Investing in real estate through an SPV – a case study

An SPV (a Special Purpose Vehicle) is an investor’s tool. As any other tool, it should be used only, when it is justified. There are some general rules about whether to create a company or invest as a natural person.

Today I would like to tell you about investing in real estate through an SPV based on a case study of Group Housing Development. GHD is a special purpose vehicle that builds cheap houses around Toruń. It is an example of using an SPV mechanism to implement a simple business plan: a repeatable process of buying land, developing houses and sales.

When to go the SPV route?
SPV (a Special Purpose Vehicle) is an investor’s tool. As any other tool, it should be used only, when it is justified. There are some general rules about whether to create a company or invest as a natural person. For the real estate market investor a company carries a lot of advantages, even though 5 years after buying a property a natural person becomes PIT exempt. So why would you want to invest in a venture that cannot dodge PIT and can also be subject to double taxation related to dividends? Well, it is worth to use an SPV mechanism and simultaneously invest as a natural person.
Due to the legal definition of running a business and a large turnover it is quite easy to become a VAT payer, which can be painful, as deducting VAT is a lot more complicated when you are a natural person. On the other hand, registering a business in the real estate market as a natural person will deprive you of all of the individual tax benefits. This is the main reason a proactive investor will quickly go forward with establishing one or several SPVs, which will handle all the turnover that requires paying VAT.
Secondly, an SPV will have its own credit rating. Real estate transactions made by natural persons not running a business are not counted towards your credit rating. In contrast, transactions done by a company influence its credit rating.  Next, it is easier and cheaper to trade in company shares than individual properties. Lower or nonexistent notary costs, the capability to trade several properties at once, no legal obligation to make changes to the mortgage register, mitigation of administrative errors by eliminating the chance of them occurring, these are just a few of the many benefits of this method.
The ability to rapidly scale the potential of the company by creating new shares and introducing additional funds also cannot be overemphasized.  In group investments the company plays the role of the subject implementing a shared business plan, drawn in the partnership agreement. Investors with varying capital, knowledge and geographical location can jointly participate in such a fixed term or open ended company.
The real corporate sharks also value  the additional channel of property acquisition provided by a company – it can acquire properties in exchange for company shares. In this way the company’s assets and the alienor’s profit can be increased virtually free of charge.
A person can also decide not to share the fact that they are a part of the company through a trust agreement, but that’s a subject for another time.
The risks
Of course, there are also negative aspects of running a company. First and foremost is the matter of creating a valid partnership agreement and devising plans for dealing with potential conflicts that might arise down the line.  Secondly, one must reduce the potential of a takeover by a minority group of associates, that could change the business plan or hamper its operations. I encourage you to familiarize yourself with tools such as DRAG-ALONG or TAG-ALONG. It seems lawyers have predicted all (almost!) possible situations and drafting an agreement is more akin to creating someone out of Lego bricks.
Group Housing Development
In this article I would like to showcase an exemplary special purpose vehicle, Group Housing Development, a detached house developer from Toruń. GHD was registered on 8 November 2013 in Toruń by a group of investor from all over Poland.
The company and the idea for the investment was a result of several months of work by the investors’ club Global Investor Club (www.globalinvestorclub. pl) and Aquarius Property Investments (www. aquarius-investments.eu), which is the manager of the whole investment on behalf of the investors. You could say the company was custom-made for the members of the investors’ club.
It all started with club meetings during which requirements of the invested where decided upon. The exact form of the investment was not part of the discussion. The members agreed that:

1. The investors were looking for a long-term investment with a regular return which could be deemed as a passive income.
2. The profit-sharing payment should be made at least once a year.
3. The investment should generate an annual return rate of about 20% (at the time of this discussion the interest rate on bank deposits was about 5%).
4. The investment should be made on the real estate market.
5. The investment should have a higher return rate than renting a property and simultaneously eliminate the legal risks posed by the Tenants’ Rights Act.
6. The investment could make use of a bank loan.
7. The investment should allow for a start with a small capital and the possibility to add funds during the endeavour.
8. The investors should not be required to work on the investment.
9. The investment should provide liquidity.
10. The investment should have a built-in emergency plan that would allow for the recuperation of invested funds.
11. The object of the investment should not be an experiment and it should be comprehensible to the investors.
Only after creating this list of requirements did the search for the object and form of the investment begin.

