Podcast Series 11: How to buy Small Apartments with Joint Venture. Featuring Real Estate Attorney John Gutierrez
Cordell:
Hello everyone Cordell Davenport here with small apartment investors and I’ve have a YouTube channel and I have a podcast that I talk about mindset skill set when it comes to small apartments and my very first podcast I mentioned that I want to introduce different people and bring people the main pillars when it comes to being successful and those are CPAs real estate attorney ,a mortgage program property management those like the four main pillars, you got to have somebody like that on your team and what I have today. I have John who represents the wheelhouse so to speak for the real estate attorney side of things everyone but on camera is not working right now.
I’m going to give a little intro about John he’s going to tell us about himself and then today he’s going to talk about joint ventures. John is and has been real estate attorney in good standing with the state bar of California. For 30 years specialized in practice his exclusively transitional real estate land use and business law practice includes among other things business information joint ventures partnership corporations limited liabilities buying and selling businesses, which is a great one.
I didn’t know you did that actually John that’s a good thing. Buying a selling leasing real estate both residential commercial subdividing property to create. Lots and condominiums and developing an entirely property for residential commercial use purposes use a graduate of University Wisconsin Badgers, I’ve been in Wisconsin. He went to UC Berkeley School of Law.
So now I welcome everybody John.
John:
Hey everybody, thank you for that introduction. Cordell. I appreciate the opportunity to be one of the first people to participate in your adventure. Thank you. It sounds very interesting. And I appreciate the opportunity to meet anyone or every one of the people who are listening.
Yeah, I name it. Sorry. I’m just going I’m just adding good good, all right. So, my name is John Gutierrez. As Cordell has read to you. I’ve been practicing law for 30 years. I grew up. I was born in Mexico came to the United States at a very young age grew up in the Midwestern part of the United States at.
Attended the University of Wisconsin studied economics and political science, of course and attended the University of California. School of Law formerly known as Bolt Hall School of Law. And. My initial incarnation as an attorney was as a corporate and securities law attorney. I practiced in Chicago for a few years and then moved back to California after a couple of winters and summers reminded me what the weather was like in the Midwest came back to California.
Continued practicing corporate and securities law. Took some time off and managed political campaigns state local and national campaigns. And then returned to the practice of law this time practicing business and real estate law. And I have to say that in general, I have found real estate law practice to be more satisfying and fulfilling.
Than some of the other more esoteric areas that I practiced and really it comes down to real estate is something you can see. It’s something you can touch. It’s something you can feel and it just made it more interesting to me.
The simplest explanation is that. I decided in my first year of law school that I did not want to be a trial lawyer. I preferred transactions to litigation. There’s a certain pro lack of a better word. There’s a certain personality that does better as a litigator and that sort of showman is just not me.
I’m much more sort of practical and I like connecting dots and make. Things which is how I view transactions as opposed to personality conflicts and clashes, which is how I see litigation no disrespect to my brothers and sisters who practice litigation but as I said, it just wasn’t for me and I found transactional work to be much more satisfying.
It’s collaborative. It’s working with someone on the other side to arrive at a mutually satisfactory conclusion, whether it’s a joint venture, whether it’s to acquire real estate. Whether it’s to develop real estate. And to have something standing after I finish my representation is satisfying to me as opposed to just having a notch in my belt of having one or lost the lawsuit, so that’s that’s the short answer.
Cordell:
All right so now we’re going to get into joint ventures and the thing about a joint ventures everybody is it’s something actually that I’m going to try to do next year myself. But the thing is for joint ventures is that you can basically accomplish more by 20 forces of other people and sometimes where you have a strength the other person have a weakness or vice versa a person may have money my person may not have money with I know the one thing that John is going to probably talk about is that everybody has to have an active role in comes to a joint venture and joint ventures are.
John:
All right, well we’ll just sort of wing it here, okay? So joint ventures are is just a fancy way of describing collaboration, it’s two or more people as you said Cordell two or more people with different strengths different weaknesses combining with each other to create synergy to create something bigger than two people or three people.
There are different ways people do that they form partnerships, they create corporations or limited liability companies. They all become owners of the same entity whether as shareholders or as members or as the partners. Or they do it as joint ventures where they can either be separate but connected in a variety of different ways or the members of the joint venture can all operate under a single umbrella such as a corporation or a limited liability company or a partnership so one of the things that’s interesting about joint ventures is that there are many different ways that you can structure the joint venture depending on what the needs and objectives.
Cordell:
Of the different members of that joint venture or JV how do you slice up the pie though in regards like one person may do let’s say asset management or paying how big the property is or what kind of property it.
One person may say okay well I’m come up with the down payment and I come up with earnest money and one person makes a young. I’m gonna manage all the contractors. I’m gonna manage to rehab. I’m gonna do whatever it is. How does that typically work? And setting up my percentages of who gets what within a joint venture.
