From Real Estate Finance to Founder of Development Company - Q&A

It's a cliche, but there's never really a right time to start a business; there are always reasons why it's "not the right time." The GFC definitely affected us. We closed on one of our development sites one month before Lehman blew up, and then in 2010 we had another project in lease-up. In the first case, we closed on the site with cash and very little debt. It sucked, but we (and our investors, who were patient and realistic) could afford to wait it out. The project eventually got built and was very successful. In the second case, we had a conservative debt structure with no short-term maturity. Thank god for that. We also had the cash to fund lease-up reserves as we ran through them quicker than projected. That project has also ended up being very successful. Lesson - if you have a good location and a good product, and the financial (and emotional) resources to get through down-turns, you will likely do well, provided you didn't put stupid/aggressive debt on the deal to start.

I've seen too many smart guys get too aggressive, lose properties (and marriages) due to excess leverage, and then watch as the projects became very successful a few years later - after they'd lost it.

You don't need to (and shouldn't try to) make all your money on one deal...

Our first deal was sourced "off the market"; in fact that's how almost all our deals have been done. It was a 50-unit apartment deal, and most of the equity came from outside LPs. Did we give up a lot to them? Yes, but we earned a development fee and more importantly, we started building credibility and a track record, which is what enables you to raise more money and do bigger deals going forward.

With respect to sourcing deals - we turn over tons of rocks, are never afraid to be told "no", etc. I could tell you some incredible stories about the odd ways we've found some of our best opportunities. It's really that simple, but amazing how many guys don't want to get their hands dirty; they'd rather go to conferences, roundtables, etc. and talk shit about the market, stuff like that.

It depends on what you want to do long term. I can say this for certain - the best way to learn the development business is to do the development business. There's no substitute for learning how to source a deal, negotiate a P&SA, do the due diligence, hire your third-party guys (architect, GC, civil engineer etc.), manage the design process, manage the budgeting and GMP process, negotiate a construction loan and an operating agreement, then manage the construction process, live through a lease up, etc.

The great thing about this business is you can learn these skill sets (and make your inevitable mistakes) on very small deals. Buying / rehabbing a 4-plex will teach you much of what you'd learn on a 200-unit deal.

I didn't get started until I was in my 30's. If I had to do it again, I'd start in my early 20's. Go find a small deal, raise the money from friends and family. Take a fee out of the deal, make it successful for your investors, and you're on your way.

My guess is a lot of you guys are young, single and have few financial obligations beyond rent and alcohol (maybe student loans, too). Now is the time to do it.

I run across guys my age all the time who are more intelligent than me, have been in the business longer, etc. But they're still working for someone else. I used to worry that they'd go out on their own and be competition for me. But they most likely won't, because they've got a wife, kids and a mortgage ("the whole catastrophe", as Zorba the Greek said). It gets a LOT harder to go out on your own once you have people depending on you to earn a living.

Another thing - if you're under 30, you probably have a more intuitive feel for what the renter demographic wants than a guy my age. Use that to your advantage. What's the worst that can happen? You do a bad deal, "blow up" and move on. You'll have learned things that only come through doing, not through analyzing on someone else's behalf.

The reason my partner and I left the last place was because we both always knew we wanted to do our own thing, and we knew that buying or building apartments is not rocket science. I've got friends who started tech businesses - that's much more of an all or nothing proposition. They could easily spend 5+ years of their life giving everything to the venture and could still lose everything. Real estate isn't like that (if you manage the risk with some common sense.) You get a lot of "at bats", and you only need a few triples or home runs over a career to make out really well.

In terms of saving money before you do it - that's a personal question for you. If you've got a rich uncle or older family friends who gets off on helping a young guy succeed (don't discount that, BTW), you might need less than others. But really, if you're good at finding opportunities, you will find the money.

My partner and I have very complimentary skills. One of us is better at sourcing deals, designing the project, etc. (the left side of the balance sheet), the other is better at structuring the financing. We are both good at raising money. Temperments are also different. One is aggressive, the other more cautious. It's worked very well.

As noted above, some of the first deals we did were tax credit deals, so we got big fees (that's why we did them; there's not much long term residual value in many cases.)

Some of the first deals we did were tax credit deals, so that was the perm equity, but there were still pursuit costs up from that required our own limited cash. You learn to make your cash go a long way or you go out of business. That really became our culture in a way; we're still obsessed with limiting our dead deal costs; they can KILL YOU, especially early on. We see a lot of local / regional developers (not the merchant builders that's a different case) with large staffs and wonder how they do it. They end up doing deals largely for fees just to feed the beast. We've never operated that way. We still answer our own phones (no admin help at all), source the deals, do the pre-dev, financing, etc. all amongst the partners and one project management guy.

