The Dynamics of Developer/Contractor Co-ownership Relationships In one sense, general contractors have been acquiring interests in real estate ever since they’ve been filing and foreclosing liens. And, on occasion, contractors have provided "sweat equity," contributing a portion of their construction services for an ownership stake in a project. With higher borrower equity requirements now needed to obtain financing, contractors are considering providing credit support to development transactions by becoming equity participants in or credit enhancers for the underlying real estate project, in addition to serving as the general contractor on the project. For example, a general contractor that owns property to be developed could team with a developer to benefit from the developer's expertise. As a second example, a developer finds itself out of money — often on an existing project — and looks to the general contractor on the project for some capital in exchange for a piece of ownership. And finally, in a twist on the second scenario, some developers may offer equity positions to the general contractor's principals as opposed to the general contractor entity. Though one executive at an international contractor opined that the "contractor-as-part-owner" trend is neither strong nor sustainable, some contractors and developers may find themselves entertaining such options while the economy recovers. Moreover, the contractor-as-part-owner arrangement can be beneficial to the contractor in several ways. First, the contractor can increase its opportunity to be engaged for the construction work in an economy that is seeing fewer real estate project starts (and those that are starting are being heavily bid by contractors with excess capacity). Second, the contractor’s investment helps insure that the project will move forward by providing equity to obtain loan approval. Finally, the contractor is able to receive both a fee under its construction contract and a return on its equity investment. Dual Roles
The contractor must evaluate the proposed equity transaction as both a service provider and an investor. As a service provider, the contractor must understand how it is going to be paid the contract price and its fee. As an investor, the contractor must be assured of the viability of the project and understand the financial contributions required, the expected return on investment and the source of repayment. In some respects, the roles of service provider and investor may conflict. For example, seeking the highest contract price and fee may impact the return on the contractor’s equity investment. The contractor should evaluate the construction contract pricing and equity investment together to determine the best overall economic result. The contractor will need to understand the leverage that the developer holds over the contractor's equity position in the event of disagreements over construction matters. The developer may attempt to offset the dollar amount of disputed construction costs (such as cost overruns) against distributions to be made to the contractor under the ownership agreement. The contractor should consider holding the equity interests through a separate legal entity as opposed to holding the equity interests itself in order to create better legal separation of roles. Such concerns may also exist for the developer if the contractor attempts to offset costs against any development fee due the developer for its services to the ownership entity. ... more |