John:
That’s a good question so let’s assume then that the joint venture is you and I and a third person coming together the first thing we decide is what is each of us bringing to this opportunity. Is it money is it real estate is it a skill set is it some or all of those things?
And presumably the reason people create or become part of joint ventures is because they’re lacking in something of the money the expertise and knowledge the motivation even so let’s assume that in this particular joint venture there are three of us and we organize ourselves as a single limited liability company.
Or an LLC. Each of us will be a member of that LLC each of us will have an ownership interest in that LLC. In terms of dividing the ownership interests. First and foremost we look at what is each of us bringing to this party. Cordell, you may already own the real estate or it could be that you’re going to be the primary person who scouts.
A location for a particular type of property and you find that property it might be that you have the deepest pockets among all of us, you’ve got the most cash. Available. For again you have the expertise from your property management background from your mortgage lending background, all of those different things have taught you things that perhaps I or the other member of our venture don’t have or not as strong in so often enjoyed ventures, the property has already been either identified or has already been acquired.
And sometimes it’s one person who already owns the property who is going to contribute. That asset to the joint venture. In that scenario where you’re the owner of the property your probably the biggest player in in the joint venture. So your share of ownership is going to be bigger than say my side which might be I have no money but I have a lot of expertise and so we put some value on my expertise and the third person who’s joining us.
May also have a an asset in the form of a big pile of cash. So with one of us already owning the real estate, another person who’s going to provide the sort of lubricating Greece the money to make things happen and the third person who’s going to be the sort of engine that’s pushing whatever it is that’s going to be done with that real estate.
So often the purpose of acquiring somebody else’s real estate as part of the joint venture is. To change that real estate in some way to make it bigger more productive oftentimes someone who is a member of the JV will own raw land or they’ll own property that has either a single family home or a small number of residential units on it and the plan of the joint venture is to scrape that land and redevelop it into 10 units 15 units 20 units30 units, etc.
So again in that scenario you the landowner probably have the biggest piece of the pie typically we try to create some sort of financial profile to value all of the different assets that each of the members are going to contribute. My know how your real estate somebody else’s cash and the percentages will probably flow according to the relative.
Percentages that each of the three of us or the values rather of the assets that each of the three of us is going to contribute. So as the owner of the of the biggest asset. And again the purpose in the scenario that I’m describing is we’re going to take an asset that’s worth let’s say a million dollars the real estate that you already own and we’re going to scrape it and we’re going to get it entitled for 20 residential units and we’re hoping that those units will either be rentable and a high market rate or they’ll be saleable.
Typically as condominiums. At a much higher value. So we’re hoping to take our million dollars and turn it into 10 million dollars.
Cordell:
But let’s say that someone’s going to buy a 30 unit apartment building and but now is it like five is max? I heard regardless of JV members live about five people.
John:
No. Well, there’s no. Well, let me say it this way just to try to keep it simple.
JV’s can any any collaboration any joint venture any? Investment to organization that two or three or four individuals might create together.
May look simple on the surface and has a lot of complexity below the surface and one of the complications or potential complications is that and in this case I’m speaking specifically about the law and the mechanics of creating an operating a joint venture. So one of the first questions in determining the organization of of a joint venture is who are the members?
What are their backgrounds and qualifications both intellectually asset-wise sophistication? And net worth. And how many people do we need in order to hit the target that we’re trying to reach? One of the questions that comes up is that generally speaking selling somebody a membership interest in a joint venture can be considered a security.
When people think about securities they think about the stock market. However, a stock in a corporation is just one form of security. A security can be anything that. Arises from one person investing in the knowledge brain power and capital of another person who is going to take that money and try to make it grow.
So party a giving money to party B in the hopes that B will turn the money into a three times five times ten times return. Potentially can be treated as a security. And as a security it has to comply with either registration requirements before the membership can be offered and sold.
And the people who are acquiring security may need to have certain qualifications in order to minimize the process. Or avoid the process of having to register securities with the commissioner of corporations in California. So determining who are the members of the JV what their backgrounds and qualifications are will lead to the conclusion that selling them an interest or having them invest either will result in a security that has to be registered because they are a passive investor which is often the I’m sorry the other way around.
Because they. I’m sorry. I’m confusing myself here. Securities generally speaking must be registered, however, there are certain sales of securities that can be exempt in order to determine whether or not registration will be required or that the sale of interest to different members will be exempt hinges upon whether or not the people who are investing contributing are of a certain net worth.
Incredibly right. Accredited or sophisticated in California, it’s not merely accredited it can be people that have done business transactions with the promoter in this case you a promoter or sponsor it can be people who have a net worth of a million dollars independent of any equity in in their home or it’s people that own individually $200,000 per year or as a couple hundred thousand dollars per year.
