How do you scale as a developer? Or DO you?
Do you eventually phase into deploying more of your own cash and continuing to do small deals? Seems like a way to focus on good returns and building real wealth.
Or do you do bigger deals and more volume and hire a bunch of expensive people, ultimately evolving into a fee heavy shop doing possibly mediocre deals?
Honestly the same question applies to lots of buyside roles. Like a PE fund. Instead of eventually focusing on his own deals with his own money, Steve Schwarzman doubled down repeatedly on the OPM model. This has worked well for him given his current net worth, though I wonder how much of that is due to the Blackstone company valuation itself. Hard to say if you can do the same as a real estate GP.
I have no idea what the answer is as I am also trying to figure this out myself, but I have put quite some thought into it and here's where I'm at. First, I think the way that you scale depends on what your strengths/resources are. For example, if you have a strong institutional background and have the connections to raise equity, then the way to scale would probably be by raising funds, hiring expensive people, and pursuing "bigger" deals where the returns may not be spectacular, but the fees and nominal profit are by nature of it being a larger deal. Tbh, I can't speak too much on this method because it is not the strategy that I am pursuing.
I fall into your first category of doing smaller deals that generate very strong returns; however, I will say that I am very fortunate in that my parents started the real estate business and have amassed a decent amount of capital in order for me to pursue my strategy and my dad is a GC so we construct/renovate in-house. Basically my goal is to deploy a good chunk of my family's capital in order to generate fixed income. The strategy is to focus on acquiring and renovating 3-unit properties and holding them long-term for rental income. If I can generate enough fixed income to hire in-house property management and a very experienced construction supervisor, then we can 1.) pursue larger developments that my family previously could not due to lack of construction experience and 2.) pursue multiple development projects at a time in order to spread the cost of the construction supervisor. Some properties will be for rental and some will be for condos, then hire more construction supervisors...rinse and repeat. The 3-unit strategy may be slow, but the risk for my family is also low because renovating 3-units is well within our wheelhouse and if shit hits the fan, 1 bad 3-unit investment is not going to break us
If you do not have a lot of capital to invest, then I think the strategy is to be more of a merchant developer and sell every project until you've amassed enough capital to be able to hold onto some properties as rental and others as condos. But eventually I believe fixed income is needed in order to grow. It's difficult to hire employees and plan for the future if your cash flows revolve around sales
Just my 2 cents, if you know of an easier path, I'm all ears lol
I’ll add my two cents. The larger a development the more nominal fees the project can generally support (which supports scaling and why people try to go bigger faster). Also, the bigger developments generally have larger nominal profits and therefore a larger nominal promote (even if the returns are lower). Lastly, many developers who do large deals pass all salaries back to the project. Which means the fee income is all profit. A smaller development just can’t do this because adding an extra $300K to a $20MM project is very different than a $150MM project. So personally, I think many people try to scale size and you always must make sure to charge market rate fees so your development platform (business) is profitable. That way you can live when the deals slow down and you don’t rely on promote only.
I think many developers (and GPs) make the mistake of not charging market level fees and therefore relying on the promote to pay them back and run their operating company. A deal needs to be profitable for the LP, GP, GP’s operator company, and the property manager to make sense.
Also, how do you define mediocre deals? I believe that generally the institutional deals will get underwritten to a 2.0x Equity multiple and 20% IRR. Assuming you believe the returns and market efficiently prices (questionable). What do you believe is a mediocre deal for scaling vs a ‘good’ deal. Personally, if you can raise money at the returns you advertise, and you can hit those returns, was it still a mediocre deal? I think it’s about hitting the returns you advertise at during your capital raise. If you can’t do that, than it’s a bad deal.
I understand what you're saying, but I think you're skipping a few steps. I could be wrong, but I think OP is doing deals at the sub-$5mm level, maybe even sub-$2mm level and he's asking about growing to the next level. If he was able to do $150mm projects or even $10mm+, I don't think he would be on WSO quite frankly lol and you don't go from doing $5mm to $150mm over night...probably not even in a lifetime unless you are incredibly lucky and well connected. Tbh even doing deals in the $10mm-$20mm TPC is incredibly competitive and difficult...in my area, this equates to a ~20-75 unit development depending on the cost of the land and can generate nominal profits of $8mm-$15mm...There's not a lot of opportunity that allow for this and in my experience, rarely does it even hit the market. It's easy to talk about doing "bigger developments," but in reality it is a lot more difficult. First, you need more equity. Now do you go out and raise equity, which is another huge challenge in itself or do you put more of your own skin in the game (if you even have it)? One bad market or setback could ruin you. Second, do you have the experience for larger projects? Developing 4 unit properties is very different from developing 30 units...even if you use a GC, you won't be using the same GC for 2-families as you would for 30 units so that will require you to take the risk of a GC that you have no previous experience with. Larger numbers also means larger cost overruns and larger carrying costs. Then you have the entitlement process which can easily take 3+ years. During this time do you just eat mortgage payments for 36 months? Do you know the right zoning attorneys/consultants/architects? How do you pay them? What do you do when the whole neighborhood comes out protesting your project? Lastly finding a site to develop 30 units is arguably the most difficult. Land in which the city will allow you to develop 30 units is very rare and even if the opportunity presents itself, you probably won't even know about it as a larger, more recognized developer already approached the seller via cold mail/email/call or if the seller hires a broker, the broker already has a list of developers to take it to and you're not on it. Also, these opportunities are usually in markets that have not gentrified yet, which means that you may very well be a first mover by investing in this market, which means significantly more risk as you are likely projecting sell-out/rental figures that are not supported by any comps. In my opinion, the best way to grow is incrementally. Don't jump into an asset or a project size that is way out of your skillset/resources unless it is truly a home run with a large margin of safety, but a deal like this is very rare.
