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. The "waterfall" refers to the order in which available cash is distributed to the parties, and the "promote" is embodied in the waterfall.

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 is increasingly being used in real estate JVs to allow the operating partner to receive or realize its promote without a capital event. 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.

If the promote is crystallized, the sponsor will receive its promote early in the life of the JV. As such, the promote will not be affected by later poor performance of the JV, changing economic conditions, or other fluctuations which are outside the control of the sponsor.

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.