The debt on those deals was recourse through completion but could be done with limited or no repayment guarantees given the way the debt was structured. Still, we'd be on the hook for tax credit recapture post-completion.

I can tell you, it was nerve wracking the first time, but it forced us to watch every detail during construction, which was a great learning experience.

First deal we ever did on our own was an affordable / tax credit deal. The $50K (plus a little $$ from a mentor) got us through to the point where we secured the credits which we sold for the equity in the deal. 2 yrs experience in the affordable housing world was somewhat meaningful to credit buyers (back then, at least). But there was definitely some shucking ad jiving that had to be done.

That's part of being an entrepreneur - convincing other people that you already are what in reality you're still trying to become...

Would I have made more money staying in RE capital markets? I look at it this way - give the competition, number of peers, etc., I would have had a low % chance of making a huge amount of money, vs. a high % chance of making a lot of money doing what I'm doing. Does that make sense? But as you'll find out, it's not just about the money. It's also about the ability to control your time and how you live your life. I could've stayed in NYC, ground it out for 15 years and made the huge sacrifices necessary to be (potentially) highly successful there. Or, I could do what I'm doing, which allows me to i) enjoy my work; ii) take days off to go ski/surf/whatever; iii) take three days off to go with my kids to their sports tournaments, etc. I can count on one hand the number of days I've gotten to work before 8:30AM or worked past 6:00PM over the past 12 months. That's a question each has to answer - is it more important to earn "X" and have the life you want, or "3X" and not have one. If you're highly insecure and/or your sense of identity and self worth is tied up in 3rd-party validation, etc., then maybe the latter is more important. For me, I had/have my "number", and beyond that, it's about controlling my time and what I do with it.

Will answer 2 and 3 later, have to run.

Didn't even know I wanted to get into real estate until I took some classes in business school. That's when I realized it was a perfect fit for my personality type - entrepreneurial, like to do many different things (legal, finance, construction, marketing, etc.), and a desire to be my own boss. Looking back, I wish I'd know it in undergrad, because I would have jumped right into the business and accelerated things by about 6-7 years.

Prior to MBA I worked in a non-finance type industry and then started my own business. It failed, but I learned a lot through that failure; the price of a real-world education, I suppose. Having that experience on my resume also helped me get into grad school, and helped a lot in finding my job post-MBA. It certainly wasn't my finance experience, which was nil up to that point. I still remember one of my first on-campus interviews with an MD from one of what you'd consider a top 5 firm...the guy asked me what I liked better, equity or debt. I stammered some bullshit non-answer, I'm sure it left a horrible impression. That was my first inkling that long-term the finance side of the business was not for me; too many very smart people who live and breathe that aspect, whereas I was much more interested in how to buy or build something that would enable me to turn $1 into $3 (for ME, not for someone else.)

High point(s) - every time we finish a project and get it leased up to the point where it's performing well. Aside from the $$, there is (for me) huge psychic value in being able to drive by a great-looking building, know that I conceived it, took the risk to get it built, and now there are people paying me and our investors to live there. Also, knowing that our investors are happy enough to ask about re-investing with us is very gratifying.

Low point (so far) - 2010, a huge project of ours comes on-line right in the teeth of the great recession. Lease-up much slower than projected, etc. It felt like death, I won't lie. We got through it though, mainly because we proactively reached out to our lender to tell then a problem was coming. Lenders hate surprises. Doing that enabled us to restructure the debt in a way that kept us in control of the property (we still own it), and get another bite of the apple, so to speak. Long term it will likely be one of our best-performing assets.

1) We've done about 20 projects to date, mainly development but a few act/rehab deals.

2) Yes, only in our own market(s). Our competitive advantages are i) knowing where the good sites/opportunities are so we can (hopefully) get them before they hit the open market; ii) understanding local dynamics and the "mental map" of renters (which may be very different than a map on paper); and iii) knowing what is really costs, right now, to build the project. This last one is incredibly important - it allows us to effectively filter the feasible from the un-feasible. Because we're active in the market and know many of the GCs, we can determine early if the costs will work.

This gets back to the importance of dead deal costs discussed above - few things are worse in this business than spending $1MM on pre-dev costs for a large project, and then finding out that the hard costs will be 15% higher than projected and therefore the deal can't get financed. It happens to a lot of guys, though. When it does, they magically convince themselves that they can also get rents 15% higher than their initial pro-forma. Sometimes they can even convince lenders and LPs. Sometimes they're right. But sometimes they're not.