So determining who the membership is important because it has consequences or potential consequences at the very beginning of the transaction even before anything has happened in terms of taking money from people or starting the the business of the joint venture. So as I say oftentimes joint ventures look fairly simple on the surface, but when you scratch them and you look below you discover that maybe there’s a wide variety of potential investors and they vary according to their net worth.
They vary geographically. If you are trying to solicit money from people outside of the state of California, then you have to be mindful of the laws of the state where the person you are soliciting reside. And again, generally speaking it’s securities laws that we’re looking at because you’re selling something to someone who has the expectation that they’re going to make a return or a profit on their investment and depending upon whether they are actively involved or passively involved that may have some bearing on how you manage the securities law compliance process.
Cordell
Good something to add on to that, so I know it’s syndication yet a GP yet the LP General Partners under Department so analogy. I was told is like a airplane. Everybody in the car kick are the GP’s they’re the one deciding or the land and make decisions the people who are the passive investors are the LPs, so they can’t they can’t make any calls they just put up their money and get a return but because of joint ventures everybody has kind of quote-unquote say so right they all have.
All have a viewpoint how is it worked out when the disagreements come about and like what are the most common disagreements that are within a JV structure that people should be aware about if they want to go that route sure.
John
That’s a very interesting question often the most challenging part of the JB first let me just say that again, there are different ways to structure a joint venture there are many joint ventures, whereas Cordell is suggesting everyone is an active participant there are also JV’s where some people are more active or less active than the other members and again sorry to keep harping on this going back to securities law if everybody is inactive player.
And there’s a California resident then generally compliance with securities laws it’s very simple if somebody is a passive player then there may be more need to understand that person’s background there may be more paper to push with the state but assuming we get over that that hurdle the disagreements that arise in JV’s are similar to the disagreements that arise in life in general.
Either because there’s a assumptions that are erroneous. Or because information has not been communicated clearly and there’s a misunderstanding or there’s disagreement and they can fail for personality reasons as well generally the kind of joint ventures that we’re talking about are small, they’re not necessarily limited to five people but I think most people have found that big events are great in certain instances, but in other cases keeping its.
Small is better it’s more intimate it’s more manageable communication is easier administration is less bulky and expensive and like any small group personalities can differ so I think one of the important things is you pointed out Cordell is to understand at the very beginning what are the strengths and weaknesses of the different participants and to try to assign roles in a way that capitalizes on somebody’s expertise and in a way that minimizes.
The risk by putting responsibilities on others who may not be qualified to handle those responsibilities. A big drivers generally speaking in a joint venture are the expectation of making money. And. The disagreements often arise when the amount of money then it costs to run the joint venture to try to make it successful exceed what the projections were.
So again, very important to have a very sober view of what it is that you’re trying to achieve and how you think you’re going to go about achieving it best not to let yourself get carried away with you know, pie in the sky. Projects that you’ve never done before dollar signs that are you know, unrealistic etc.
So that money doesn’t become the divisive problem that it can be. And again, it’s money in the form of. Suddenly the members are told that it’s going to take more money than we originally projected. And the questions are going to be why did that happen? Why didn’t we anticipate thisin the first instance?
It can be a problem at the back end. Everything went smoothly during the joint venture, but the market just wasn’t where everybody hoped it would be when the joint venture started a year two years three years into the joint venture when again depending on the type of. Investment we’re talking about here if the intent was to rent at a certain level possibly rents have dropped as we’ve seen during this pandemic residential rents around the Bay Area have started to move significantly.
There are a lot of projects that have been in the pipeline for which this covetine pandemic is just completely out of left field. It’s skewed all the numbers and even the feasibility or practicality of projects as we’re discovering now people. So thrilled to live in high-rise buildings that have elevators and common hallways.
So the numbers that the promoter and the investors were operating on 18 months ago, when they first started the project now suddenly look different not necessarily through the fault of anyone but the numbers are different because rents are dropping or the value of condominiums in high-rise, for example. Another joint venture project has dropped and some.
Of their disagreements and disappointments that arise because of the failure to achieve expectations either because the projections were wrong to begin with. Or something completely unpredictable like a pandemic happened. So, people disagree about what their roles are they disagree about. Whether or not you’re doing your job properly, they disagree about why it is costing X and not why?
Why is my return X and not Y. And then there are. As you can imagine all sorts of misdeeds that happen when we’re talking about money.
Cordell:
Yeah. In fact, the checks and balances things like have someone who’s going to deposit a check to reconciliation. Now. For the memorandum, that is the document that I guess is that everybody goes off.
Does it work for you when you work with people like? You say okay here you guys here’s a checklist or here filling a blank. You fill in a blank and then I’ll get this document and then I’m going to make up your legal document and then this is what is going to be so everybody’s on the same page is it?Does it work something like that?
