Residential development joint ventures - a fine view

Andrew Brecher, Joint Senior Partner at niche property law firm Brecher surveys the new landscape for residential development joint ventures

Prince William and Catherine Middleton are not the only example of a successful recent marriage between Royalty and commoners. The London residential development market has recently seen a spate of mating between UK property royalty ie long established institutional funds, property funds and REITs; with residential property developers. We have introduced developer clients to the good and the great of the "institutional" property world and vice versa over the course of the last two years to form joint ventures for many developments in prime areas of the Capital.

There was a time when no self respecting institutional fund manager would even utter the word "residential" and would certainly not be seen in the company of a "residential developer". Yield and covenant acquisitions and "active" estate management were the only game in town for the institutional community but today in order to achieve realistic prospects of IRR returns around the 20% mark the institutions and funds are looking at the London high end residential development sector and realising that this is a sensible and astute area in which to invest. We have developed a variety of different structures which enable these institutional investors to feel comfortable entering into joint ventures with developers.

The most common drafting weapon of choice is the Development Management Agreement or "DMA" whereby the investor acquires the property and retains the developer as a development manager. The investor takes the top slice of the profit as a preferential coupon and the balance is then distributed in a manner that will hopefully result in the investor achieving a return in the high teens or early twenties. By taking the residual profits the developer is backing itself to achieve the projected figures it proposed to the investor at the outset of the venture. This type of arrangement allows the investor to retain ownership of the asset whilst allowing the developer to run the development pretty much in accordance with its usual modus operandi.

DMAs of this nature enable the developer to continue to carry on business and hence ultimately to make money, albeit on the basis of returns which are far less lucrative (on a percentage basis) then those achieved in the market a few years ago. The main risk from the developer's viewpoint is that most DMAs give the investor the right to rescind in the event that the developer is in breach and the developer therefore has to trust the institution or fund to take a sensible approach in the event of project timing or spending overruns. The developer has to trust the investor not to take advantage of a technical right to rescind the DMA and keep the property with the benefit of any accrued planning or other development work and effectively cut the developer out of any profit, purely as a result of a technical breach. We have found that pragmatism usually rules and an institution or fund's need for a lucrative IRR matches the developer's need to carry out business (which would be impossible without recourse to this sort of equity) and that these new unlikely bedfellows are in fact entering into successful relationships despite what may have appeared to be major cultural differences at the outset.

Now that the residential genie is out of the bottle I have no doubt that there will be far fewer institutional noses turned up at the residential development sector in the years to come.

Photo by Torcello Trio via Flickr.