Why General Partnerships in Commercial Development Are Destined to Fail
By: Matt Burgess, CEO, Missouri Land Company
General partnerships are a risky way to structure a commercial real estate development company.
COMMERCIAL REAL ESTATE development is a unique industry. Compared to many of those involved in residential real estate, CRE professionals typically deal with larger projects, higher risk and more complex technical disciplines.
At the same time, however, business is just as personal. That’s why a successful career in commercial development typically requires both great people skills and a particular type of business acumen. So it seems a little contradictory to say that most commercial development partnerships are destined to fail. But they are. In “The Nuts and Bolts of Real Estate Joint Venture Partnerships,” Jonathan Farrell wrote, “While it may seem counterintuitive, all parties [in a partnership] should start by looking at their exit strategy.”
For the purposes of this article, “partnership” is defined as a general 50-50 partnership at the company level. Financial partners — those who infuse capital and seek return, but are not invested in how you get that return — are a necessity in CRE development. Compared to a limited financial partnership, however, a 50-50 partnership is difficult to maintain. In fact, according to management consultant Amanda Neville, in “Why Partnership Is Harder Than Marriage,” (Forbes), “[A business] partnership is far more difficult to maintain than marriage. Whereas 50 percent of marriages end in divorce, the number is closer to 80 percent for business partnerships.”
Here’s why commercial real estate development partnerships are destined to fail:
Synergy Is a Dangerous Word. In business, synergy is typically defined as the benefit derived from combining two or more businesses so that the performance of the combination is higher than that of the sum of the individual businesses. That’s why partnerships are generally formed. In theory, it makes sense that two parties can leverage their assets (resources, expertise, client base, etc.) for the mutual benefit of both. Unfortunately, this synergy-based approach is not sustainable in the real world of CRE. Because of the industry’s high-risk, high-reward nature, every decision is an important one — and disagreements are bound to arise. With a 50-50 partnership, the result of disagreement will frequently be an impasse. This can be disastrous to the underlying business.
Robert Shemin, author of “Successful Real Estate Investing,” makes this point: “It should never be a 50-50 partnership; someone has to be in control and make decisions, and that person should be you. Make sure you work with silent partners who do not interfere [with day-to-day decision making]. About 70 percent of real estate partnerships fail because two equal partners cannot agree on anything.”
Commercial Development Is Volatile. In an industry that inherently involves big risk, you have to expect the occasional loss. There’s no telling how each partner’s principles and standards might change in the face of adversity. Take the case of Stan Kroenke and Michael Staenberg, longtime partners turned legal combatants. For two decades, Kroenke and Staenberg were partners in THF Realty, a prominent St. Louis-based shopping center development company. They became two of the richest men in Missouri; Kroenke also became the owner of the St. Louis Rams football team. But after a string of events, Kroenke sued his longtime colleague in 2012. He sought $20.2 million because he said Staenberg reneged on paying him as part of the unwinding of their complex web of real estate holdings. He also fought to block repayment of a $1.2 million loan Staenberg had made to their company.
In November 2015, the dispute spilled over into Kroenke’s potential plans for a retail development in Maryland Heights, a St. Louis suburb. Staenberg accused Kroenke of going behind his back to acquire the land. This legal feud is a prime example of what can — and likely will — go wrong when big money and bigger risk are involved. When each partner has different expectations and a different idea of what is fair, the road to recovery is a long one.
The Better Option: A Real Estate Limited Partnership. Although 50-50 CRE partnerships are destined to fail, successful commercial development still requires two components: capital and the knowledge to put that capital to good use. Partnering with a “passive” investor can open up significant opportunities for a real estate developer. This structure, known as a real estate limited partnership, is typically organized with an experienced owner/operator or real estate development firm serving as the general partner. Outside investors, or limited partners, are much like stockholders in a public company, in that they have only limited influence on the business operations of the limited partnership.
Limited partners also have limited liability. If a company faces losses, limited partners are only liable for the amount of their capital contributions. It’s still important, then, to develop an exit strategy early on. In “Real Estate Investment Partnerships” (NuWire Investor), Melana Yanos wrote, “Although the concept of forming an investment partnership is simple, outlining specific terms in structuring a partnership is not a do-it-yourself process. Hiring a legal professional who specializes in real estate law is a critical first step.”
What’s the takeaway? Don’t waste your time experimenting with general partnerships for commercial real estate development efforts. General partnerships do not work in this industry. Real estate limited partnerships are much more effective for CRE companies.
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The chairman and CEO of a Milwaukee, Wisconsin-based regional real estate development and investment company, as well as a member of NAIOP’s 2016 Board of Directors, shares his insights and perspectives on the commercial real estate industry.