For context, I’ve been doing some underwriting on potential development opportunities in my market that would be feasible for someone to do as a first development at some point during their career (let’s say total project cost of ~$5m for simplicity). Not talking about what your firm requires.
I’m not sure if it’s the market I’m in or if I just have unrealistic expectations, but nothing seems to pencil a return that I think justifies the risk/effort compared to public market investing? I’m curious to hear from those that have done their own deals - what return profile do you need to get off the couch?
This is a very loaded question especially for development as there are endless capital structures you can employ to juice returns.
At the developer I’m currently at typically we do 65% leverage and then target an equity IRR of 17-20% but the actual waterfall structure gives us promoted interest at different tiers so on the developer side it is more like 50%+ IRR. Again it really depends on the capital stack and structure and how the waterfall terms are negotiated.
Agreed it is, but chances are if you’re just starting to do your own deals you aren’t going to be having a complicated capital structure? I could be wrong but my presumption is you have to offer something in return to entice investors (pari passu equity with maybe a small development fee?). Again, curious to hear from those that have done this and what things looked like before getting established.
Don’t cut dev fee just to get started. If you have to do that to raise money, be very cautious. Here’s the issue. Your job is to watch the development and make it happen. Does the LP who’s putting money at risk really want to have the developer discount their services? Why will you be incentivized to provide the best service if you’re not receiving market fees? If your dev co isn’t running profitably, how’s does the LP expect you to have the talent to manage the development appropriately?
I would say if anything the capital structure would be more complex when you are starting out as you have less capital to put into deals and so have to get creative with pref equity, co-gp or paying someone to flash their balance sheet to banks to lend you money.
That being said whenever you are first starting out I would agree with the other post saying not to discount your developer fee. I would think dev fee between 3-5% of total project costs should be reasonable and then maybe pari passu to 9%, 20% to a 12%, 30% to a 15% and 40% for 15% IRR and above. These should be pretty market terms that capital partners will probably not have a problem with.
Tbh I don't think IRR is a good metric to quantify returns at the $5mm level. I am currently working on a development that has a TPC of ~$4mm with a profit margin of ~$3mm in ~2 years and I wrote about it here https://www.wallstreetoasis.com/forums/ama-home-run-dealproject-3mm-pro…. If you were to do an IRR analysis on this the IRR would be in the multihundred to thousands %. Yes I agree this is a homerun project, so let's use a more "standard" example. Let's say you acquire a property for $1mm, put in $200k of renovations that takes 6-12 months and the bank finances 80% of the acquisition and 100% of the construction cost and you sell it for $1.5mm. After adjusting for 5% cost of sale, your profit is ~$225k, which tbh for all that work isn't that great, but your IRR will be something crazy because of the short hold period...but for such a low nominal profit, sometimes a high IRR doesn't justify all the risk, time, effort, and opportunity cost of that investment. Everyone on here is talking about IRR because they work at large institutional developers where a 50% IRR is a home run because the nominal profit is massive...but on a $5mm project I wouldn't touch a 50% IRR deal with a 100ft pole
Fred Fredburger very interesting! I never thought to look at it like that. What metrics do you look at when analyzing deals? Do you look at making a certain multiple on your equity? How do you determine a good deal? And as these deals are so profitable, do you have any insight into why more people aren’t doing it?
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