Forming an entity to purchase, develop and operate real estate is generally a good idea for many reasons. There are tax considerations and liability implications that should always be at the forefront of any discussion when investing in real estate.  These are primary questions whether there are multiple partners or only a single investor involved in the deal.  But, when there will be more than 1 partner in a project, some sort of entity will need to be formed, whether a corporation, general or limited partnership, or a limited liability company or similar limited liability entity.  The “partners” (I am using this term generically to cover all  possible entities) should enter into an agreement carefully to set forth the rights and obligations of each partner so that there are not any questions about what happens in the future if/when certain problems arise.

Every relationship starts out with the best of intentions. Friends and family members, even acquaintances, generally trust each other to do the right thing.  But when money is involved or deals turn side ways, all bets are off.  Here are 6 provisions that should be considered in every shareholders, partnership or operating agreement, particularly when real estate is involved:

  1. Management Authority and Major Decisions – going into a real estate deal, 1 or 2 people might be the sponsors, or, 1 partner might have certain expertise and another might have a different expertise. Very likely, 1 partner might be the real estate guy and the other or others might be providing the capital.  It is important to determine who will make the day to day decisions and what decisions constitute “major decisions” requiring a vote of the partners.  Will  major decisions require a majority vote or a super majority?  Perhaps even a unanimous vote?

 

  1. Admission of New Partners – it is important to determine whether there will be spelled out criteria for admission of new partners and whether a vote of the partners is required to admit new partner or if the managing partner may admit new partners on his/her own. More importantly, will the admission of new partners dilute the voting interest or equity interest of the existing partners?

 

  1. Transfer of Ownership Interests – there are 2 concerns here, voluntary transfers and involuntary transfers. A voluntary transfer is the ability of a partner to freely transfer or sell his/her interest to 3rd parties.  Should this be permitted?  Or, should voluntary transfers be tightly controlled or absolutely restricted?  Involuntary transfers include transfers due to bankruptcy, divorce and death or a partner.  These are of concern to the partners because often, the non-transferring partners don’t want to be partners with the ex-spouse or surviving spouse, or be forced to deal with the bankruptcy trustee.  Therefore, it is important to provide mechanism for dealing with involuntary transfers.

 

  1. Capital Calls – the partners must determine the procedures for dealing with the need for additional capital and what happens when a partner does not fund.

 

  1. Buy/Sell Provisions – often, partners want to add provisions allowing for a partner to buy out the other partners. Sometimes, these mechanisms allow for “put and call”, requiring a potentially purchasing partner to sell his interest instead so that the financially stronger partner can’t force out the weaker partner any time he/she desires.  These provisions also can include rights of first refusal.

 

  1. Exit Strategy and Other Obligations – what is the partnership’s overall exit strategy? Have the partners agreed to sell the property at a fixed benchmark such as the exercise of a purchase option by a major tenant? What about other obligations like loan guaranties?  Are any of the partners obligated to provide guaranties for financing for the project?  These kind of provisions must be included in the partnership agreement.

 

These 6 provisions might only scratch the surface of issues relative to real estate deals. Every partnership and real estate transaction is unique.  If there are deal specific provisions, they should be added to the partnership agreement so that no questions or expectations are left unanswered.

Selecting the right property to buy or lease can be tricky. Every one knows the old adage “location, location, location”.  Clearly, location is crucial to every one involved in a real estate project from brokerage to development to construction; from lending to investment; from management to leasing, location will be a crucial factor in everyone’s return on the investment in real estate.  However, a corollary to location is zoning, zoning, zoning.  A property that does not have the proper zoning and land use designation for the proposed use, and one that can not be appropriately re-zoned, or variances obtained, will have no value to a buyer, developer, tenant or investor and location will add no value.

This rule applies to properties that are being purchased or that are being leased. A retail location might be the best spot in town for your client’s hot new night club.  But zoning might not allow any business which serves alcohol to be located in that location because a church is located within 1000 feet.  Or, noise regulations prohibit music after 10:00 because of the hospital across the street.   These are some of the things that should be considered even before entering into a contract or a lease.  They can save time and money.

When purchasing a property, it is a good idea to have preliminary, exploratory conversations with city planning and zoning staff to discuss the site. This is a good way to learn what the city would be comfortable with.  The meeting will help the buyer understand what approvals will be necessary for the project and will assist in formulating a timeline for obtaining approvals.

Upon preparing the contract, the buyer should make the obligation to close contingent upon obtaining the necessary approvals. The approvals can be specific, but I like to keep them as generic as possible.  For example, I define “Approvals” as all approvals necessary to enable buyer to obtain building permits to construct the Intended Improvements.  When pushed, I will list approvals to include, without limitation, zoning, land use, platting, site plan, and I will expand as necessary.

Many times, going into the contract, the parties know precisely what zoning is going to be required, or the seller has already begun the process of re-zoning in anticipation of a sale for such a use. This should not affect buyer’s contingency as the use drives the value of the property and must be in place prior to closing.

Zoning diligence before contract can make negotiations smoother and faster. It can also help buyers and sellers set a realistic price for a property, particularly because with proper approval contingencies, buyers won’t have to close if the zoning is not sufficient for the intended use.  But patient sellers will be more likely to get their desired price.

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