Development Fund vs. JVs

My partners and I are at a point where we have a ton of upcoming pipeline (mostly multifamily), which is going to require a few hundred million of equity over the next 3-7 years. Traditionally we've always gone to institutional partners on a deal-by-deal basis, but we've noodled with the idea of using these deals to seed a fund.

Ergo, I wanted to start a discussion to get this forum's thoughts on the pros and cons of having a platform vs. raising capital and negotiating every deal as you go to put them into production. We love the idea of building out more of a fee-based business to smooth cash flow, but obviously a fund comes with a ton of overhead and I have no idea how much (if any) of those fees are actually profit.

Comments (8)

Jul 29, 2022 - 11:18am
Steam, what's your opinion? Comment below:

Are all your deals you're looking at going to fall within similar hold period / geography / product type / strategy? If the deals are wildly different across any of those metrics it's going to cause headache in terms of locking in LP capital across such a broad mandate. Most of those guys who will commit blind pool, long dated capital have strict requirements for how the capital can be used and when it can be returned.

Additionally, you're looking at way longer time period to hit your promote as it will likely be fund based and not deal based - forget about cashing out on refi here if the fund overall still hasn't hit pref at that point.

From what I've seen developers who did go the fund route ended up regretting it for those reasons - they like the flexibility to handle each deal on a case by case basis and get their promote earlier. I've seen much more interest in forming programmatic JVs than an outright fund wherein the capital isn't outright committed up front and there's no ongoing AM fees to collect while searching for deals but you typically have an agreed upon mandate for which a larger LP will definitively commit capital upon certain deal criteria being hit.

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Jul 29, 2022 - 12:42pm
CREnadian, what's your opinion? Comment below:

Mostly agreed with this, but a couple points on structuring a fund that can circumvent some of the above-mentioned issues assuming your strategy is an appropriate fit for one.

1. You can always structure with an american-style waterfall (i.e. deal-by-deal) to get paid earlier, but the downside here is you're going to need a clawback provision so if your fund returns don't line up at the end you'll be paying back a chunk of that money and will likely need to hold it in escrow (or at least a good portion of it).

2. If your fund strategy is build and hold, another workaround is to allow for crystallization in the fund. For example, once the equity is fully funded and you've refinanced whichever projects you're going to hold, then you crystallize the GPs share and earn your promote that way. Still requires you to wait for build out but if its a long time horizon you get paid much earlier.

Aug 1, 2022 - 7:57pm
abell6, what's your opinion? Comment below:

In addition to what youve outlined, you can also do pools under the JV and paper it so promote can't get clawed back between pools.

I've done deal-by-deal, European with pools and with crystallizations... 100% prefer crystallization, just have to make sure you're papering it so the value is based on the full portfolio and not on FMV of each asset.

Jul 29, 2022 - 11:25am
decrebepro, what's your opinion? Comment below:

They're all in the same metro area, asset class (multi with some mixed-use components), and the stars appear to be aligning in terms of groundbreaking dates - although there is still plenty of entitlement to be done which makes the timing rather unpredictable.

I hadn't though about the promote being at the fund level - which is such an obvious but great point.

Jul 29, 2022 - 12:00pm
pudding, what's your opinion? Comment below:

Upside of a fund is consistent fees. Downside of a fund is the capital becomes less flexible. If you raise and say you're going to achieve a 20% IRR and 2x EM and the market moves on you. If you can't get those returns anymore - there goes your ability to put capital out the door and your promote. 

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Jul 29, 2022 - 5:06pm
MidMarketMcLovin, what's your opinion? Comment below:

Are your existing investors the same type who will commit to a fund? We do a lot of LP equity in development deals through our own discretionary funds and we would not commit to a fund with a GP, we couldn't justify the additional layer of fees to our own LPs and we would also have reduced line of sight on capital deployment which makes it a lot harder for the portfolio managers to allocate capital. We'd do programmatic JVs instead to address these issues. If you're working with investors who can invest in individual deals or discretionary funds this issue goes away.

A fund creates issues around pooled promote. While you can get paid out deal by deal, there'll be a clawback and other mechanisms to protect the investors as CREnadian has pointed out. If the market blows up or you fuck up a few of your deals you can end up with no promote. If you split the deals into 2-4 programmatic JVs instead you'll decrease the pool mitigating this risk.

  • Principal in RE - Comm
Aug 1, 2022 - 10:23am

as others have mentioned, fund investors vs. LP investors are different, so my feeling is you'll have difficulty raising a fund. I'd stay deal by deal, try to find someone programmatic (with uncrossed deals), and maybe approach a few of the very large capital allocators (like a nuveen) to see if they would just take it all down

  • Associate 2 in IB-M&A
Aug 1, 2022 - 10:39am

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