How does "build to hold" work?
If a developer wants to hold an asset indefinitely, how do they attract investors who could instead deploy their capital in deals that would return it within 3-5 years? How does an LP get their money back if there is never a sale? Is it as simple as refinancing every few years?
I’ve noticed (not actual data, just personal experience and watching trends) that develop and hold firms are usually smaller and have substantial family money. I’m close with a developer whose niche is being the go to guy for a ton of doctors. They call him up and he’ll JV with them and develop the building, from securing debt to leasing it up and everything in between. He makes a fee and gets his upside investment (mostly fee heavy since hurdles are hard to hit). They refinance and hold it as long as they can. Because debt is normally due every 10 years, they refinance.
We have a open ended core fund that does a good amount of build to core.
For one off deals, it’s usually big pension funds that want a high quality asset in a top market, but don’t want to pay as much as an acquisition of a similar new asset would be.
Ah yes the classic building below acquisition cost. You sound like a genius sir please take my money.
Edit: I can't believe this fuck is a director at a fund.
yes that is how you are able to achieve attractive risk adjusted returns
Oh you can’t believe it bro?? Post another topic on how fund vs property level pref works
Now go buy at a 4 cap from me prick
It depends on the underwriting assumptions, of course, but generally when you convert to perm financing you'll refund a good deal of capital and then you sit on the cash flow. And yes, you can assume a refinancing every so often.
This is an interesting observation. I'm not sure I agree (also based entirely on anecdotal evidence) but I'm also not sure I have a good reason why. Perhaps its an issue of motivation for principals? All I know is that I suspect you have got the cart before the horse - smaller firms with more personal relationships with their investors may have those qualities specifically because they build and hold. It allows multi-transaction relationships to develop, and also almost demands a smaller shop, because the idea is to do fewer deals and then manage them, rather than have three active projects, three being entitled and a million more being looked at at any given moment in time. Just my feeling, though
I work for a family-office developer - we are mostly active on the multi-family side for new development, mainly in the northeast excl. nyc and boston. Echoing some of the comments above, we definitely benefit from re-financing to pay out capital partners, if we have any involved in the deal at all. Buy-sell provisions also give another options for partners looking to exit at different times. Since we are generally a "never sell" kind of shop, having a pre-negotiated plan for these types of situations gives our LPs some confidence that they have a vehicle to exit.
What return metrics are these deals judged by? Do you assume a sale at year 10 for the sake of calculating IRR? Are you just looking for a certain yield above market cap on cash flow?
On our development deals we have a minimum stabilized return on cost that we require. We also calculate an IRR but we rely less on this metric. For the IRR we assume a sale upon stabilization at some conservative cap rate. We generally do not model out 10 years for our development deals because in our view it can distort whether or not the actual development is profitable - instead we try to isolate the development return from the return through a typical holding period
From what I've seen YOC and the development spread are more important than IRR but in my experience yes you model out a year 10 exit for investment committee/bank purposes even though you plan to hold past that point
You just have to find the right LPs. Funds don't do it because they have finite time frames they have to operate in. But family offices/high net worth investors are under no such constraints.
Different equity, more of a focus on EM over IRR. Some investors don't want to redeploy capital every 3-5 years and get hit over and over again with closing costs and taxable events or exchanges.
If you're in an asset with good in-place YoC, strong tenancy, and you like the long term growth in the product/location, long term holds can be great. If you want to pull out some equity, you can always refinance along the way. From the GP perspective, you would just want to structure the deal in a way that it isn't as capital event driven - avoid IRR hurdles in favor of a single-tier splits above pref (country club type splits) or EM hurdles.
Institutional groups often have underlying funds with associated timelines that they have to work within. Less institutional money can be a lot more opportunistic when it comes to these kinds of long-term holds.
Can you elaborate on the single-tier split above pref?
Country club investors give 80%-90% of equity. They have to hit 8% return, anything above an 8% return GP gets promoted to 30-40% of returns. Instead of pari pasu return.
GP doesn't get much cash flow in years 1-3, but get's a 2% acquisition fee to keep the lights on. GP also pulls out a majority of cash flow from capital events, which is not taxable if refi.
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