One of the more common ways that an institutional investor (Investor) invests in real estate is by teaming up with a local operator or developer (Operator) in a joint venture (Venture) to acquire, and sometimes develop or refurbish, real estate. More often than not, in the authors’ experience, the Investor will contribute at least 90 percent of the required equity capital to the Venture with the Operator contributing the balance and being given more than a 10 percent share of the profits if certain economic hurdles are satisfied. This structure is sufficiently common that forms have been published to document such an arrangement.1 This article will briefly address the desire of many such investors for assurances regarding the ownership, control, and continuity of the Operator and how the Operator may react when asked to provide these assurances. For convenience, this article will assume that in the Venture under consideration the Investor will contribute 90 percent of the required equity.

THE INVESTOR’S PRIMARY OBJECTIVES
The Investor’s decision to team up with the Operator is, in effect, a wager by the Investor that the Operator will be able to successfully produce a profitable project if the Investor provides 90 percent of the required equity investment. Prior to forming the Venture and making the investment, the Investor will typically seek to identify who owns and runs the Operator, the sources of the Operator’s 10 percent investment, and the individuals who will be critical to the project’s success in order to reassure itself that investing capital with the Operator makes sense.

The Investor’s review of the Operator will likely also seek to satisfy the following Investor objectives and concerns:
• That the Operator is capable of bringing the project to fruition;
• That the Operator’s team will be able to comply with the Investor’s strategic, operational, and regulatory requirements;
• That the Operator’s team will be sufficiently incentivized to care about the project for the duration of the project;
• That the Operator has a good reputation; and
• That the Operator’s team is of good character.

These objectives and concerns may bring to mind familiar concepts in the fund context of sponsor due diligence, alignment of interest, skin in the game, and key persons. The consequences for failing to satisfy these objectives and concerns may vary but the intentions are similar and the requirements for the Venture may go beyond those imposed in the fund context.

The Investor’s primary objectives may be achieved in a number of different ways such as:
• Requiring a minimum level of investment in the project from the Operator’s own capital;
• Requiring the owners of the Operator to maintain majority ownership and control of the Operator for the duration of the Venture;
• Requiring the active involvement of the critical individuals in the project for a specified period of time; and
• Requiring the disclosure by the Operator of significant problematic information regarding the Operator or the Operator’s team.

As with most venture issues, the devil is in the details.

CLICK HERE to read the full article, which was originally published in ALI CLE’s The Practical Real Estate Lawyer.