individuals which can be legal human entities and legal corporate entities. These two entities can form a Partnership which is a legal entity that must be registered in each Province and is an entity that must file taxes for the partnership in addition to the individuals. Also all cash distributions of gain or loss must be passed onto each individual. The danger of such a partnership is that one party can sign cheques or make commitments on behalf of the partnership and the liability of the partnership is joint and several.
Limited partnerships are a sophisticated form of ownership of a property. Limited partners are simply money partners that play a passive role and are only liability for their investment. There can be many limited partners but there can only be one General Partner. The General Partner can be a person or a corporation that is the active manager and owner of the property that has liability beyond its capital investment. Limited Partnerships that raise money through many unrelated parties are selling securities and thus must register an Offering Memorandum with the provincial securities regulating body and those that sell these securities in Ontario are called Limited Market Dealers (LMD). I am registered with a LMD in Ontario and the investment is sold in increments of $25,000 each. The return offered to limited partner units is 12% paid on a quarterly basis with a profit-share of all limited partners participating in 15% of profits made on the sale of the property. Therefore there may be an annualized return upwards of 20 percent per annum.
So far the property is owned by all parties of a joint venture which means they are all on title and on the mortgage. Some investors may not want to be on title nor on the mortgage for various reasons including confidentiality and limited liability beyond their investment. In this case the property and mortgage qualification would be the role of the individual in the Joint Venture that will hold the property “in trust” for the Joint Venture. In other words, a Bare Trustee is the individual that has full title ownership and is on the mortgage. An investor will hold ownership interest in the property by contract with the Bare Trustee which can be registered on title in the form of a Caution, which in the Ontario Land Registry, is a caution requiring all parties to make themselves aware of the Caution registered before the mortgage is refinanced or the ownership interest is transferred. Another way for an Investor to register its ownership interest is in the form of an equity participating mortgage registered on title.
A corporation is a practical Bare Trustee that has share ownership in the form of joint venture percentage interest. The joint venture agreement can in the form of a shareholders agreement. Shares can be held by persons and corporations. The benefits of corporations holding property are limited liability of shareholders; the privacy of the shareholders; the separate accounting, banking and tax filing required. The negatives of corporations are additional paperwork and costs to maintain the records and tax filing. This form of joint venture vehicle is for sophisticated parties and larger properties including commercial properties with sophisticated commercial tenancies. Another difficulty is that for shell corporations that are formed for the purpose of holding property have no credit history and require shareholders to give their personal covenant for the liability of the mortgage.
Certificate of Independent Legal Advice
All parties of a Joint Venture are highly recommended to receive legal advice to complete understand the implications of the joint venture relationship and agreement. In the courts of law, the unsophisticated investor can weasel out of an agreement by claiming ignorance and a sophisticated party such a realtor or manager of a joint venture would be liable for releasing the unsophisticated party, unless the investor received Independent Legal Advice (ILA).
Cash calls and Property Reserve Bank Account and Operating Account
The Financial Manager will deposit the rental income and pay the expenses of running the property. To prevent additional cash calls beyond the initial capital invested the Joint Venture may require a Reserve Fund to be funded with a minimum of about 12 months gross rental income before there are distributions to joint venture parties. Controls on how funds are being spent by the financial manager may require a limit of example $1,000 dollars before the joint venture parties must all sign off on funds being spent.
What if a cash call is made and an investor does not fund within a reasonable time? Then other investors may be able to acquire additional ownership interest by funding the required capital.
Reporting, Notifications, Distributions and Sale
Modes of communication should be properly defined either by mail, email, fax or phone. Accounting, investor relations and property management communication by the Financial Manager should have their frequency of reporting agreed upon giving investors comfort that the property is being taken care of and all needs are being met to protect and grow their investment.
Distributions of rental income, proceeds from refinancing or proceeds from sale of the property are definitely something to celebrate and bring comfort to investors. Sale of ownership interest should give current investors the first right of refusal to retain ownership within the original ownership group.