Overview of Real Estate Investment Agreements: Requirements and Best Practices

What Is a Real Estate Investment Agreement?

Real estate investment agreements are the legal contracts that outline the terms between an investor and a property. They lay out the rules and expectations for the partnership and help minimize misunderstandings in the future. A real estate investment agreement is a type of business contract that defines a business relationship, including how a property will be purchased, managed and sold. It establishes rights and responsibilities and outlines how much each party will contribute to the effort, including financing, time and actionable components .
A primary objective of a real estate investment agreement is to address the responsibilities of each party. An individual may invest his or her savings into a property, but not wish to actually invest time into the upkeep or management of it. Others may wish to invest their time, but only some cash. A real estate investment agreement essentially creates the terms for the business elements of the relationship, including:
By spelling out the responsibilities in advance, a real estate investment agreement can help the investors avoid many of the problems that arise when everyone has different expectations about the arrangement.

Essential Components of a Real Estate Investment Agreement

The typical real estate investment agreement will include, among other things, terms and conditions addressing the following key components: (i) the parties involved (including, but not limited to, the issuer, any sponsors, broker-dealers, and underwriting entities); (ii) the terms of the proposed investment, including the purchase terms, offering price, and contingencies; (iii) an accurate and thorough description of the subject property, its appraised value, legal description, current conditions, uses, and operating history; (iv) the financial aspects of the investment, including distribution of income, fees and economic benefits, park status (thereby qualifying tax incentives), go-dark provisions, and leasing requirements; and (v) diligence expectations, including annual inspections and reporting (which includes specific financial reporting and other disclosures to be provided by the issuer). Depending on the complexity of the investment being offered and the risk assessment factors, additional provisions may be included in the investment agreement, which are beyond the scope of this article.

Different Types of Real Estate Investment Agreements

Real estate investment partnerships often come in three different forms. In some cases, the investor and developer have an equity agreement that is more akin to a joint venture in which both parties receive identical rights and responsibilities. In others, the developer maintains full control over the property and enters into a debt agreement with the passive investor. A third option is a "middle ground" in which an investor may vote on major decisions, but they are largely uninvolved in how the property is operated.
Real Estate Equity Agreements
In an equity agreement, the investor and developer both share responsibility for the property. It is a true joint venture: land is owned together, debts and profits are split evenly, and both have a 50/50 say on what happens. Neither owner has a say on the other’s behalf, nor do they owe any fiduciary responsibility to the other. As such, the agreement itself does not stipulate that the investor must even show up. They could simply provide the funds and leave the daily management of the deal to the developer.
Real Estate Debt Agreements
The passive investor under a debt agreement is put in the role of a lender rather than an equity partner. The developer has no obligation to include them in discussions about the property. Instead, the investor has a set amount of votes on major decisions. Although they lack the voting power to dismiss the developer, the investor has more experience in running a property, and their experience may be called upon if major changes must be made.
Real Estate Joint Venture Agreements
A compromise between the two is a joint venture agreement. Under this form of deal, the investor is generally uninvolved in decision making but can vote on major deals. Responsibilities still fall to the developer, yet the two must meet if both agree. The investor thus has some opportunity to weigh in on the deal. The language of the agreement allows the investor to be directly involved, yet permits them to remain uninvolved if the decision does not warrant their participation.

Real Estate Investment Contract Considerations and Legalities

Navigating the real estate investment landscape requires not only a keen eye for opportunity but also the understanding of complex legal nuances that govern such agreements. These legal considerations form the backbone of any agreement, ensuring that both parties are protected and their interests are held paramount.
At the outset, real estate investment agreements must comply with all local and federal laws. This includes zoning regulations, tax implications, and any disclosure requirements specific to the property type or industry involved. For example, if the property will be used as commercial space, certain state laws dictate modifications to the structure, such as making it handicap-accessible. Tax structures also differ based on the type of real estate and its intended use, so precise language reflecting these factors should be included in the investment contract.
Another critical area is liability. Both parties must clearly delineate responsibility for any risks associated with the property. This includes liability for defects, breaches of contract, or any other circumstances that may arise after the agreement is executed. Many agreements stipulate an indemnity clause, where both parties agree to cover each other against damages that might occur during or because of the period of ownership or development.
Additionally, termination clauses and dispute resolution mechanisms are essential components of real estate investment agreements. Parties must agree on how the contract can be terminated, and what procedures will be used to resolve any disputes that arise in the future. Some contracts may require arbitration or mediation before any judicial proceedings can begin, while others may mandate a particular jurisdiction be used.
A final legal consideration is the duration of the contract. Some real estate investments might span decades, while others are only short-term. The contract must clearly state the agreed period, procedures for renewal or renegotiation and any provisions regarding new investors or co-ownership arrangements that may come into play during the duration of the agreement.
By addressing these key aspects, a real estate investment agreement can deliver a clear framework for the parties to follow, while also protecting their respective rights and interests as circumstances evolve over time.

