Introduction:
In this article, we will review one of the most common, but also complex, real estate transactions, which is the combination transaction.
A combination transaction has advantages and disadvantages for both parties involved, namely the landowner and the entrepreneur or contractor, as well as issues of critical importance that must be considered during the negotiation phase between the parties.
One example of the aforementioned issue, which we will touch on in this article, is the question of construction rights in a combination transaction; can the entrepreneur or contractor be required to utilize the full construction rights? Who will own future construction rights (if any)? And so on.
What is a combination transaction?
A combination transaction is a type of “exchange” transaction, in which land owners sell some of their rights in the land to an entrepreneur, including existing or potential building rights in such land, in exchange for the construction of some of the new units to be built on the land by the entrepreneur (or the contractor on his behalf).
Although most combination transactions are carried out on land designated for residential use, this is not necessarily always the case. Combination transactions can also be conducted on land designated for a variety of uses, including commerce and/or offices, where the principles of the transaction are maintained and applied, subject of course to the necessary adjustments.
In parenthesis, we note that there are often more than one owner of a certain land, a fact that may make it difficult to negotiate with the entrepreneur on the other side. Therefore, we recommend that land owners who are interested in advancing a transaction on their land first draw up a partnership agreement between all the owners in order to eliminate possible disputes between themselves, and also to create a single authorized body that will deal with the entrepreneur – which will be an advantage for the entrepreneur who does not wish to deal with multiple owners.
In general, there are two types of combination transactions, a percentage transaction and a net transaction. In a percentage transaction (the classic model), the parties decide on the percentages that the owners will receive from the new units that will be built (the combination rate), which is affected by the land valuation (the higher the value of the land and its building rights, the higher the combination rate that the owners will receive). In such a transaction, the parties share the tax and fees payments in a variety of ways specified in the combination agreement.
Without going into detail on this subject, we will note that most of the time the division is such that the owners pay the betterment tax and betterment levy for the portion of the land sold to the entrepreneur as part of the transaction, as well as the VAT for the construction services, and the entrepreneur is responsible for paying the purchase tax for the portion of the land he purchased from the owner, and of course the planning and construction costs and fees for the entire project.
In a net deal, the parties decide in advance on the net consideration that the owners will receive for their share of the land, with the entrepreneur taking on the full payment of taxes, including the owners’. On the one hand, this is a seemingly tempting offer for the owners, who will be left with the full consideration they receive (for example, a number of apartments, office space, retail space, etc.), but on the other hand, the consideration they will receive will be lower than what they would receive in a percentage deal.
Advantages and disadvantages of a combination transaction:
Combination transactions have a number of significant advantages.
For the owners, this is usually a higher return than they would receive in a regular sales transaction, inter alia due to the fact that the portion of the land that will remain in their hands will be significantly improved and will continue to generate a return for them. Also, since it is a percentage transaction, the owners will pay less taxes than in a regular sales transaction, since they are selling only part of the land.
For the entrepreneur, this is a project that he can carry out without risking significant equity to purchase the land, and from his perspective, taxation will also be lower because he is purchasing only part of the land and not all of it.
On the other hand, signing a combination transaction can pose a risk for both parties.
For the owner, this is a long-term contract in which the returns will only be received after several years, and there is always the potential risk that the entrepreneur chosen will encounter difficulties during the project period, which could leave the owner in a problematic situation, despite receiving collateral from the entrepreneur as is usually required in this type of transactions.
For the entrepreneur, there is always the danger of an incorrect valuation of the real estate and the combination rate or receiving lower than expected building rights, which could lead to a lack of profitability from the project or even losses.
The issue of building rights in combination agreements:
As we mentioned at the beginning of the article, a combination transaction is based on the sale of a portion of real estate, including the building rights associated with it (existing or potential), which will be used by the entrepreneur to build the project. The intuitive assumption is that the more building rights there are, a larger project may be built, which will yield higher returns, and therefore the parties will want to take full advantage of the rights.
However, this is not always the case. Sometimes, the cost involved for the entrepreneur in utilizing the full building rights granted to him exceeds the benefit that can be gained from such utilization. This can create a conflict of interest between the owners and the entrepreneur, which is important to address early at the negotiation stage and to determine in advance whether the entrepreneur is obligated to utilize the full rights.
Another issue related to building rights concerns future (potential) rights that may be granted to the land in the future, and the question of who these rights belong to – the owners or the entrepreneur?
On the one hand, it can be argued that the entrepreneur, in the actual planning of the project, is the one who has created the additional rights as mentioned, and is also the one who needs as many construction rights as possible in order to plan and build the project and maximize the profits for him and the owners (subject to the issue of their full utilization as detailed above), and therefore the construction rights should be attributed to him. On the other hand, it can be argued that these rights belong in part to the owners for the portion of the land that remains in their ownership. Of course, it is always possible to determine that construction rights will be divided between the parties according to their share of the land, but in any case, this is an important issue that also needs to be expressed within the framework of the negotiations between the parties and the combination agreement that will be concluded between them.
Summary:
A combination transaction may seem like a simple real estate transaction, but in reality, it is a complex transaction in which each issue can be translated into very large sums of money for each of the parties.
The issue of future building rights is just one example of such material issues, on which we have chosen to focus in order to emphasize the importance of addressing even the smallest details of the transaction, which may seem immaterial or trivial, but the opposite is true.
Therefore, we recommend that real estate owners who carry out real estate transactions in general, and certainly combination transactions, be accompanied by the appropriate professionals who know how to skip the pitfalls that may rise and obtain for their clients the maximum realizable returns from the land and the transaction.
Hanan Efraim, Adv. Hadar Yair, adv.
Office: 03-6916600 Office: 03-6916600
E-mail: hana@ekw.co.il E-mail: hadar@ekw.co.il