Eventually, from among the contending projects, Global Investor Club chose to create a detached house developer for the budget market segment. Toruń was chosen as the location of the investment, because Aquarius Property Investments was creating the utility infrastructure in the region, which allowed the newly established company to immediately commence with the development procedures.
Company type
One of the problems with special purpose vehicles is their legal form. Civil law partnership was rejected on the grounds of its fiscal nature and a relative low usefulness for larger groups of associates. The choice came down to a limited liability company and a limited joint-stock partnership. Although the latter had an advantage in the form of a tax exemption for dividends, it was the former that won, due to its simplicity and familiarity to all of the investment’s participants. All the other types of companies were too complicated, making some of the investors wary of investing in an incomprehensible legal form.
Another strength of the limited liability company lay in the speed of registration through the KRS internet system, without the need of a notary registration.

The management
When considering investment tools one should decide on the actual role of management. In the case of a simple business plan, you should establish only the most basic Management Board, as it will mostly serve to fulfil legal requirements, not ones born of circumstance. Group Housing Development was operating on the real estate market, so according to the Polish Commercial Companies Code each transaction required a resolution from the shareholders’. The shareholders were based in several locations, which would inhibit the response time of the company, so this required each of them to grant the power of attorney to an agent. An agent cannot be a member of the Management Board, so in the end the company came under management of a two-person entity: the chairman of the board and an agent of every investor, whose participation was required to pass resolutions and further the goal of the company. Granting an enduring and irrevocable power of attorney was a cross-collateral on the part of the investors and might be the subject of a separate article.
In companies where investors have a decisionmaking role I would consider making them a part of the Management Board or establish a separate entity, like an Investors’ Committee, that could pass resolutions which the Management Board would later implement. All in all, using a company as an investment tool is something completely different than using it as a means of creating a business with partners – you should keep this in mind when assigning roles to the governing bodies and when applying solutions from outside the Commercial Companies Code.

Introducing the capital
With GHD, it was decided to introduce the share capital gradually, so the company wound gain credibility. Due to legal and tax-related constrains, only 10% of the funds become the share capital. The rest of the funds were introduced as aggio for the supplementary capital, which is subject to a more lenient law.
The business plan
The key aspect of the investment was creating a business plan that would be simple and repeatable. It was decided that all of the company’s costs would be outsourced. This way the costs became transparent and each investor could compare his costs to the market conditions. This transparency mechanism facilitated the management of the company’s finances, as it did not employ workers or own assets other than those that were the object of trade.

Using mathematical models the optimal level of capital for the Toruń investment was determined to be PLN 1 million. Raising of the funds commenced. A computer simulation was used to delineate the boundary conditions of success and company flexibility, that is the point at which, in the event of not reaching the set goals, the project would need to be closed.    This was a very advanced approach to investment that ensured the security of the capital. Favourable land prices and a sales and advertisement network made the emergency sale of individual properties or the whole company at cost price the basic exit strategy in the event of a failure of the investment. I consider weighing up failure and planning an appropriate response an  inseparable, yet often overlooked, element of the right way to prepare an investment. This is just risk management.
The product was chosen from among the most popular on the market, based on a ratio of house size to final customer price. That final retail client had limited funds, mostly in the form of a low credit rating, but also a limited marketing scope and perception, seeing a house as an alternative to a flat. This forced the company to set the price of the house on the level of a 3-4 bedroom apartment in the city.
Exit strategy
It is much easier to trade company shares than the actual rights to properties. It is also much cheaper. The standard exit strategy for an investor of GHD was the secondary sale of the share or a redemption of shares by the company itself. The latter was more beneficial for the remaining investors, so the decision-making on whether to redeem the shares or assent to the sale was left in hands of the Management Board.
One of the main aspects of any business plan is the exit strategy in the event of a legislation change, a change in the situation of the company or the lack of sales in a given period. In such a case the building plots, acquired at a discount, and the houses already built on them would be sold at cost price to the end-users and local companies, regaining most of the incurred costs or making a modest profit. A strategy with this level of security is probably only possible on the real estate market.

