About
Hello everyone. Based on some recent comments in another thread, it looks like there is some interest in a dedicated conversation related to starting a new development shop and how to get there. Feel free to post them here. WSO has been a useful resource for me over the years, hopefully I can pay it forward.
Quick backstory: I left an institutional public development company a year ago to start a development shop with one partner. We have capitalized four live deals so far with total project costs totaling approx. $500M. Our target product type is multifamily, but we have a significant office pipeline as well.
The last question I saw was on investment strategy/thesis, specific to single vs. multiple product types. We are trying to focus on multifamily while selectively targeting office assignments in order to diversify our holdings and track record. We also expanded to a second market to diversify geographic risk and avoid getting pigeonholed as a company with single-market capabilities only. With respect to the office transactions, we have brought in an office development partner on two deals to help with execution. This gets our equity and lender partners significantly more comfortable with our ability to perform, and gives us the benefit of reducing workloads while expanding our office track record.
Let me know if you have any questions.
Mentoring
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Do you have true conviction in the fundamental value and long-term success of your deliveries or are you more incentivized by the prospect of cashing in and out while we're still on an upswing?
Most our current deals are OZ deals, so we will hold them on a long-term basis and are designing them to a higher quality/more durable spec. We are not taking a merchant builder approach, which is to build to as low of a basis as possible, stabilize, and sell for the highest margin.
I think this is best strategy long term; i) it allows you to build and be proud of the best product you can, which goes a long way to establishing a reputable brand; ii) patient capital means you are not subject to a specific market climate at a predetermined sale date, and can consequently wait for the best time to sell; and, the timing flexibility creates better alignment with capital partners=better long-term relationships.
Capital stack is typically a 95-5 JV where we have a single LP come in for the 95% portion. My partner and I typically fund the GP portion ourselves; if it is a very large deal, we will syndicate the GP, again trying to minimize the number of investors (it's just a pain in the ass to coordinate in terms of time invested, money spent on attorneys, etc.). Both GP and LP are sourced 100% on relationships so far--my partner spends most of his time managing this process. We have only hired a broker to source the debt.
Debt is a construction loan at 60-65% LTC with a perm refi option contemplated post-stabilization. We haven't gotten too far on this piece as most of our projects are ground-up an we are not deep into construction just yet.
I am extraordinarily impressed by this. It probably would have been easier to just be merchant builders.
How do you handle GP guarantees to your LP (for capital contributions), and to lenders?
Are you taking recourse construction financing? What terms are you seeing?
Who signs completion guaranty, environmental indemnity, and bad boy carve out guaranty? If your LP signs up for all of this for benefit of your partnership, what are you trading off to get them comfortable?
What guarantor entities are you putting up to satisfy lender liquidity / net worth requirements?
What fees do you bake into each deal beyond development management? Have you had any trouble getting your LP comfortable with paying said fees?
Good question. On most deals, we are securing non-recourse financing and jointly (GP/LP) signing limited guarantees: completion, bad boy carveouts, environmental imdemnities. We are having to pay our LPs a fee (up to 2% of their equity contribution) that gets capitalized into the deal to sign up with us on this and to flash their balance sheet to satisfy lender net worth and liquidity requirements, since we can't do it yet.
On one deal, we are signing up recourse financing with a full repayment guarantee; those rates appear to be ~210 bps lower than our non-recourse construction financing option on a roughly apples to apples deal.
In terms of fees--as sponsor we are typically charging a 4% development fee; a 2% asset management fee; intermittently a 1% (or frequently lower fixed) acquisition fee. We also capitalize our third party costs (accounting, construction management) into the deal which has not been problematic, since we have those functions third partied.
