1 Club deals
It is becoming increasingly common for two or more investors in major real estate assets to invest as a consortium in what is commonly known as a club or club deal. Investment through club deals enables investors to meet diversification requirements by investing smaller amounts of capital in major real estate assets, thereby freeing up capital to invest in other assets.
Investment through club deals is usually structured through incorporated, trust or limited partnership structures, where the investors have little day to day input in the management if the asset, or where the investors hold direct interests in the asset, in which case day to day management of the asset will be delegated to a property manager.
In each of these cases, the investors will usually enter into some form of co-ownership agreement to govern the rights and obligations of the investors while they remain co-owners. Described below are the main features of co-ownership agreements that are becoming more common.
2 Major and minor decisions
Co-ownership agreements usually provide for the establishment of a management committee or investment review board, made up of representatives of the co-owners, to make decisions about matters affecting the property.
Often, the matters to be decided upon by these committees are pre-defined as either minor or major matters, depending on how critical the co-owners consider them to be in the administration and ongoing strategy for the property. Major matters include those that relate to budget determination/variation, capital expenditure, development, reinstatement of the property and leasing decisions (among others).
Where major and minor matters are separately addressed, the co-ownership agreement will provide for different voting thresholds for resolutions to be passed in respect of those matters and different dispute determination mechanisms. The different resolution thresholds and dispute determination mechanisms reflect the relative importance of minor and major matters.
Where a matter that is unable to be resolved is a minor decision, it is not unusual for it to simply remain unresolved. Alternatively, it might be referred for expert determination.
Major matters that are unable to be resolved can be elevated to persons in senior management positions of each co-owner. Where decisions on major matters remain unresolved between co-owners, they are usually referred to expert determination and can sometimes lead to “Russian roulette” buy-outs.Unresolved decisions that relate to the determination of budgets are often addressed by a provision that requires the budget for the immediately preceding period to be continued with an indexed uplift (such as CPI).
3 Default processes
Obligations that are governed by co-ownership agreements include the requirement for co-owners to contribute their proportion of funds to the administration and operation of the property (usually determined by the proportionate interest in the asset).
It is important to ensure that where a co-owner fails to contribute its proportion, there are mechanisms that allow for these funds to be raised to ensure the continued administration of the asset. This is particularly the case for development assets.
A popular mechanism to provide this protection is to allow other co-owners to make a “default loan” to cover the defaulting co-owner’s proportion. If an co-owner makes a “default loan”, it will be entitled to interest payments in priority to any distributions of income to the defaulting co-owner or other co-owners.
Continued default by a co-owner may give rise to forced buy-outs of the defaulting co-owner or, particularly where a property is held by a jointly owned trust, a sell-off by the trustee to the market of the defaulting co-owners units in the ownership trust.
Where a sell-off to the market occurs, the agreement may allow for the trustee to sell the defaulting co-owner’s units at a discount, to assist in locating a new co-owner who is able to contribute to the costs of administering the property in a shorter amount of time.
4 Minimum hold requirements
Co-ownership agreements may provide that co-owners must hold a minimum proportion of the beneficial interest in the property. Minimum hold requirements are ordinarily imposed to ensure that beneficial interests in the property are held in marketable parcels, particularly were the asset is held through an ownership trust.
Marketable parcels ensure that all co-owners have substantial interest in the asset and will assist to locate interested investors, particularly where a party is forced to sell its interest – for example, upon default.
Minimum hold requirements also result in limiting the way in which a co-owner may seek to dispose of its interests, by requiring co-owners to sell blocks of interests which meet the minimum hold requirements and restricting co-owners from selling blocks of interests that may result in that co-owner holding an interest that is less than the minimum hold requirement. Such limitations may also impact on the pre-emptive rights provisions.
5 Pre-emptive rights and restrictions on sale
Co-ownership agreements will ordinarily include pre-emptive rights so that the existing co-owners may acquire a greater interest in the property, before interests are sold to third parties.
Pre-emptive rights provisions will sometimes require co-owners to offer to sell all of their interests and require the other co-owners to accept all of the interest on offer. Alternatively, pre-emptive rights provisions may allow co-owners to “cherry pick” the proportion of interests they wish to acquire. Where multiple co-owners accept pre-emptive rights offers, the pre-emptive rights provisions may provide waterfall provisions for the allocation of the interests on offer among the accepting co-owners.
Permitted transfers are those that allow co-owners to dispose of their interest without being subject to the pre-emptive provisions. Permitted transfers will usually allow transfers to group members or new trustees, where the co-owner is a trustee of a trust.
In some circumstances, co-ownership agreements provide that a transfer will be permitted where it is to an entity that satisfies certain criteria as to financial standing and respectability. This test may also be imposed on transfers to third parties of interests which have not been acquired by the co-owners during a pre-emptive rights process.
Co-ownership agreements sometime contain rights that enable co-owners to equalise their interest in the asset, where another co-owner is selling, in priority to the usual pre-emptive rights.
Equalisation rights have been seen where a co-owner enters into ownership of the asset in circumstances where it was not originally able to acquire an interest that was of equal proportion to the other co-owners’ interests, but where the co-owner would have done so, if possible.
7 Drag and tag
Co-ownership agreements may also provide for “drag-along” and “tag-along” rights.
“Drag-along” rights entitle a co-owner who is selling its interest in a property to require all or part of the interests of other co-owners to be sold together with its interest – that is, to drag-along other interests. Similarly, co-ownership agreements may entitle co-owners to elect to “tag-along” their interests with the interest being sold by another co-owner.
Drag and tag rights are included for a number of reasons, such as to reduce a co-owner’s exposure where another co-owner is exiting the property and a purchaser of the exiting co-owner’s interest has yet to be identified.