Programmatic JVs: Structural Distinctions, Key Considerations
- Jul 06, 2016
Historically, institutional capital sources and real estate operators and developers have made real estate investments together through either single-purpose joint ventures or commingled funds. While these models remain commonplace in the industry, a hybrid approach known as programmatic or platform joint ventures (PJVs) can offer significant, mutually beneficial efficiencies in respect of critical considerations such as time and expense needed to underwrite transactions, deal flow within a specific investment strategy and certainty of execution. However, PJVs have certain inherent structural distinctions that investors and sponsors alike should consider, in particular with respect to exclusivity, investment strategy and economics.
- Exclusivity. A primary benefit of PJVs is they permit investors to deploy (or at least commit to deploy) large amounts of capital through a small pool of quality sponsors who are typically subject to some measure of exclusivity. In return, sponsors secure a reliable source of capital on known terms, which can be an effective mechanism to quickly create or expand a brand, as well as increase assets under management–and sponsors are often compensated for their exclusivity. However, as in a single-purpose joint venture, the parties must balance the investor’s desire to retain control with the practical need for the sponsor to both execute the PJV’s investment strategy and operate its broader business. An exclusive relationship also introduces additional complications. For example, under what circumstances can the investor decline investment opportunities or the sponsor pursue declined investment opportunities, or either party terminate the exclusivity? And how much time and attention must each party dedicate to the relationship?
- Investment Strategy. The importance of a rigid versus flexible investment strategy will likely depend upon several variables, but will be influenced in large part by the answers to the questions posed above. For example, in many cases, PJVs are structured around an investment strategy that takes into account asset type, equity required on a deal-by-deal basis, geographic footprint, leverage restrictions (both asset and portfolio) and target returns. But deals rarely fit neatly into that box, and while the investor might expect the sponsor to present all investment opportunities that are a potential match, the sponsor may instead shy away from exposing a likely outlier opportunity to the restrictions applicable to declined opportunities. Accordingly, it is important for the parties to consider common variables on the PJV’s investment strategy at the outset, such as whether the PJV should provide for the ability to pursue “outsize” deals with a third-party capital partner or enter into a subsidiary joint venture with another sponsor if necessary to secure or realize an opportunity (and if so, whether that should have an impact on the economics within the PJV).
- Economics. As in a commingled fund, both investors and sponsors can realize meaningful efficiencies through the pre-negotiated fee and promote structures inherent in most PJVs. In addition, pooled or crossed portfolios (or, alternatively, a holdback or clawback) are common in both commingled funds and PJVs, and protect the investor’s overall returns. But the investor’s discretion with respect to the PJVs acquisitions and operations means the parties will need to ensure that the proposed fee and promote structures sufficiently align the parties. For example, should the sponsor be entitled to an advance of fees that are based on invested capital, or to force a premature sale in order to maximize IRR and promote?
PJVs have emerged over the past few years as a compelling investment model for both investors and sponsors, but it is important to understand their nuances to maximize the available efficiencies.