100% I agree with you. I was just trying to show how someone scales as they get larger. It is really really really difficult to develop smaller assets because the fee base isn’t as high.
These are two very different leagues. I think it is extremely rare for someone to go from building duplexes to eventually developing a $100m+ project. The way people get into the larger projects is by having connections to institutional capital partners and not by having more money or by showing their experience of building duplexes. I think most people/companies that are doing these larger developments have been working on larger developments for most of their career at institutional shops before branching out on their own.
Ex. Mill Creek Residential was founded by a group of TCR veterans who realized they were capped at TCR and wanted the opportunity to own their own company
Hypothetical Ex. Someone who works at Hines/Greystar/etc. for 10+ years and realizes they have the connections and expertise to do their own deals and leaves.
This is an interesting question. OP, are you asking from the prospective of a "firm" or an "individual"? Because I think the options are very different. Firms can add capital and people in proportion to the availability of deals they want to do. Like for a devco, growing/scaling can be as simple as hiring a team/opening an office in a new market. Or adding the people/tools to do a new property type in an existing market, or just to do more of the same. I.e... as "easy" (sarcasm intended) as anything else.
If you are asking an individual, whether who is part or full principal in deals or an employee of a large devco, scaling clearly requires some leveraging of "firm" resources as above. If you are a sole principal, you may need (likely) to add partners and thus create a "firm", the more you do this, the more your operations and opportunities will be like those of large devcos. Alternatively, you could "scale" your career/position within a "firm", like be the one who opens the new market or property type. Or even just get "promoted" to command larger and larger teams/resources. Kinda same problem, different means of attack.
I will add a nod to some of the above comments about the difficult in going from $5 million type small deals to $100 million + "Big" deals. The firm I work for is very much in that latter set of deals, and we could never execute a small deal successfully (not to suggest we would think of such), and in reality, even looking at "smaller" deals for us (something we would do), comes with more challenges that often lead to abandoning pursuit even if otherwise a good deal. It's a classic "stay in your lane" type problem, when you deviate from what works and you specialize at doing, you find new costs, delays, and competitors (like you are more likely to suck).
In fact, the really successful jumps in operations type seem to occur when "forced"... like mall developers becoming apartment developers. Still, I see far more big jumps of big urban type developers moving to other big urban markets and suburban developers finding more suburbs than I have ever noted of urban type going suburban or vice versa. Clearly, there are exceptions and I am in no way implying a "hard and fast" rule. Just saying that if you want to totally transform your business (or career) it is a lot more work, risk, and time required than "scaling" what you already do well in more places.
redever would love to hear you discuss further the part you mentioned about staying in your lane. Why do you feel, that say an institutional developer who generally does $100MM plus deals, jumping down to do, maybe a $30MM deal, is so hard? What is so different between the institutional market and ‘middle market’ or non-institutional market?
Well, first, this is not any sort of hard and fast rule, lots of exceptions and examples going both ways by many firms. But still, "staying in the lane" is a common behavior, or more correctly, staying at the "top" of one's lane (meaning firms tend to focus on their own "highest and best use"). Why? This is generally what will maximize firm profits/success. Here's why..
- Firms hire, attract capital, and maintain relationships for the types of deals that normally do - so jumping from say $100mm to $30mm may make all those items less fit to do those deals (read... more expensive than needed)
- People specialization also means that those on dev teams that can do $100mm + deals are probably going to be bored with $30mm deals - so if the firm can't keep doing those "big" deals, those people may leave if other firms can
- If you are "built" as a firm to do a certain scale of deals, going below will likely lead to lower than acceptable/targeted profits (remember you can't eat IRR) - the reality is it probably takes same amount (or just about) of people and firm resources to do a $100mm deal than a $30mm deal
- In the case of going from "high" to "low" - you probably pick-up a lot more competition from other developers (generally, less barriers to entry), and thus, may have more issues competing for deals (goes back to having a misaligned cost structure). Going the reverse strains resources (pursuit costs scale up pretty fast!) and thus keeps smaller firms from going up (so they partner more often than not if they land such opportunity)
Still, firms are forced to make such shifts when the market shifts. The mall developers becoming apartment and mixed-use developers is a great example (or the suburban office developers adding logistics/warehouse deals). When this happens, the firm probably looks like its totally re-organizing, and will probably hire differently going forward. For some, it is the acquisition or loss of a key capital provider may cause this shift (honestly, it feels like capital is the tail that wags the dog in the developer world). For others, its pure market forces.
Still, I can think of more examples of "big" firms jumping to new markets than other property types or doing smaller deal sizes. Silverstein has being doing this recently (entering the LA market with the acquisition of the US Bank tower, essentially a value add play). I can think of similar types of moves by firms like RXR and Related.
From the perspective of a one man firm, to answer your question
Well, then hiring a person would be a major increase in capacity! Seems like the next step.
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