A JV (or JVA) is a Joint Venture Agreement; basically, it’s a partnership. Some people recently have been asking me my opinions about whether they should get involved in these types of operation agreements. The story is generally the same: one investor knows of a distressed and motivated seller and approaches another investor to partner on a Honolulu flip deal. Why would the first investor approach another instead of doing the whole thing himself? It could be a mix of multiple reasons:
- Doesn’t have enough funding to acquire and/or rehab the property on his (or her) own
- Doesn’t have the rehab knowledge or an available rehab team ready to go
- May not like the neighborhood of the property but still wants to capture some profit
- May be willing to sacrifice some profit in exchange for the time it will free up to work on other deals simultaneously
The last one is interesting because it represents not a limitation (as in the first two) but a strategy. Instead of having all your eggs in one basket, this method allows the investor to diversity his interest in multiple properties. I also need to point out here that while diversification (referring to stocks and bonds, generally) is usually talked about as a good thing in investment circles, there are many who have the opposite approach and consider it a drag on returns instead. So again, this strategy is not necessarily the correct strategy, but it is an option for the investor who believes in diversification as beneficial.
Holes in Your Joint Venture Agreement?
Back to the point – should you agree to a joint venture agreement in the first place? Assuming a two-person JVA and clearly defined responsibilities for a fix and flip deal, here are just a few of the risks:
- Partner doesn’t bring in required funding as per terms of the JVA (the terms should clearly define who is responsible for what). These could be funds towards the earnest money deposit, cash at closing or rehab.
- Partner undervalues the after repair value (ARV), shrinking potential profits or even sending the deal into a negative equity situation
- Partner mis-manages the rehab (hires inadequate contractor, underestimates cost or needed repairs, over-rehabs, etc.)
- Partner doesn’t assist with finding a buyer after rehab or generally becomes lackadaisical
- Partner micro-manages you and becomes unpleasant to work with – this could be the worst one of all!
So does this mean you should not enter into a JVA on that great deal in Pearl City? Not necessarily. I know an investment group here in Hawaii that only does JVAs and is apparently doing quite well. I’m even likely to join them for a couple projects in the very near future. However, there are some clear guidelines you should follow to maximize profits as well as protect your investments. Here’s a list of what I feel are the most important:
- Define your terms upfront. Without questions, all parties should know exactly who is responsible for what and on what timeline. Mis-managed expectations is a sure path to failure. Get this in writing.
- Know your partner(s). Don’t go into a JVA with people you don’t know well. Do you have similar goals for the property? Similar ideas on the profit structure of the deal? Do you trust your partner? Talk to others who have gone into business with them. If you have any reservations about the motive or integrity of anyone else involved, do not do it.
- Verify funds. Talk is cheap. If your partner says they are contributing $100K towards a deal, be sure they have it. Ask to see a bank account statement or proof of funds from a lender, otherwise you risk becoming trapped in a deal that you can’t back out of or to which you’ll need to contribute unexpected funds.
- Do your own homework on the deal itself. Run your own CMA comps. Is that Makakilo house really going to be worth $525K when it’s done? Show it to a separate contract or handymen if you like to verify your partner’s rehab numbers. Maybe the roof needs to be replaced after all – your partner may not have budgeted for that.
My mentors generally suggest that if you’re going to enter into a JVA, that you do so on a deal-by-deal basis which I think is great advice. That way, you can “test out your partner” and see if it’s a business relationship you want to build further or if it’s a once-and-done experience. Joint Venture Agreements can provide an easier form of entry into the real estate industry for the beginning Hawaii real estate investor. Just understand that they also present other considerations and potential pitfalls that demand your attention if you’re going to be successful.
Do you have experience with JVs? Good or bad? Share your thoughts and experiences below….!