We’re looking at an opportunity to become a co-GP on a multifamily development deal where we’d contribute our land plus some additional equity. The sponsor wants to have the co-GPs split predev costs pari passu before calling the LP capital. They believe that by derisking the deal first we will be able to negotiate better terms with the institutional LP.
How common is this approach? And how do you underwrite the predev costs?
We don’t do much development so this is a first for me.
Appreciate any help!
This approach, where co-GPs split predevelopment (pre-dev) costs pari passu before calling LP capital, is not uncommon in multifamily development deals. Based on the most helpful WSO content, here are some insights:
1. Splitting Predevelopment Costs Pari Passu
2. Underwriting Predevelopment Costs
3. Lessons from WSO Threads
4. Advice for First-Time Developers
If you’re new to development, this is a great opportunity to learn, but proceed cautiously and ensure you have a clear understanding of the risks and costs involved.
Sources: From Real Estate Finance to Founder of Development Company - Q&A, From Real Estate Finance to Founder of Development Company - Q&A, "Pre-Stabilized" Investments - Multifamily, What is PROPER underwriting process like for development projects
It really depends on the deal type and situation. LPs want to derisk their money as much as possible and don't usually come in putting entitlement / predev money in before knowing you can actually build what you want. Yes, you'll get better deal terms from LPs if it's fully entitled and you've spent decent pursuit money already. If the sponsor is a real developer they should be able to provide you with estimated predev costs for the project (consultants / environmental, architectural, permits, etc)
Have worked on several co-GP deals. Have always split the predev/pursuit funding with the other GP, and if it's a deal where we know we'll need an LP investor, we typically plan for it to come at the end / and closes at the same time we close a construction loan. So essentially all pre-dev work is funded between the two GP partners. That said, I have talked with others at huge development platforms that have done so many JV's with various LP's that they'll sign up an LP earlier in the process, but in my experience that's not as typical. Those huge GP developers have done a boatload of JV's with LP's over decades and have enough relationships in that space that they can float the deal to a few LP's to gauge interest earlier in the process (even during early due diligence) and the LP may share in the predev spend...but again, not typical, at least not in my experience. So basically two possible paths: LP comes in at the end and is really funding construction (and at better terms since the predev risk is removed at that point), or they come in earlier and go alongside you during predev, but that's not typical, and as others have mentioned it's going to come with worse terms since they're sharing in the risk.
Very common, and accurate. Predev dollars are the riskiest, since there is no real underlying asset securing them. LPs quite naturally don't want to take on that risk; think about the difference in a secured vs unsecured loan in general.
That being said, if you aren't the managing member of the partnership, I would be a little cautious about writing effective blank checks to your partner. Maybe have a reimbursement agreement or something, rather than covering costs pari passu up front. Developers get up to all sorts of shit, all the time, and you don't want them subsidizing some other projects by overpaying for a consultant on yours.
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