Programmatic (or platform) real estate joint venture (JV) structures represent a sophisticated evolution of the traditional real estate joint venture model. In case you missed it, in part one of this three part programmatic JV 'mini-series' we gave a crash course on programmatic JVs and explained why we believe they could prove important in this next phase of the economic cycle. To read it, please click here.
In parts two and three, we delve into the topics that form the foundation of programmatic real estate JVs. We explore the specific terms that distinguish these structures from traditional JVs, providing you with insights into common negotiation battlegrounds. In this part two, we focus on exclusivity and investment discretion. In our upcoming part three, we will explore economics, liquidity, and default.
Exclusivity
One of the biggest drivers behind the evolution of the programmatic JV has been capital partner desire to secure access to operating partner deal flow in an increasingly competitive commercial real estate market. Capital partners in programmatic JVs are laser focused on trying to 'lock-in' the operating partner so that it routes its deal flow exclusively through the JV. On the other hand, operating partners want to maintain flexibility to operate their wider business without excessive constraints.
As ever, the compromise position between the parties largely depends on their respective bargaining positions, but a common middle ground is to grant the JV exclusivity, or a right of first offer (ROFO), over pipeline deals meeting specific investment criteria. These criteria typically include factors such as asset class, geographical location, projected returns, equity requirement parameters and/or projected hold period.
The operating partner will want the right to pursue any deals rejected by the JV independently, but the capital partner will ideally want the JV to be the operating partner's sole focus. The capital partner will, ultimately, make an assessment as to whether the operating partner has sufficient resources to juggle both. Regardless, the capital partner usually insists on a blanket restriction against the operating partner pursuing rejected deals that compete directly with the JV's existing assets.
Crucially, operating partners are typically only willing to marry their deal-flow to the JV for so long as the JV is actively investing. Therefore, it is common for the exclusivity provision to operate for only a defined period of time or until all of the JV's allocated capital has been deployed, whichever comes first. Operating partners also typically seek a 'strike-out' provision, where exclusivity falls away entirely or for a specific duration if the capital partner rejects a certain number of deals presented by the operating partner.
Capital partners subject to a 'strike-out' provision need to be cautious not to define the investment criteria underpinning exclusivity too widely or loosely, otherwise they risk striking out on deals (or a portfolio of deals) which sit outside the JVs investment focus. To mitigate this, capital partners often establish a narrower 'core' investment criteria for the strikeout provision and exclude proposed deals with certain threshold issues, such as environmental concerns.
Investment discretion
Given that a primary feature of programmatic JVs is the aggregation of assets over time, establishing a framework to govern the acquisition of new assets is crucial. This is often achieved by the operating partner sourcing deals and running the acquisition process, but with the capital partner retaining ultimate investment discretion. This investment discretion can be maintained through a veto right or by requiring affirmative approval from the capital partner. In some cases, capital partners may also have rights to unilaterally compel the JV to acquire certain assets that meet the investment criteria of the JV.
Whilst the capital partner will aim to maintain final decision making authority, it is in the best interests of the JV for the operating partner to be capable of acting swiftly and decisively in the market. Therefore, it is important for the parties to establish a clear and streamlined investment discretion process. This process should outline the information and materials to be provided by the operating partner, timelines for responses and decisions, whether updated consent is required when terms and details change, etc. However, even the most well-oiled investment discretion process cannot always keep pace with every transaction in the market. We find that the most successful JVs are able to operate dynamically and flex away from the prescribed process where necessary.
Another key point to consider is which party bears the transaction costs incurred in pursuing deals. Typically, these costs are chargeable to the JV, but a well advised capital partner will seek guardrails, such as per-deal caps or requiring the operating partner to bear a proportion of the costs if a deal is not approved. If the capital partner ultimately rejects a deal and the operating partner proceeds independently (as discussed in the exclusivity section above), the capital partner often requires the operating partner to reimburse the JV back for the transaction costs it incurred for that particular deal.
Anecdotally, we have observed a growing trend where capital partners are placing greater emphasis on the operating partner bringing seed assets to the table when establishing new partnerships. This approach enables the capital partner to deploy capital from the outset and provides both parties with insights into each other's underwriting approach. This alignment in underwriting is crucial for achieving significant scale in the partnership.
To be continued...
Stay tuned for the upcoming third part of this programmatic JV mini-series, where we will further analyse the differences in key topics between programmatic JVs and the traditional JV model across economics, exit and default.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.