We met at the development company we were both working at before we split off. My partner, who is the founder of the company, is excellent at sourcing, relationship-building (capital partner relationships), and structuring deals at both the deal and GP/LP level. I am still learning the structuring component of the business but would like to consider myself very strong at the soup-to-nuts development execution component. We didn't really plan it, but fell into those roles naturally as our business progressed. I think we are also both really efficient with our time; we have had surprisingly few "strategy sessions" or higher-level thinking exercises where we are just kicking tires, and instead channel almost 100% of our energy trying to execute our existing deals and hunt new ones down.
Obtaining financing has not been a problem....again, presenting a united front with an LP has been sufficient, along with solid underwriting/business plan, to get it done. The most critical issue is satisfying net worth and liquidity requirements, which is a critical component of JV negotiations early. We have passed on certain capital providers who liked the deal but were unwilling to co-sign on the completion guaranty and/or use their corporate balance sheet to back up the financing instrument.
There are a few key challenges so far. The first is knowing that there is nobody else behind us to "figure it out." Whether it is a challenging deal-related problem or some kind of BS administrative task, there is no deeper bench to help execute as everything is on our shoulders. That can be daunting. The other is stress management. We are both working 70-80 hrs/week and traveling a lot, which is significantly more than we were used to. There is also a feeling of being able to unplug, as there is nobody behind us to pick up the slack. Still struggling with this one.
Do you need an analyst?
+1 would love to be considered
PM me, we do.
I was a commercial office broker, and leveraged my experience in that discipline to getting a development analyst job at an office development company. I think there are a couple of main tracks: finance (capital markets/investment banking/acquisitions), and construction (CM, civil engineering, project management). At the end of the day, it is very difficult to get "development experience" without working directly for a developer. Job openings in development are very difficult to secure, mostly because of the low number of openings, and how infrequently they turn over. IMO the best way to get into development is to cold email/call developers, establish personal relationships with as many as you can, and stay on their radar by checking in frequently so you are top of mind when that opening arises. Word of mouth or direct referrals will get you the job 99 times out of 100 over a selectleaders or other online application.
He was explaining that he and his partner defer fees. 500MM * 4% = $20MM of implied equity
Thanks for doing this AMA Rosay. I enjoy the value you bring to the RE forum. A couple of questions for you:
How did you know that you were cut out to be an entrepreneur vs staying on the institutional track and climbing the ranks?
Knowing what you know now would you have changed anything in regards to your career? Maybe starting in investment sales instead of leasing, etc?
Is being an entrepreneur all its cracked up to be?
I hated the concept of "paying my dues" at an institutional shop. The bigger the public company, the more your ascendancy of the ranks is dependent on your tenure at the firm, instead of how good you are at your job and the value that your work generates for the company. Every company seems to have this structure in some respect...searching for a pure merit-based opportunity was a big part of the sell for me, despite the risk. I'm also fortunate enough to be in a stable position with no debt, no kids, etc...felt like it might be my only chance to take a high-risk leap.
I wouldn't change anything. I think starting in investment sales or acquisitions would have certainly facilitated a quicker transition into development, but I met a lot close friends in brokerage who I would not have met otherwise. I also think brokerage gave me a lot of interesting perspectives that are still useful today.
I still don't think of myself as an entrepreneur, the structure has its positives and negatives like any other. I love the "just get it done," non-structured culture component...I can work out in the middle of the day, take trips whenever I want, etc. and just have to find the time to get things done when they need to be done. I love being able to quarterback the deals and think about what we can do to be different, create some unique pride of ownership, etc. But, the work is 24/7 and there really is not an "off" button. Maybe we are too small at the moment without sufficient team, but I would be too stressed out to check out for a week and go off the grid. That wears you down in faster cycles than I'm used to (I get burned out and need a mental reset of some kind almost every two weeks).