Negotiating a Real Estate Investment Agreement

Negotiating a real estate investment agreement requires a careful balance of interests, a clear strategy and open communication. When you are dealing with multiple parties, as you will in the context of real estate investment, this becomes even more challenging. Without the right approach, you could quickly find yourself at an impasse.
At the outset of negotiations, create a list of deal terms that you want to include in the investment agreement. Noting where you are willing to be flexible, as well as where you are not, can be helpful both to you and to the other parties involved. Understanding the priorities of your co-investors—why they value certain aspects of the agreement over others—is essential to creating a constructive discussion. After all, you are more likely to get the deal that you want if you are extending an olive branch and offering the same to the other parties.
Real estate investment agreements often include lots of different provisions , and you should be able to prioritize the matters you feel are most important. Think about how virtual data rooms (i.e., the "VDR" you may have heard about) could be used to help streamline your negotiations. This secure, online environment enables parties to come together in a controlled space and collaborate on deal terms. You can use the VDR to share and store confidential documents, ensuring that they are only exposed to those who need to see them. Also, given that negotiations can sometimes take place across time zones, a virtual deal room helps to facilitate extended talks.
Consult your attorney if you are unsure about what you should propose. The parties could go back and forth many times before reaching an agreement, so it is important to get it right the first time.

Common Mistakes and Avoiding Them

Real estate investment agreements can go awry when the terms of the agreement do not match the investors’ expectations. If the agreement is too vague or lacks contingency plans, investors may face a capital call or a forced sale of their investment. It is therefore imperative that investors read through agreements with a keen eye to ensure that they have the ability to manage their investment in a way that limits their exposure to unexpected losses.
As we discussed in our previous post, a capital call costs investors money because it requires them to inject additional funds into a project gone awry, often at a time when it would be least convenient for the investor. It is important that an investment agreement clearly address the timing, scope and voting weight needed from limited partners to approve a capital call. For timing, investors should expect to see a minimum number of days’ notice prior to any capital calls, particularly so that investors have sufficient time to secure the funds needed to respond to the call. Depending on the investment, the investors may also expect to see limits in the amount of the capital call set by the manager, even where the additional funds are being paid back as a loan to the property manager. Of course, investors would want to ensure that the voting weight needed to approve the sale of the property is clearly spelled out in the operating agreement, so that they can check that the approval needed is at a level that they can satisfy.
The next most common pitfall is the lack of conditions on a sale of the property. In Realty Mogul Co., LLC v. Garrison Ventures, LLC, a California court considered whether the manager violated its fiduciary duties when it executed a short sale on a property despite the unavailability of a third-party purchaser. The court explained that, despite the ill-fated return on investment, the manager did not violate its fiduciary duty or act in bad faith because the managers were not contractually required to exhaust all available means to sell the property, and because the managers had complied with the reporting requirements under the agreements. Citing the fact that the Manager had complied with the reporting requirements set out in the operating agreement, the court was hesitant to "second guess" its decision based on hindsight, and instead "leave the business risks with the parties that voluntarily agreed to bear them.
Even where plain language in the agreement gives the manager broad discretion to make decisions, the court will likely have less tolerance for the exercise of that discretion if the managers knew that the investment was going under and did not offer Limited Partners other options before accepting a short sale. Because all LP agreements use slightly different language, the applicability of the Realty Mogul opinion will depend on how the terms of the agreement compare to those at issue in Realty Mogul.

Why Hire a Lawyer for a Real Estate Investment Agreement

The most important reason to utilize a legal professional in the creation and review of real estate investment agreements is to ensure that contracts can be enforced if necessary. There are many laws and rules, both federal and state, that impact each publically-raised real estate investment programs which should be reviewed by an experienced securities professional. The cost of not having these issues properly addressed in a private placement memorandum or by a mutual consent agreement far outweighs the benefit of saving money in the short term. The same can be said for the fact that agreements to enter into a joint venture or preferred equity position have substantial consequences when it comes to tax liability and should be properly vetted by professionals who are qualified.
In addition to these concerns, there are many other legal issues that should be addressed. For example, appropriate steps should be taken to mitigate liability for losses caused by fraud, negligence or material misrepresentation. It is also critically important to understand the roles and rights of each party in the event of a foreclosure. You want to make sure the contracts you enter into make it possible for you hold any party making a claim liable for their wrongful acts. An experienced legal professional will be able to advise on the correct language to accomplish this.
Dispute resolution should also be part of the paperwork that is created for your real estate investment agreement. Depending on the size of the project, the parties to the agreement can agree to arbitration or litigation in the event of a dispute. That being said, both of these options can be costly. A good lawyer will create a plan for minimizing these costs.
It is important, of course, to remember the difference between a lawyer who specializes in this type of real estate investment and one just starting out. You want someone with the experience to provide you with the right advice.

Real Estate Investment Agreements in the Real World

Case Study 1: The Multi-Property Syndicate
A group of investors sought an attorney who specialized in real estate and syndicate agreements for a deal involving multiple apartment buildings in three states. The attorney drafted separate operating agreements for each entity and an overarching operating agreement that governed the investors’ rights. The client was able to purchase the properties, and didn’t have any major disagreements with the property managers in their five years of ownership.
Case Study 2: Inheritance Gone Wrong
An heir to a small but valuable property purchased with family funds comes of age and realizes the equity doesn’t belong to him. He argues with his parents , who never intended to give him the full share of his inheritance while his siblings receive nothing.
Case Study 3: The Adventure Property
Five friends decide to buy a beach house together to use as a rental and vacation property. They agree to share the costs for mortgage, repairs, and cleaning expenses, as well as the profits from the rentals. They put together a joint venture agreement that clearly outlines expectations and responsibilities, preventing any major conflicts, and even bringing them closer together as friends. The investors have each agreed to sign the operating agreement that is now with their attorney for review.