Real Estate Development: Business Structure

In the first installment of this two part article, we canvassed the common forms of development financing. We now turn to the various business structures available to the developer to carry out the development and discuss the advantages and limitations of each.

Corporation

Incorporation remains the most commonly used structure in the development world. Even where various forms of partnership and joint ventures are used corporations are frequently found in the underlying structure. Corporations provide insulation from liability; however, where the company is the primary borrower the lender will typical seek personal guarantees from the principals of the corporation thereby limiting the value of the limited liability afforded corporations.

Further, incorporation can bring simplicity to complex arrangements, providing flexibility to bring in, and remove investors in an orderly fashion pursuant to the scheme provided in the articles and shareholders agreement. However, basic incorporation is falling out of favour for certain large projects because of taxation planning factors. Before determining that incorporation is the correct structure obtain an opinion from your lawyer and tax specialist.

Partnerships

Both Limited Partnership and Limited Liability Partnerships have become more prevalent over recent years and are frequently the tax driven structure most commonly found in larger projects. In short, each type of partnership allows income to flow through to each partner where it is taxed.

The management of the two types of partnerships is the primary difference. In a limited partnership there can be only one general partner responsible for the management of the business. This is a crucial requirement to comply with. One of the primary benefits of limited partnerships is that limited partners are generally not exposed to any liability or exposure beyong their financial contribution. Once a limited partner becomes involved in the management of the partnership that protection is lost. In contrast, limited liability partnerships allow limited partners to participate in management. Limited partnerships can be converted into limited liability partnerships. Further, both structures, while not as flexible as incorporation, can permit numerous investors and allow them to buy and sell their interest with minimal effort and can accordingly work well where many parties will be contributing to the project.

Joint Ventures

Joint ventures are popular when a small number of parties are involved in the project, each with a unique set of skills or contributions that will be provided to the benefit of the enterprise. Often, the joint venture is comprised of other structures. For example, the two parties to the joint venture could be companies or partnerships.

Summary

This has been a very brief summary of a few of the common entities used in real estate development projects. Choosing the appropriate structure for the development is an imperative first step to be considered by your lawyer and accountant. It is important to remember that the circumstances dictate the structure. What works for one project may not be appropriate for the other.