Joint Ventures
Sometimes it is not possible or desirable to buy properties in bulk, or in a syndicate. If you are considering buying a property by yourself, it is still possible to receive a genuine discount off market value.
Properties in the early stages of a medium size development are often sold for less to encourage sales. However, the disadvantage to buying at this early stage is that the development may not proceed, due to poor sales. If there are a few properties left at the end of a development these may also be sold for less, either because marketing one or two properties is not cost-effective, or the developer may simply want to move on to the next project.
Vendors sell for many reasons, and these factors can also lead to properties selling for below their true market value. To take advantage of opportunities as they arise, you must carry out thorough research and become an expert on sales prices in a particular area. If you find a property you like, but you think is too expensive, make an offer anyway. It costs you nothing other than time, and unbeknownst to you the owner may have an urgent need to sell.
If you cannot afford the cost of a deposit bond or do not qualify for a bond, you need a joint venture partner.
Joint ventures are usually between two parties, each of whom is providing something the other party needs. You might have the time and knowledge to find properties at below market value, and the confidence and ability to negotiate the purchase of a property at a genuine discount price, but not the money or the assets required to get a deposit bond. A joint venture partner could secure and pay for a deposit bond, but may not have your real estate knowledge, ability, or inclination to find the right investment property.
What you should know
In order to persuade a potential joint venture partner that you have found a suitable investment property, you need to prepare a mini financial report in the way I have described. Ideally it would include:
- An agreed purchase price
- Comparable sales evidence
- Rental estimates
- Financial analysis
- Independent valuation
- Depreciation schedule
The last two items are not absolutely essential.
If you cannot afford the cost of an independent valuation, you will need to use comparable sales evidence to convince your potential joint venture partner that you have negotiated the purchase of a property below its market value. You will still need an independent valuation later to satisfy the bank, but your joint venture partner may agree to pay for this as well as the deposit bond if you can reach a satisfactory joint venture agreement.
Likewise, it does not matter who pays for the depreciation schedule and other costs, provided that the person who is paying is compensated in some way through the joint venture agreement.
If you cannot afford a depreciation schedule but you still want a joint venture partner, leave the allowable depreciation total at zero dollars. If you do identify depreciable items at a later stage, you can claim these in your tax return. However, your main focus should be on securing investments that are positively geared before tax. Any allowable depreciation items will not affect this.
If you do not know what income your joint venture partner makes, make a conservative guess. Just like a depreciation schedule, a person’s income has no bearing on how an investment is geared before tax. The financial analysis asks for a person’s income to determine how the investment will be geared after tax.
If you underestimate a person’s income, and the investment is still positively geared before and after tax, the correct income will not affect how the investment is geared, either before or after tax.
If, on the other hand, you overestimate your joint venture partner’s income and later insert a lower figure in the financial analysis, it may affect how the investment is geared after tax.
For these reasons, it is not crucial that you have a depreciation schedule before you meet with your potential joint venture partner. Likewise, it is not mandatory to have an independent valuation when you agree in principle to a joint venture agreement. However, it is better to have an independent valuation before entering into a sale contract to purchase your investment property.
It is, however, crucial to have the first four items on the above list when meeting with a joint venture partner.
I have already explained how to collect rental estimates, comparable sales evidence and how to prepare a financial analysis.
The purchase price
The other crucial piece of information is a purchase price that the property owner has agreed to. Knowing that you cannot afford a deposit bond, you must proceed carefully when negotiating an acceptable purchase price, but there are ways you can protect yourself from making commitments you cannot meet.
The simplest way to avoid any problems is to keep your negotiations verbal. Usually, though, as negotiations draw to an end, the estate agent and owner will want you to sign a sale contract. To delay this, make it clear you will sign a contract but only after you reach a satisfactory agreement. Without an agreement, there is no need to waste anybody’s time with unnecessary paperwork.
If you agree on a satisfactory purchase price, meet any potential joint venture partners you have in mind, but be aware that if you delay signing the sale contracts too long the owner may sell their property to someone else.
If you do sign a sale contract before you have had time to finalise a joint venture agreement, you can include a clause in the Sale contract to this effect:
This sale is subject to and conditional upon the purchaser obtaining a deposit bond, which shall be provided to satisfy the deposit requirements of this contract. This condition ends after 7 days from the date of this contract. If the purchaser cannot obtain a deposit bond within the time specified, the purchaser may end this contract by informing the estate agent (or owner) in writing and if the contract is ended all monies paid must be refunded in full.
This condition gives you one week (or longer, depending on the time specified) to find a joint venture partner and secure a deposit bond using their assets. If you are unable to find a joint venture partner, and as a result you cannot secure a deposit bond, the sale contract can be terminated without becoming a liability.
Options
Another way to protect yourself is to use an option. An option gives the purchaser greater protection than the clause above, because it does not apply specifically to deposit bonds and allows the purchaser to end the sale contract for any reason.
Options are usually created by solicitors, and accordingly, they attract legal fees. Options also usually include a non-refundable cash payment, which is paid to the owner if they agree to the option.
An option is like having an extended cooling-off period, during which time the purchaser can contemplate whether they will buy the property. Because options offer the owner no guarantee that their property is sold, the owner usually receives a non-refundable cash payment to entice them to accept the option. The owner keeps this money whether the option holder decides to buy the property or not.
