Don’t get taken advantage of - SPVs, contracts with investors, the easiest things to forget…

Residential property development can be very profitable, however equally costly if not approached with vigilance.

Taking the first step

Residential property development can be very profitable, however equally costly if not approached with vigilance. In this blog series over the coming weeks, we reveal our 15 key lessons that are the result of experiences in the recent past. These lessons have been learned the hard way, sharing our experiences so you don’t have to make these same mistakes. Hard work, determination and the deal modelling tool coupled with these rules to live by will lead to that long and profitable property development career you dreamt of.

Don’t get taken advantage of - SPVs, contracts... the easiest things to forget

Entering into full-time property development is starting a business that requires funding – and a lot of it. If you lose any of this funding, those who lent it to you will not be best pleased and they will come after you for anything and everything they can, because you in their eyes are accountable entirely for protecting and growing their investment. Sadly, this industry creates an enormous amount of greed, so when a savvy investor sees a young, cashless developer – their wealth can mean the power to take things and control away form you in the form of legal battles. Though you might be, and probably are right, and they might be stealing from you – do you actually have the money they have to fight you? Commonly not. As such, it’s vitally important to understand your legal position form the start and how you can be taken advantage of. By hoping legal matters will never arise, you are guaranteeing you will stumble upon trouble – better to have some understanding of your legal position as this shows your maturity and understanding of business – an attractive asset to investors.

As in many areas of business, lawyers are a necessary evil in property investment transactions... Firstly, it is obviously a requirement to use a conveyancing solicitor when purchasing or selling a property - and you do get what you pay for.

A very strong recommendation is that when purchasing a property in an area with any sort of complications (leases, share of freeholds, neighbour’s rights etc.) such as London - always use a solicitor local to the area. These complications are commonly unknown to solicitors outside of their locality (unbelievable with this level of professional but very true). You would (hopefully) not use a back-street mechanic to repair a classic Ferrari. Overall, the price of a good solicitor is not relevant (cost difference is negligible on a 6 or 7 figure deal cost) and only time will educate a developer as to how valuable an experienced solicitor is. If the difference in a cheap solicitor impacts your overall return, drop the deal. Or buy some aspirin.

Typically, when purchasing a property with multiple parties, it makes sense to set up a Special Purpose Vehicle (SPV) which is merely a company used only for the ownership of the property and nothing else - it is either sold to the purchaser or closed down when the property is sold. This is done for the purpose of a clean slate - something all debt lenders will require (i.e. no previous trading relationships that may entail debtors and creditors having any claim on the company). A lawyer is not needed to set up an SPV (as it is just a standard company) - but an accountant is usually helpful in doing so. Where you need a lawyer…

A second strong reason for good legal relationships is that of contract lawyers - commonly based in a commercial team. When you have identified an equity investor to work with - they will certainly require a contract between all parties to protect their funds and position in the deal. While this might seem an area to save costs and work on the goodwill of a handshake or napkin contract (NEVER ever do this), it will end in tragedy as clearly neither side recognises the weakness of not having a legal relationship and so will guarantee a conflict that will grow like aggressive mould when the slightest problem occurs – which, again, they will.

In property development, many things can and always will go wrong - all parties involved need to have the stomach to handle these and some form of legal agreement to fall back on if an agreement cannot be met. Most problems have no effect on the overall deal but will have the impact of making the investor worry and become too involved. There are off-the-shelf Development Management agreements available but sadly, if a capable contract lawyer does not execute them, they become useless, as the executors do not understand how to rely on the content when needed.

A competent commercially trained solicitor should have a sound understanding of what each party expects out of the agreement and ensure that both sides agree and have actually raised and discussed each matter.

It is common that two parties enter an “agreement” of some form but do not actually make clear their expectations - until a bad taste occurs. A relationship is rarely salvageable after this type of occurrence which puts huge pressure on all involved in finalising the deal. When people fall out, everyone loses money. It can be almost guaranteed that forming the terms of an agreement will be very stressful to those lacking experience in doing so on their first few occasions - do not be down-heartened by this, but do expect it. As long as the other party is still at the table - they want to do the deal as they see value in it. They may have strong terms (that they have learned through experience) and they may be unreasonable but as their funds are on the line and being trusted to your execution, they will ask for all security they possibly can and commonly not consider your position at all. Recognise that they are commonly in the strong negotiating position but stand your ground by ensuring what you are asking for is always fair and equal. If their demands do not mirror these simple guidelines, point it out to them and just explain that taking too much of the risk on can be very demotivating for you and this is not a good way to start a relationship or a deal.

If a sound agreement cannot be achieved where both sides are content, walk away. This may be the best advice you will ever receive in this business - never be afraid to walk away. Better to lose three deals because you are not comfortable than starting down a road you secretly know (but may not want to admit) ends in an explosion. And when it does, it will not be pleasant. People’s nature generally change completely when they risk losing something.

Finally, ensure that all legal costs are made part of the deal, to become deal costs - you as the development manager (or promoter) should not have to fund the legal whims of your investors.

You as the promoter can always get screwed. And you probably will. The guy with more money is typically stronger in these positions - as they can fund a legal battle more than you can (or you wouldn’t need their money). At all costs, work tirelessly to show your investor they are the most important person in any deal and ensure you are always delivering all possible information to them, good or bad. It could be said that there is no such thing as too much information - the more you give them, the less they chase you! Always record every bit of information shared and agreement met or discussion you have. If you do need to rely on your position, it is far easier to be able to show how you have acted in a proactive manner. Above all, you will get screwed over - you may have acted perfectly but sadly this business as plagued by a disease known simply as greed. It can be hard to recognise in another at first, or sometimes months or years into a relationship and as such, always maintain a healthy distrust of anyone in this business - it will stand you in a better position when the inevitable occurs.

As and when such a situation arises, nine times out of ten, the best advice is merely to walk away and cut your losses. A legal agreement is only worth what can be funded to prove, and litigation is a word you never want in your diary of experience as litigation solicitors charge by the second and never, ever provide an easy or cheap way out. If you do enter into the consideration of a litigious battle, take advice first on how much it is likely to cost you to complete - then add a little more. Better still, have more deals going on, and move on. Your sense of equality and fairness is your compass; consult it regularly.

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