John:
Um, there’s some people like you mentioned okay, we’re going to sign rolls okay, you’re going to do this you’re going to do this you’re going to do this. But the point is how would you even know what to look for? You know? Yeah, that’s a good question.
So again, I guess the short answer is it depends on and how many participants you’re looking?
Is it is it a handful of people? Is it three people? Is it 10 people 15 people?Generally, there’s sort of an upper limit of 35 people for securities laws purposes. But we’ll leave that out because I think what we’re talking about is something smaller. Yeah, the bigger the venture.
The more burden there is on the promoter to define what that venture looks like to define what it will entail. Including to define what are the risks associated with the venture? So the bigger the bigger the joint venture you intend the more people you intend to solicit than generally the more information you or the core group will need to put together in a presume what you’re referring to Cordell is a private placement memorandum.
Yes a PPM. A private placement memorandum refers to the fact that, Securities can either be offered publicly or privately. So, in this instance, it would be a private offering of a security. Ownership interest in this joint venture. And the,
The information about the joint venture. About its scope about its risks about the projections of what you hope it will generate in a return is something that generally the promoter puts together. You may know. Who you want to go out to who the pool of people are that you want to go out to and you might structure the joint venture in a way that that fits the interests or needs of those people but generally speaking if again if if we’re talking about a handful or more of people then it would probably be on you or the core promoters to come up with the plan including some sort of written offering statement.
PPMs are not required in all transactions but generally speaking again depending on who your audience is again based on their sophistication and experience based on their net worth etc. You may need to provide more information in some cases or less information in other cases in order to attract those investors.
But it’s a function that the core group or individual puts together then circulates. The two potential investors and you can get feedback from investors that say I don’t like this type of venture. I don’t like this type of structure. I don’t like this type of return and so you might modify it before you actually start taking money.
Cordell:
Okay, one more question for your time now for things at a person to do this to generate a joint venture, what is the cost illegally to do all the paperwork around what’s the range?
John:
Well, that’s a good question. Just to keep it very simple and again folks we’re talking in generalities today.
I look forward to having more conversations with you Cordell where we can dig deeper into some of these points. So today is not definitive legal advice for orally talking about generalities what it will take in terms of paper what it will take in terms of structure and management what it will take in terms of cost will depend.
On your specific project. But, in and this is a gross generalization based on looking back over the last few years the transactions that I’ve handled for small groups of investors. The cost is the cost typically of organizing an entity and the more entities that you want to use and by entity I’m referring to a limited liability company or an LLC or a corporation.
There’s cost associated with organizing an entity if you plan to have multiple entities then obviously the cost of organizing those entities goes up according to the number that you have there will be at least one or more different contracts that find the different members, it could be a single operating agreement or a shareholders agreement and operating agreement is the is the, Just as it suggests the operative document for the members, the owners of a limited liability company in the case of a corporation, we call it a shareholders agreement in the case of a partnership we might call it a partnership agreement, but it’s an agreement that defines what the rights and the obligations of each of the parties are in some JV’s there is a management company that exists as a separate entity and the JV LLC will contract with the management company to handle.
The management there is a loan documents or there are loan document. To be reviewed in the case where the JV is borrowing money either to acquire property or typically to acquire and renovate or construct property, so there might be construction loan or purchase loan documentation there is depending on the nature of the project applications that have to be made or may have to be made for land use permits for building permits to a city or a county.
Again, very important to define what the project is to understand what the different aspects of it are and what are the different paper needs of all of those different aspects of the project but to boil down your question to something really simple and basic generally speaking a an operating agreement for a small number of investors again a handful of investors typically you could go anywhere from five to ten thousand dollars.
It can get even crazier than that depending on again the complexity of the project the type of investors the number of investors, so just the cost of creating an agreement that ties the joint venture together. For ten and then the other costs associated with other contracts and applications that you make for permits etc. all have the their own costs but the organizing costs are generally the cost of creating an entity in California.
Filing articles of incorporation or articles of organization is measured in hundreds of dollars low hundreds of dollars. The state of California requires an annual minimum payment of $800 to the franchise tax board in order to maintain and operate an LLC or a corporation. And then there’s the cost of creating the operating agreement to shareholders agreement or partnership agreement.Those are your basic setup costs.
Cordell:
Okay, well right that’s going to be it for this one. So everyone hopefully next time sometime next month, we’ll have John back. John how can people get in contact with you?
John:
Thank you. Cordell, it’s been a pleasure. My offices are in Berkeley, California.
My telephone number is 510-647-0600, my email address is John J. O H n at metal long string of letters without breaks at J the initial. Gutierrez law the outcome that. It’s one word j g u t i e r, r e z l a w.com. John F. J. Gutierrez law.com, okay, all right all right then now it’s been a pleasure have a good day stay safe everyone look forward to meeting you with you again, okay bye for now.