3) Worst deal - see above, the deal we delivered in 2010. Long term it's proven to be fine, but in the short term it was awful. Biggest lesson learned was the value of manageable leverage. I remember as the project was being conceived (2007), we had debt brokers pushing shorter term, high leverage construction financing..."80% LTC, once you stabilize you can put on enough perm debt to repay the construction loan and get back all your equity!!". If we'd taken that route, we'd be dead. Of course, if we'd started the project in 2004, and taken that route, the deal would've been an immediate home run.

That's survivor bias, though - we all see guys who "pushed their chips to the center of the table", took the big risks and hit it out of the park. What you don't see, though (or hear much about) are the three other guys who did the same thing, and through bad luck, bad timing, whatever, lost the bet and BLEW UP. I know a few of those guys; some have recovered, some are working for someone else now.

What you're doing is not much different from what I still do - turn over rocks, keep building the network, etc. Two practical suggestions:

1. Every time you meet with someone, don't leave the meeting without getting at least two other names. The network builds geometrically that way.

2. One of the best (but most overlooked) ways to break into the business is to find a few real, potential opportunities and bring them to the group you're trying to get in with. You can do this while not totally giving away the deal specifics (i.e., you can protect yourself.)

Example - if a guy comes to me and shows me one or two REAL, live opportunities that he's put together, and has done his own thoughtful analysis, etc....I'm probably hiring that guy over someone who might have a better pedigree. Why? Because i) it shows initiative; and ii) opportunities are the life blood of this business. Guys who can build a 20-worksheet Excel model are a dime a dozen (sorry), but guys who can source deals are not as common. And if he can find one or two, he can find more...

It depends on the deal (sorry). We've done it all ways, from preferred equity to JV equity, and in some cases been able to get an equity multiple hurdle instead of IRR hurdle (which is great when a project takes longer than expected to stabilize and sell/recap!)

I think it also depends on what our goals are for the project; there are projects that we might want to hold for a very long time, others that we think we'll want to sell post-completion. Some we can get more leverage than others, some have more market risk, etc., etc. We really do look at everything on a deal by deal basis.

Another example - we go long on a piece of land (well before we have capital in place to go vertical); the sub-market improves and the land suddenly has a market value $1.5MM higher than our basis. When we go vertical, we want to be able to contribute the land at market value and get equity treatment for it (unlikely we'd get paid out that land value up front.) Potential JV equity partner says no, but here's a really attractive promote/waterfall structure if you do the deal with us. Preferred equity guy says, OK, we'll give you market value/capital account for your land, but our preferred equity gets it's accrual and then repayment before you see first dollar back on your land value. I'm pretty sure the deal will perform well enough to get paid back that $1.5MM land value. How does that compare to the JV deal where I MIGHT make more on the promote, but I might not? It really does (for us) come down to a deal by deal analysis.

My "pedigree", such as it was, was I went to private high school, graduated with a solid B- average, and attended my safety school, which was a State U (out of state, but not a Michigan, UVA, etc. caliber school). As I noted earlier, I started my own business about a year after college. It failed, but I leveraged that experience as a way to differentiate myself and get into business school. I was not the boarding school, Ivy-league, Bulge Bracket analyst guy, but nor was I a blue-collar, up from nothing guy. I was solidly upper middle class.

A more general comment - when I was in college, leaving college, etc. - there was little to no social media. The only people I had to benchmark against were the people I knew personally, or maybe saw in a movie, read about in a magazine, newspaper, etc. So while social anxiety was real (always has been, always will be), it was nothing like today. I actually feel sorry for guys growing up in an environment where the WHOLE WORLD is their benchmark. You see everybody! It must drive you bananas to see all the people doing things that are bigger, sexier, richer than what you're doing. When I was younger, those people were there, but we didn't know much about them.

A certain level of insecurity is actually a good motivator, I think. But you also need to filter out what other people are doing, don't worry so much about what they think about you (Hint - they're not really thinking much about you at all), and just do your thing because it's what you want to do. My purpose here is to give you some insight on one path taken.

It makes sense, though you tell me - you're closer to that age group than I am. One general comment - I think that in markets where there is a large net in-migration of young people, there's a good opportunity to build in neighborhoods that are on the upswing but not totally "there" yet. Why? Because young people coming from out of town have no memory of what the neighborhoods used to be like. That's where older, long-time local developers can be at a disadvantage - they have institutional memory and find it hard to put themselves in the minds of a young person just moving to their market.

