Target Return for Spec SFR Development?

I have an opportunity to buy some land that could be easily divided into a handful of single-family home lots. Looking at buying the land and then spec building the houses one-by-one and selling them. I would buy the land with cash and get a bank loan for the construction. The GC, whom I know well and have worked with before, sourced the land so I would likely give him a slice of the promote in addition to his GC fee.

I know how to execute this on a technical level, but I'm curious what returns the board would target for a deal like this. Thinking in terms of my own levered equity multiple and levered IRR. This is in a secondary market that's been strong for a while.

 

Sponsor level levered returns will certainly be dependent on your equity contribution and promote split- you mention a promote so I’m assuming you would raise mostly outside equity.

I’ve looked at doing a couple of these on my own- for the smaller subdivisions I’ve seen most deals pencil where you’re not making money until 30-50% of the homes have been built and sold. The upfront capital requirements for infrastructure are pretty meaningful (roads/utility’s etc etc).

 

for the smaller subdivisions I’ve seen most deals pencil where you’re not making money until 30-50% of the homes have been built and sold. The upfront capital requirements for infrastructure are pretty meaningful (roads/utility’s etc etc).

Agree, but that isn't the case here. Lots are on an existing road and each will have a driveway connection to the existing road and utility connections to the existing utilities on the road. 

 

In a scenario where you put in all the equity, there would be no promote because there is no waterfall. All proceeds would flow back to the partnership (you + contractor). I would keep it simple and figure out how much upside you want to give him, and back out that capital as a % of the net proceeds in your UW. Keep it all pari passu, just give him a little slice.

 
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BestCoastRE

In a scenario where you put in all the equity, there would be no promote because there is no waterfall. All proceeds would flow back to the partnership (you + contractor). I would keep it simple and figure out how much upside you want to give him, and back out that capital as a % of the net proceeds in your UW. Keep it all pari passu, just give him a little slice.

Agreed here. If he sourced the deal but you bring all the equity, I would just give him a flat fee or a fixed percent of the upside and keep it super simple. Also, I would make sure the deal is framed where you close on the lots you want to work on one by one, absolutely no need to take all the land down now when you can phase it and focus all on one deal at a time, sell, rinse repeat. Have a few going overlapping by 3-6 months depending on how long new builds/rents sit post completion. This way if you make a good amount of money and get the remaining lots to a certain point, you have more flexibility to sell the unfinished lots off if you’re happy with your returns so far. If you take down all of the land you’re paying interest on land you aren’t even touching, which will sink your overall returns. If it’s build for rent then you can build more at once in theory, but you also start to can cannibalize your own rents. Also, you can build a couple lots and rent them out, refi and then do work on the next lots to bring them to vertical ready, and sell them off and make nearly the same amount from the land as building, renting and refiing multiple years later… 

spit balling but there are def ways to get creative and smart in how you structure, but should be super simple with a GC fee… 

 
Theft
BestCoastRE

In a scenario where you put in all the equity, there would be no promote because there is no waterfall. All proceeds would flow back to the partnership (you + contractor). I would keep it simple and figure out how much upside you want to give him, and back out that capital as a % of the net proceeds in your UW. Keep it all pari passu, just give him a little slice.

Agreed here. If he sourced the deal but you bring all the equity, I would just give him a flat fee or a fixed percent of the upside and keep it super simple. Also, I would make sure the deal is framed where you close on the lots you want to work on one by one, absolutely no need to take all the land down now when you can phase it and focus all on one deal at a time, sell, rinse repeat. Have a few going overlapping by 3-6 months depending on how long new builds/rents sit post completion. This way if you make a good amount of money and get the remaining lots to a certain point, you have more flexibility to sell the unfinished lots off if you’re happy with your returns so far. If you take down all of the land you’re paying interest on land you aren’t even touching, which will sink your overall returns. If it’s build for rent then you can build more at once in theory, but you also start to can cannibalize your own rents. Also, you can build a couple lots and rent them out, refi and then do work on the next lots to bring them to vertical ready, and sell them off and make nearly the same amount from the land as building, renting and refiing multiple years later… 

spit balling but there are def ways to get creative and smart in how you structure, but should be super simple with a GC fee… 

Forgot to add: depends on your market but investors want basically a 7% untrended (MINIMUM) return on cost to do anything today for rentals. If you decide to sell them off, which makes more sense in my market, then it’s a profit number and you’d hope to be getting 20%+/- profit over costs. Maybe more for smaller time shops such as yourself on smaller deals

 

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