No problem. 1. We usually post between 1-3% of the PP for our earnest money deposits. On deals that require entitlements, we push for a deferred closing where the earnest money is at risk after DD (60-90 days), but we don't have to close for 6-12 months, depending on how much time we think we need to secure City approvals. All of our projects are a 50-50 split between us and LP on pre-development costs, which include due diligence; entitlements (attorneys' fees ($150K) and architect entitlement phase drawings ($25-60K depending on jurisdiction)). We also always try and push for full construction docs so we are not burning carry waiting for entitlements before we design the building. That portion is significant and can be another $750K. 2. No huge issues with local politics yet. We are mostly operating in development friendly communities. Saving the sponsored hookers and blow for a rainy day. 3. Great idea on the fee guarantor, we have heard that floated around a couple of times. So far, we've been able to structure deals with our existing capital partners that did not totally gouge us on the promote in exchange for balance sheet support. The fee guarantor guys usually want like 30% or more of the promote which is a lot if you can find a way to avoid it.
We are primarily focused on market rate multifamily rental, yes. We are not worried about a rebounding homeownership rate...generally speaking, young adults have the lowest average savings profiles and highest relative consumer debt in history. The rental market is not going anywhere when people can't afford down payments for homes.
What does worry us is hard costs. Every time we reprice a deal costs are increasing. Hard cost inflation is over 5% per year in many markets, and there does not appear to be an end to that trend in sight. Hard costs generally comprise 65%+ of a total deal capitalization; when you twist the screws on an input that large, many deals can blow up and not pencil. That is especially problematic when you see inflation continue to press once you are fully pregnant on a deal (ie, already closed and knee deep).
We really like sunbelt cities with low state income tax rates, lower relative costs of living and high job growth: Phoenix, Dallas, Vegas, Austin, Nashville, Orlando). The combination of good weather, jobs, low cost of living, and a highly educated population are a big draw to those metros.
Would you consider modular construction to save on costs?
How many deals did you start with and how many do you have now? How do you pay for the deals after you run out of your own money, or do you always have some of your own money in it?
When I first started working after college, I always hear the word sweat equity and didn’t understand much of it, and now I’m basically only doing refi and acquisition and have limited exposure to construction deals. I am always under the impression that developers like yourself use up all or half of your own money to start one or two deals, but construction and lease take 2-3 years to complete. How do you pay yourself during those starting years when it’s just cost coming in and there’s no income?
We started with one and have six right now. We haven't run out of money...mostly because we had sufficient dry powder to keep roughly three going easily with personal capital, and are drawing on fees on one of the larger deals which is sufficient to keep up buoyant for the others.
Fee income is really how you stay afloat--primarily acquisition fee and development fee. Frequently, the development fee doesn't get paid until you start construction, so there may be an early deal period (6-12 months) where you are waiting for that money to start kicking.
We have a corporate project to project total fee incomes and their respective timing so we can budget for a contingency fund to pay for dead deal costs and build up a "new deal reserve" to slowly start backing out personal capital as we continue to grow.
Little granular, but mechanically how do your fees generally work? I assume that acquisition fee is baked into deal as (some of our all?) your equity contribution? What about development fee? I assume this is set as X% of development costs, then do you draw it down in equal portions over your development period? (eg. $100K fee, 20 month build -$5k/mo paid to you?) Do lenders allow you to include all of your fees in project costs when calculating LTV constraint?
They are not in our home city. We travel a good amount, probably averaging to 1-2 days per road.
The project management piece just requires pure exposure. There really is no seminar, online module, or textbook to help you learn that piece. You have to find a way to get first-hand exposure to the ins-and-outs of entitlements, permitting, scheduling, construction pricing, financing, underwriting (including rent and OPEX comp analysis)...any individual exposure above will help you build towards the overall experience.
Not sure what stick handing means, but assuming you looking to hire a development manager to handle the execution process on a single transaction: 1. Development manager with 4-5 years of development experience is probably fine. 2. For just a single project, I would think $120K-ish all-in is fair. No participation. Or, lower salary and offer them a point on promote.
I don't think you will be able to nab a senior guy with a pipeline of one project. That's not a knock on your operation at all, I'm just saying you will probably have better luck targeting a younger guy with an appetite for risk that understands the upside trajectory if you continue to grow your business.