Look at Washington, DC - 10-15 years ago, many of the currently hot neighborhoods were absolute hell-holes. But there are so many young people constantly moving to DC from out of town, who don't have any recollection of that...

If you can you should buy, fix and sell as soon as you can but you don't want to get caught with your money in the market at the wrong time (obvious, right?).

I just left a breakfast meeting, sponsored by CCIM, IREM and NARPM, here in South Florida where the speaker was predicting a recession by the end of the year. His name is Jack McCabe of McCabe Research and Consulting - you can look him up.

Whatever you do it should be well substantiated by at least two sources. Not all data but definitely not all gut. An HBR article I read recommends 50/50.

Being an long-term successful entrepreneur requires A LOT just running a business with a singular focus - think painting contractor.

Being a developer is ten times as hard. You HAVE to know a lot about everyone's job: Realtor, title company, lawyer, contractor, lender, etc. They are ALL deal killers. It's hard to tell which is the most deadly. I feel like I'm going to scream out loud in this Starbucks because I'm having flashbacks.

The author of this thread is correct, deal sourcing is a vital skill but there is so much more you need to know from that point. You can source a deal but then you can't lock it up or you can't bring it to the right people or you can't bring it to the right people and not get screwed out of the deal.

So after you 1) get the deal and 2) bring it to the right people and 3) not get screwed, you still have to go through 4) the lawyers to get it under contract and then the 5) title company and 6) lender(s) to get it closed. THEN you have to go through the 7) A/E to put together the construction docs and the 8) city/county to get them approved. THEN you have to get 9) GC's to bid it (make sure you get multiple bids) and then 10) select one to build it. And here is where things REALLY get crazy 11) hopefully your GC AND his subs know what they are doing OR you can forget about your budget and your schedule and your project and your money and your investors money. BUT assuming you survive that you have to 12) find a Realtor to 13) sell or lease your project. Lucky number 13.

And you can throw a market analysis from a real estate Market Analyst in there depending on the size and complexity of your project.

I've thoroughly described the problem, right? So what is the solution?

Study, study, study and start small. And then study some more. If you don't have a professional library you need to start one. Having a job is normal society with all the protections. Being on your own is the Wild, Wild West. Everyone - everyone, I repeat EVERYONE will cut your throat and not think twice about it. "It's just business." Everyone!

"In all of your getting, get an understanding." - Proverbs 4:7, The Bible.

Best way to source deals? Drive for dollars. Weekends EARLY in the morning - no traffic - and drive the area where you want to do deals. Get as many addresses of abandoned or distressed looking properties as you can. Sit down and spend some quality time with your county's tax assessors website. Get the property details and Owners info. Record. Get contact info (skip tracers) and communicate. Always remember this "the fortune is in the follow up".

Next, you've got to learn to value the property type you're focused on.....yikes! And the list goes on and on and on.......

Everyone!

On the initial small deals, we had the good fortune to work with a GC who'm we had prior experience with. Once we got into the market-rate side of things, we almost always hired (still do) an Owner's Rep. And from day one, my partner and/or I attended EVERY estimating meeting, every design meeting, etc. We personally worked through all the lighting packages, plumbing fixture packages, cabinet/countertop packages, etc. to make sure we had the best cost/value combination. And then once the job started, we attended every OAC (Owner/Architect/Contractor) meeting on the job site, walked the site all the time, etc. Once the job was about done, we walked every single punch-list walk with the rest of the team. We still do this on our projects.

For the first few deals, it was incredibly time consuming, but there is no better way to learn the construction side of the business. And if you don't learn it, you're basically going to school every day and practically begging the bullies to take your lunch money. You will learn quickly that a Guaranteed Maximum Price contract does not necessarily guarantee a maximum price for the job.

1. • Long term goal is to keep doing this until I die or get dementia. I enjoy it that much, and am now close to the point where we can pick the deals we want to build or buy, etc.

2. We have two people (project manager and a reporting/compliance/construction draw person) and a part-time bookkeeper. We build/have our own Excel models, etc. It's not rocket science. Experience has enabled us to do projections that focus much more on accuracy than precision. I think it was Warren Buffett who said he'd rather be roughly right than precisely wrong. Reality is, if our model says that our stabilized yield on cost is 6.9%, it could EASILY turn out to be 6.3% or 7.5%. Have enough equity cushion, etc. to handle that and you will be OK. I always laugh now when I see a spreadsheet with a deal IRR of, say, 19.3%. Really, 19.3%? Not 19.2%? You're that sure? Focus more on the accuracy of your assumptions/inputs, and worry less about how elegant the model is, how many worksheets it has, etc.

