A.CRE

Crystallization

Also referred to as a partnership crystallization, a crystallization is a provision in a real estate joint venture agreement where the partners agree to adjust the ownership share in the venture at some pre-defined point in the future. It is most common to value-add and opportunistic investments, where a large increase in value is likely to be realized early in the investment.

The purpose of the crystallization is to allow the GP to earns its promote by way of a resetting of the ownership share percentages. The concept goes something like this:

At a point in time when the crystallization is to occur, the partners run the proceeds of a hypothetical sale through the equity waterfall to calculate the expected distribution to each partner. Based on that expected distribution, the ownership share is adjusted to reflect the share of the distribution each partner would hypothetically receive.

So, for instance, imagine a JV where the GP owns 10% and the LP 90%. At crystallization, the partners assume a $100 million sale and run those proceeds through the waterfall model. The model calculates that, based on the promote structure and terms of the JV agreement, the GP would be distributed $17 million at sale and the LP would be distributed $83 million at sale.

The ownership share (i.e. the percentage distributed to each partner) from that moment forward would be 17% to the GP and 83% to the LP. And no further promote would be paid to the GP (i.e. the promote would be frozen).

Accelerator Advanced member? Be sure to check out the Crystallization lesson in the Advanced Partnership Cash Flow Endorsement.

Putting ‘Crystallization’ in Context

Scenario Overview:

Riverwalk Development Group (the Developer) has partnered with Scenic Capital Advisors (the Capital Partner) to develop a build-to-suit, single-tenant net lease property in Chattanooga, Tennessee. The project, named Volunteer Gas & Go, is a convenience store anchored by a long-term lease with a national gas station and convenience store chain. This development is a classic “build-to-core” strategy, where the intention is to stabilize the property and eventually hold it as a core investment for long-term income.

Project Details:

  • Property Type: Retail – Single-Tenant Net Lease (Convenience Store)
  • Location: Chattanooga, Tennessee
  • Development Cost: $5 million
  • Expected Stabilized Value: $7 million
  • Lease Term: 15 years, NNN lease
  • Tenant: National Convenience Store Chain
  • Initial Equity Split: 10% Riverwalk Development Group (GP), 90% Scenic Capital Advisors (LP)

The Crystallization Event:

In the joint venture (JV) agreement, the partners have agreed to a crystallization provision at the time of rent commencement, which marks the completion of construction and the start of the tenant’s 15-year lease. The rationale behind the crystallization is to allow the developer (Riverwalk Development Group) to realize and lock in their promote early, recognizing their efforts and success in bringing the development to fruition.

Crystallization Process:

1. Hypothetical Sale and Valuation:

At the point of rent commencement, the property is valued at its expected stabilized value of $7 million. Although no actual sale will take place, the JV partners simulate a hypothetical sale to determine what the proceeds would be if the property were sold at that moment.

2. Equity Waterfall and Promote Calculation:

The partners then run the hypothetical sale proceeds through the equity waterfall model. The terms of the JV agreement stipulate that after the return of capital and a preferred return to the LP, the remaining profits are split according to a promote structure that rewards the developer.

  • Initial Distributions:
    • Return of Capital: $5 million (to Scenic Capital Advisors)
    • Preferred Return: Assume 8% IRR hurdle has been met.
  • Remaining Proceeds: $2 million

Based on the promote structure, which might offer the developer, say, a 30% share of the remaining proceeds after the preferred return hurdle is met, Riverwalk Development Group would be entitled to $600,000 out of the remaining $2 million.

  • Total Distribution:
    • Riverwalk Development Group (GP): $600,000
    • Scenic Capital Advisors (LP): $1,400,000

3. Adjustment of Ownership Shares:

The crystallization process adjusts the ownership shares in the JV based on the hypothetical distribution. Before crystallization, the ownership split was 10% to the GP and 90% to the LP. After the hypothetical sale, the GP’s share increases to reflect the proportionate distribution it would receive.

  • Revised Ownership Split:
    • Riverwalk Development Group (GP): 23% ($600,000 / $2.6 million)
    • Scenic Capital Advisors (LP): 77% ($2 million / $2.6 million)

The GP’s ownership interest is now crystallized at 23%, effectively locking in their promote early in the project’s lifecycle. From this point forward, no additional promote will be paid, and the GP’s share of any future cash flows (e.g., from operations or sale) will be 23%.

Outcome:

This crystallization mechanism benefits both parties. Riverwalk Development Group is able to lock in its success by increasing its equity stake early, providing immediate recognition for the value it has created. Meanwhile, Scenic Capital Advisors secures a more predictable and stable ownership structure for the long-term hold phase of the investment. This type of arrangement aligns the interests of both parties, rewarding the developer for their value creation while allowing the capital partner to transition into a core investment with a known ownership split.

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