Promote Crystallization in Real Estate Joint Ventures: Agreement Structure, Benefits, Mechanics

Description

A promote is a form of incentive or profit-sharing mechanism that is often used in real estate JVs to incentivize and compensate the operating partner for creating value in the form of profit generation. Promote mechanics are built into the distribution waterfall provisions of a JV agreement, and these provisions dictate which of the parties will receive cash returns on their investment and the relative priority and timing of the distribution of such returns.

A promote is often not paid until a capital event occurs that generates net proceeds, usually from a sale or refinancing of the property. Therefore, an operating partner is typically not able to capitalize on its promote unless and until the property is sold or refinanced and the net proceeds are sufficient to achieve the hurdle return.

To address this timing issue, promote crystallization or freezing the promote may be used in real estate JVs to allow the operating partner to receive or realize its promote without a capital event (for example, by increasing the operating partner's capital interest or making a cash payment to the operating partner, or a combination of the two, and revising the distribution waterfall so that all subsequent distributions are based on capital interests). If a JV plans to hold multiple assets, the parties must further decide whether to crystallize the promote on an asset-by-asset basis and whether a clawback mechanism is needed.

Listen as our authoritative panel examines the use of the promote crystallization structure and key considerations when drafting the promote mechanics provisions of a real estate JV agreement.