3. We fund pre-dev costs out of our own cash. It's the worst part of the business; you take fees from one deal and re-invest a portion into pre-dev for the next. As noted above, if you don't manage these costs they can kill you. Another reason developers in general run very lean from a staffing perspective, etc.

4. The worst - see above.

5. It depends, since the LP usually has a big part of this decision. The tricky thing about development is that for the sponsor/GP, much of the value creation "curve" flattens out post-stabilization, right? But maybe you want to stay in for the long term anyway. A forced savings plan, optionality on a positive external event like inflation, extreme cap rate compression, etc. But those all externalities can all go negative, too.

A few things in no particular order:

1. Learning how to effectively deal with (and get what you need from) a wide variety of people, of wildly varying levels of intelligence, education, motivation and integrity. We interact regularly with petty, vindictive or over-worked bureaucrats (many of whom are more intelligent than you might think and resent the fact that they aren't recognized as being so), asshole project superintendents, highly intelligent and experienced attorneys who often miss the forest for the trees, insecure architects and designers who take criticism personally, etc. The thing is, we need something from all these people. When you work in finance, Wall Street, etc., it's easier to just steamroll over anyone who gets in your way, even if it means alienating or antagonizing them, or else think that throwing some $$ at a problem will solve it. It's also more common to look down on people whom you think are not in your league intellectually or professionally. In our business, this doesn't usually work. You really do have to develop a high level of emotional intelligence, and know how to work all different types of people. Or, at least it helps to be able to do so.

2. Learning and keeping up with the construction side of the business is a huge and almost never-ending learning curve. Unless/until you really understand it well, or have an Owner Rep on your team who does, it's easy to make big and costly mistakes.

3. Negotiating land contracts that give you optionality and extensive time before closing is really important. Pay attention - long-term land purchase options are one of the most undervalued things in our whole business.

True story - in our 3rd year in business, we found a 2-acre site owned by (and contiguous to) a corporation that was not in the real estate business; they just wanted to get rid of the land. The GREAT thing about the land was that it didn't have the zoning needed for any sort of higher density development. This enabled us to argue to the seller that we needed 18 months to re-zone the site prior to closing, given the lukewarm attitude the city had historically had towards up-zoning. The Seller gave us 18 months in exchange for $65,000 that would go non-refundable in equal increments over the 18 months. The purchase price was $600,000.

What we knew was that the city was in the early stages of putting a higher-density, transit-oriented zoning overlay over a multi-block area that included this property. We also learned that a big box retailer was close to buying a parcel across the street. During our 18 month option period, all this stuff became public knowledge, widely known, etc. A new buyer came along and offered us $1,250,000 for the site. So we worked out a deal where we'd close at our contractual $600,000 price, and turn around and sell for the $1,250,000. Of course we didn't have $600,000 so we went to someone who did, and agreed to pay them $100,000 for short-term funding us the $600,000 (like, one week.)

So we cleared $550,000 on basically $65,000 in earnest money plus some due diligence costs, all because we had a seller who gave us a long-term option. And we took no development risk. Experienced sellers will often include anti-speculation provisions that make it hard to do this type of stuff, but in this case the Seller was not in the business.

I think this can be (and is often) done. The flip side is that a few years working for an ACTIVE developer/investor can give you good experience and a window into how successful, experienced guys think about the business. You can also do the former in conjunction with the latter.

Teach yourself how to put together an Excel model (really it's not that hard) on you own time. Read constantly. Use your time at your job to really suck in all the knowledge you can. Some of the best lessons I ever learned (you don't need to make all your money on one deal; if you're not a seller at a certain price, you're effectively a buyer at that price; etc.) came from discussions with the owner of the company I worked for.

1. I'm almost embarrassed to say, but it's not a formal "process" at all. It's really just a lot of networking, driving around, turning over rocks, etc. And we're fortunate enough that we now have enough of a track record that brokers, etc. will often reach out to us with opportunities that aren't on the market, or haven't reached the market yet.

2. That's a very general question and one that is more market-specific. However, at least on the development side, it matters just as much what construction lenders think about the market. You may have a great opportunity, your analysis supports the deal, etc., but if lenders are only doing 55% LTC, big recourse provisions, etc. that makes it tough.