Buying the plots and creating infrastructure
After registration, the company bought land plots in Łubianka i Obrowa near Toruń, creating a plot pool for the first 2 years of operations. Agreements were signed, giving the company the right to buy another 20 plots in the next 3 years. Thanks to Aquarius Property Investments, GHD gained access to plots that were ready for house development. The company immediately started negotiations with the gmina, to receive permits for creating infrastructure. Agreements with electricity providers were also signed.
Market analysis revealed that there was no demand for prospective houses still under development and that houses in developing communities generated the most interest. The person creating the offers based their work on those assumptions.
“Aquarius 7” house project
During the first 3 months the company also decided on the house project. That was an interesting experience, consisting mostly of site inspections, looking at the houses built in the Toruń area and conducting interviews with owners and real estate agents. The gathered information about the most popular projects,  as well as modifications made by the owners and problems with contractors  served as the basis for making the decision.
Along with the final house price guidelines, the above information found its way into the hands of the architects who, in co-operation with analysts from Aquarius Property Investments, prepared  the new house project. Some features were added to distinguish GHD from the competition and showcase its professionalism. The offer for the client was supposed to be simple and clear. It was also a response to local companies’ practices, which included omitting some fees in the pricing, like the price of the boiler room.
Following are the guidelines used during the design process:
1. The maximum price of the house (including the plot) should be no higher than PLN 320 000 – this would be the price for the final retail customer.
2. It should qualify for the “Mieszkanie dla Młodych” government program.
3. It should be intended for a family of up to 5 members.
4. After receiving the building permit, the construction time of a single house should be no longer than 3 months.
5. The project should create a pre-arranged space that can also be easily tailored to the customers’ needs.
6. The house should have the following functional amenities: a. a bright interior, b. a large patio, large windows overlooking the patio, c. a spacious foyer, d. a pantry, e. a bathroom with underfloor heating, f. a wardrobe, g. a passage between the garage and the house interior, h. the living space should be separated from the private space, i. a separate entrance to the boiler room, j. he awnings over the porch and patio should be enlarged, k. a fireplace in the living room.
7. The minimal use of concrete, an appropriate use of prefab components (like lintels), use of materials perceived as desirable.
8. Adoption of a higher standard: a. PCV windows imitating wood, b. interior and exterior window sills, c. underfloor heating in the bathroom, d. fireplace installation, e. painting the interiors white, f. heater installation, g. a ready to use boiler room, h. patios decorated in terracotta, i. white outlets and light switches installation.
9. Addition of aesthetic elements (like entablature, patios, awnings).
Foregoing adapting an existing project and creating a new project from  scratch meant that the company would hold the rights and could modify it in the future according to the customer’s wishes. The project was evaluated by potential buyers and deemed very good, and during the first real estate expo in Toruń the local TV station dedicate 30% of its airtime to covering it.
You can check out the first finished products of GHD at www.osadalubiana.pl and the Facebook fanpage of Osada Lubiana at https://www.facebook.com/ ghdosadalubiana.
Dividend payment
The first payment of dividends was planned for 2016. This was a result of several factors, the main one being the specificity of the operation, the market segment and the region (in the region sales happen after the end of the development process). The process of acquiring permits is long and carries with it a risk of delays, e.g. administrative errors. The development itself requires some time. Due to the seasonality of house sales (there’s a high turnover in spring, a lower one in summer and the strongest one in autumn and at the end of the year), the payment of dividends was planned for 2016 and after the spring sale (using an advance payment mechanism).

The next steps
In 2016, after the first sale, the company will earn a proper credit rating, which will allow for the development of 5-6 houses a year using funds from a bank loan. Companies like GHD should also acquire building plots for several year in advance. Plots for 20 more houses have been secured through signing preliminary agreements or outright buying them. There are further purchases planned for the years to come. The company is also ready to modify the standard house project if the market expectations change, and can also develop a project suggested by the clients or build on plots belonging to the clients.
Global Investor Club
The SPV I described here was created ‘on demand’ by the investors’ club Global Investor Club (www. globalinvestorclub.pl). From the point of view of the group of investors, the regular meetings, which happen at least once a year, are of an especially great importance – they are a perfect opportunity to control the work progress and to discuss other promising ventures. Such meetings allow the management team to showcase the ongoing operation and, by dealing with the investors directly,  to optimize some processes, like acquiring better connections with the suppliers of building materials or learning about interesting legal solutions from the investors who implemented them in other endeavours. This is also an enjoyable time that makes the investment seem less soulless and abstract.
At the end of 2014 the organizer of the investment, Aquarius Property Investments, and Global Investor Club decided to launch clones of the Group Housing Development company in other locations in Poland.
Summary
Group Housing Development is a perfect example of a special purpose vehicle designed as an investment rather than a development business. It is interesting that the company is set up completely differently than it would, if it was meant to be a workplace. The efforts were directed at lowering the need for investment management, and to lock the individual services into transparent lump sum agreements. Further down the line, this allows for profit optimization and provides investment predictability and repeatability of the process. It also allows the investors an easy way of remote supervision and lets the inquisitive types verify the merchantability of the contracts signed by the management team.
This case study used intranet technologies that provided investors with unrestricted access to all of the companies documents, from legal ones to invoices, receipts, bank statements and the so-called project log, that is the diary covering the important events of the investment process, like extensions, permit obtainments and agreement signings. The less inquisitive investors receive a newsletter written by the management team, covering not only the financial results, but also a photographic documentation of the work progress, which is a rare treat on the real estate market. I would like to admit that I am a big fan of transparent solutions, because they allow the management team to focus on the work, and the investors to control their investment. It is a shame such solutions are not an industry standard.
As of 1 April 2015 GHD sold 2 houses and is in sales talks for another two. As I write this, the company has 49 investors, members of the Global Investor Club.

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