Development Fees > Sponsor Equity Contribution
We own a property where an adjacent site is being marketed for sale. We've had a few developers reach out to us interested in combining both sites (i.e. ours and the neighbors). Some proposals have given us the option to contribute our land as equity.
As I'm assessing this option, I've noticed that the development fee is significantly more than the GP/developers equity contribution--the dev fee is 3% which seem to be within market, but the gross dollar value of the fee is more that double the sponsors equity contributions.
I understand that sponsors are limited as to how much they can fund, but my concern is about the alignment of interest--regardless of how to project performs, the developer will come out in the green. Given the current market, I'm hesitant to participate in a deal where there is limited downside for the sponsor, while at the same time recognizing that the developer deserves and needs the fee for all their work.
How should I be thinking about this? I'd assume this is somewhat common on large projects where the fee exceeds what the sponsor can contribute as equity. How do LPs usually handle this?
I apologize and admit I'm ignorant on the the topic of development. We do not usually invest in development deals so this is a one off.
You answered it yourself, sponsor has a market % contribution and market development fee, so who gives a fuck? Is it a good deal or not?
Get the fuck out of here with aligned interest lol. The fee is paid out over the duration of construction.
I don't know why this got shit - perfectly valid take. Whoever is in charge of the project should go on the guarantees. Good luck getting the dev fee, it's the last thing we'd ever give to anyone, much easier and fair to ask for a piece of the promote. The fees are market as everyone else said. Our dev fees also usually exceed our GP stake, this is not uncommon esp for larger projects. What all the people who seem to not know shit about fuck when it comes to development don't understand - our dev fee isnt there for us to pop bottles and sail off into the sunset. We have millions of dollars in payroll and corp expenses, what do you think pays for all that? Prana? Vibes? Yes we might make some money on it but the vig is not big. Wow it's a $5mm equity check and they have a $5mm dev fee omg they have no risk! Except the risk of running the company that builds the project. Except the risk of signing all the guarantees. Those are just the two painfully obvious ones. You know who we've never done business with? People who think they deserve a piece of our fees without actually contributing anything to the process. Btw we do lots of deals with land owners that contribute - and they're happy to do it you know why? Because they're smart enough to know they can't do it themselves, and they get to kick their feet back with no actual risk (and sometimes a basis step up) and actually sail off into the sunset until their checks come in. Without any of the skills or day to day nightmare that comes with development. Or you can just do it yourself if you think you can pull it off - but good luck w that.
Some of these LPs man….all they know is what they see in their excel spreadsheets.
Yeah this happens. They're just leveraging their returns with your equity at that point and minimizing their skin in the game. Personally I would never continue negotiations with somebody who sets the table with a one-sided attitude like that. They're screwing you. Let me guess, they don't want to sign the guaranty either.
Disclaimer, I don't know anything about the deal, including structure (are they asking to co-GP and contribute less than 3% of total capital??), property type, and the objective quality of the investment opportunity.
But it sounds like you might have a winner, and if you do, for what it's worth, I think you have three options. One, you self-develop. Spend a little more on soft costs, get the best consultants/advisors, have somebody smart internally work on it. Based on the development fee being 3%, this sounds like a fairly large project. There's immediate cost savings by doing it yourself, not to mention what you'd pay them in promoted interest. Two, just sell the site to them. Make them put up some real hard money at the end of due diligence. In order to get a big sale value, you'd need to comply with their land assemblage and give them time. There's risk in that too. Three, take the time to find a great development partner, which might include a structured marketing process. Best of luck and hope it works out great.
that’s how sponsor equity usually works…and as you’ve said the fees are market..
they should provide a completion guarantee and if they don’t it’s a non starter… you can also negotiate decision rights etc…
(1) The dev fee is standard. But if you really are concerned, then include in your counter to take some portion of the fee.
For example, if the land value you are contributing represents 10% of the equity, ask for 10% of the dev fee. Now, that's a bit aggressive, the ultimate number may be much lower like 1%, but everything is negotiable. They may not move much on this, but you can often get something out of the dev fee **IF** that is really an important thing for you. Although it is likely that the equity stake may go down to compensate (ie - may be 7.5% equity and 1% of the dev fee). You shouldn't expect to get your cake and eat it too.
(2) As someone else said, you should absolutely ask for a completion guarantee. This is the absolute bare minimum you should seek to make sure there is alignment.
Assuming the GP is the one on the guarantee, you would be completely out to lunch asking for any of the dev fee. Dev Fee % seems market, and GP contribution is not out of line either. That dev fee is how they keep the lights on over the course of a project, not a real profit center for a developer worth their salt.
Feel free to try to push on things like promote, basis, etc, but why should you get a percentage of the dev fee if you aren't doing anything other than contributing equity (via land)? I was at a shop previously that tried to do 95/5 JV's (equity), and then something like 60/40 Debt/Equity. What that resulted in was a Dev fee that was somewhere in the same ballpark as the GP equity. However, the GP was the one providing the completion guarantee, to be fair.
People below have commented about the various perspectives on whether it is acceptable for a GP to have their fees exceed their equity contribution. Personally I think it is case dependent.
However, there are middle ground options. Maybe tell the GP they cannot fee off your land contribution, which after all does not reflect any value add on their part. Obviously ask for a completion guarantee. You should be asking for that no matter what else is going on. Or you can co-GP the deal, and ask for a piece of their economics, though it'll mean taking on development risk. Structure it such that you get paid ahead of the developer, if you can.
At the end of the day, the only thing you can do to ensure your partner is both capable and willing of taking on risk is to vet the people you do business with. Since you have a very limited number of potential partners, you don't really have this option, so you're sort of stuck.
Why shouldn’t the developer be able to fee off the land? They are developing (i.e., making improvements) to the land…
I think your argument works against the point you're trying to make. The developer should fee off the improvements, off what they develop. But the raw value of the land owes nothing to the developer, after all. By your logic, developer fees should exclude land value. Even if you want to argue that in assembling a development site and entitling it, a developer is contributing value (a valid argument!) it still falls a little flat in this case, since OP's firm can make a reasonable argument that they're contributing a shovel ready site and thus have done a lot of that work.
Look, everything is a negotiation. I work at a development shop. We'd be out a lot of money over the last few decades if we couldn't charge fees on total development cost, and only got hard cost as fee basis instead. But OP has a valid concern, that he's gonna get shafted because his "partner" has no real skin in the game. I'm simply suggesting a few ways they can go about lessening that divergence in incentives.
Standard at my old commercial soft was dev fee was on hard and soft costs, ie not on the land in most cases
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