June 18, 2020
The secret that was never much of a secret is out... physician-occupied property is a real estate investment that is constantly near the top of the pyramid when considering returns on risk. Just take a look around at the REITs that want to buy these properties and the banks willing to lend against them. It’s no wonder that any developer would love to have the opportunity to invest in such projects occupied by strong practices.
Sometimes there can be a very good reason to join with a developer as a joint venture partner in a property that you will occupy. Other times, you may be better off passing or seeking a partner offering superior terms. The purpose of this article is to help physician owners decide whether or when it is advantageous to have a developer as a JV Partner.
As we go through this analysis there are some very basic rules to keep in mind:
- Don't conflate development and investment. They are mutually exclusive and should stand apart. A reputable developer will develop for a fee and will not tie his fees or performance to an interest in the project.
- In an income-producing property, the value is, for all intents and purposes, the lease. If your group is leasing the majority of the space, you are bringing the majority of the value and that needs to be recognized in any JV negotiation.
- In any JV, never pay more than you could otherwise negotiate as a renter. Any over-market rent or rent escalator is taking money directly from the practice’s pocket with some portion of that going elsewhere.
- Whenever possible, turn your negotiation into a competition. While the developer may be the most convenient JV partner, you should never lose sight that there are others that might be considered, depending upon the circumstance.
Okay, with those basic rules laid down, let's look at the factors to weigh when considering your developer as a JV partner.
Who’s got control?
What is important to realize here is that the developer and your practice may have very different objectives. Control allows you to utilize your property in the manner that is most beneficial to your practice and its partners. From most developers’ perspective, your project is a real estate investment. There are numerous ways to marry the objectives such that the developer receives an adequate return while the practice retains control and therefore assures the facility will always be there for the good of the practice. Always make sure that even if the developer owns enough shares to block a supermajority vote, the Operating Agreement stipulates that he or she cannot do so.
Covering the cash equity required
If you find that you need to raise additional capital or simply wish to reduce your investment, don’t limit your resources to your developer. There are many sources that are ready to invest and they should be well vetted and made to compete against one another. Again, factors such as control and the ability to buy back your interest should be considered along with the cost. A “Capital Shock Absorber” can bring needed capital during the start of a project when new partners are being recruited, or in the years where there are several retiring partners / redemptions, and the other partners don’t want to put up the cash. Investigate the opportunity to pre-agree that the developer is willing to be bought out down to a minimum investment.
If risk aversion is a priority, a strong development partner may be able to guarantee the debt and relieve the practice or its members from that requirement. This is often a good quid-pro-quo when considering the respective value brought by the partners.
Investment Experience and Partnership
Some developers bring value above and beyond that of just completing the development of a building. If we wanted to explore an exaggerated metaphor of this situation, we could investigate a start-up seeking a willing investor to support the company’s founding vision. Any entrepreneur would tell you that the experience and connections that investors bring to the table are worth far more than the check that they may or may not write. If a developer is willing to nurture and support your real estate venture and has the proficiency to add long-term value then it may be worth considering giving them a slice of the pie. Look for someone who wants to build value with you and has lots of references to prove it.
Leasing unoccupied space.
If you are building a project that is speculative in that there is a decent amount of unleased space, a partnership with the developer may be an appropriate way of sharing the risk and assuring yourselves that the risk is warranted.
The developer’s land
This last one is perhaps the poorest and most overused reason to either utilize the owner as the developer or to enter into a JV. The land should be valued and negotiated on its own merits. Steve Dobias of Somerset CPAs shares the following advice with his physician clients. “When considering the purchase of a site, do not go out to visit the site in a lab coat.” When a seller sees a doctor on site, the price of the land just went up.
Hopefully, some of what is discussed here can be kept in mind and help assure that any developer JV entered into is equitable and for all the right reasons.