If the owner agrees to the option, the property is taken off the market. The option holder then has the exclusive right to purchase the property at the agreed price. Options are usually for periods longer than one week, and may last for months. Developers or speculators who want to carry out more extensive research before buying a property often use options. This research can take considerable time and money, and a prospective purchaser does not want to commit time and funds to a property without some reassurance that it will not be sold to another buyer.
A typical example of when an option may be used is a developer wanting to buy a multi-unit development site, but only if they can build high-density units. If the property is purchased with a six-month option, the developer can approach local council and other relevant authorities to seek permissions to develop. Usually, the longer the option lasts the more it will cost the developer, but it could cost a great deal more to buy the property and then discover that there are restrictions preventing a development.
Although there may be other ways to negotiate the purchase of a property and still have the time to find a joint venture partner, the techniques I have mentioned are the most common. Estate agents, in particular, are familiar with them, and as a result, if you use these methods, you should not encounter much resistance.
Once you have agreed to a purchase price and prepared your mini financial report, meet with your potential joint venture partner and go through all the information. This meeting will be excellent practice, and a good opportunity to boost your confidence for similar meetings you will have with valuers and bank managers.
To persuade a joint venture partner to invest in the property, you need to convince them that the equity they will make from buying the property will be far more than what it will cost them. In fact, what you are selling to a potential joint venture partner is a business opportunity too good to miss.
For example, say you want to purchase an investment property for $330,000, and this property has been independently valued at $370,000. If your joint venture partner invests $2,500 for a deposit bond and an independent valuation, they will receive half of the investment property, and therefore half of the $40,000 equity. They effectively make $20,000 worth for only $2,500.
Ideally, both parties share equally all ongoing costs after the property is settled, and both parties have an equal share in the property. This ensures that when the investment property is sold, the profit is also shared equally.
The point you must emphasise to your joint venture partner is that although it may appear that they are providing the whole funds to settle the property, you expended time and energy searching for properties. You also spent money driving around inspecting properties to make this deal possible. If you both agree, you can jointly apply for a bank loan and share any ongoing costs after the property settles.
If you have found the right investment property, your out-of-pocket expenses after the property has settled should be nil or negligible. As I mentioned, this is the ideal.
Most homes are sold to couples who have a similar arrangement, even if it is not formally written down or referred to as a joint venture. However, you are not limited to joint venture agreements where both parties have an equal share in a property.
Alternatives to joint ventures
One burgeoning real estate business is buyer advocacy services. Buyer advocates work just like traditional estate agents—in fact most buyer advocates are former estate agents—but they work for the buyer, not the seller. Also, like estate agents, buyer advocates work on a commission-only basis and charge a fee based upon the purchase price of a property.
Usually, the commission fee charged is between 2–3 percent of the purchase price of the property. If you find a suitable investment property and an investor willing to buy it, you might decide to receive an advocacy fee for finding the property instead of forming a joint venture agreement. Verbally negotiating the purchase price of a property does not mean you have to sign the contracts to buy that property. You may prefer to make money from real estate without buying a single property.
Another alternative might be to find a joint venture partner who buys the property you have found solely in their name. You then enter into an agreement whereby you are entitled to a share of the profit if the property is sold in the future. Under this arrangement, you will not have to contribute to any costs relating to the property. An arrangement like this may suit people who do not want to apply for a bank loan, even with another person, for fear of being rejected.
As an example, if you negotiate the purchase a property for $330,000 and it is independently valued at $370,000, you might find a joint venture partner who prefers to buy the property solely in their name. You might agree to enter into a joint venture agreement that if the property is later sold for a figure over $330,000, you will be entitled to a percentage above that figure. There are no set rules on how you should structure this agreement. The nominated figure could be between $330,000 and $370,000, and the percentage you receive could vary between 1 percent and 50 percent.
It is important to remember that if your joint venture partner is the sole owner of the property, they will incur all costs when the property is sold. As I explained earlier in this book, the selling costs are generally around 5 percent of the property’s value. Therefore, you might include in your joint venture agreement that you are entitled to a percentage of the profit after all selling costs have been deducted from the property’s sale price.
Your joint venture partner may have no intention of ever selling the property. If this is the case, obviously you cannot use a sale price to determine how much money you will receive in the future. Instead, use an independent valuer’s assessment of the property’s value after a predetermined time frame. Based upon this independent valuation, your joint venture partner should pay you your entitlement under your joint venture agreement and the agreement is then terminated.
If your joint venture partner does not have the funds to pay you, they can re-finance the property to raise the money required.
Whether a joint venture entitles both parties to an equal share in a property or not, if you can find a property below its true market value and you can clearly demonstrate this to a purchaser, you can make money from real estate. The type and number of joint venture agreements you can make are endless. The only limit is your imagination.
Summary
- A joint venture partnership can be a good alternative to deposit bonds
- The financing partner needs to feel that the equity will repay their investment
- The depreciation schedule, and your partner’s income, do not affect gearing before tax, only after tax
- Agree on a purchase price and protect yourself, either contractually or by using an option
- Alternatives include buyer advocacy commissions, or a joint venture partnership buying in only one person’s name
