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No idea how people can make sense of suburban office and urban apartment development these days. Construction costs make no sense lmao. People doing deals for fees and LPs and lenders are lying to themselves.
The most painful part is having to present bullshit assumptions that make the deal work on paper to LPs and have the smart ones look at you like you are a moron and the only partnering with the dumb ones.
We are vertically integrated in house, so development fees, CM fees, leasing commissions, property mgmt fees, and of course selling the land to the JV for a marked up value. Dirty secret is that those are often way more than the actual promote you receive on the typical deal. And there is embedded profit in those - it's not just covering overhead costs.
Some groups need to close deals to keep the lights on, see this more often with syndicators (dumb money) than insitutional JV equity (smart money). go online and look at some of the deals on crowd street or the morons who advertise on facebook for a 18 to 25% IRR on value add deals over a 5 year period, those are the guys using insane assumptions to buy deals to keep the lights on and get fees. on a $20M deal where you raise $7M of equity, you can charge a 1% acquisition fee or $200k. If recourse loan, another 1% ($200k). You do in house property management at 3% which is $45-50K per year assuming revenue is $1.5M. you then charge an asset management fee of 35 bps on equity of $7M which is $25K. you then negotiate with your debt broker less than 1%, let's call that 70 bps on $13M loan and you pocket $39K in house. If you include overseeing general contractor on value add, another $20 to $50k.
Just in year 1, you have made $300-$500k in FEES for putting together a deal. if shit goes well. let's say you sell that property for $25M net of broker fees, etc and let's say you are able to pay promote of 6-10% with operating cash flow. at exit 3-5 years later, you make a profit of $5M and split that 70/30. you just walked away with $2.5M which is a great day... if shit goes bad and you lose your shirt, you still made $300-500K in year 1...if i include asset management and property management fee, it is probably $600-800K over a 3-5 year hold in fees.
a syndicator who has to keep the lights on or someone with a fund structure who hasn't spent all the cash might be bullish and do weird shit. it ends up being a gamble for investors aka LPs which sucks because syndicator wants to do deals to keep lights on!!!
more reason to avoid the online capital raising platforms especially late stage in the cycle. a lot are just putting together SHITTY deals and showing LP returns of 15-25% net of fees for value add or core acquisitions. anyone with industry experience knows you will be lucky to get a 14% IRR in todays market if a broker is involved. only way to show strong returns is levering like hell or a true off market deal you get at a discount because you found a sucker.
Costs up 8%-10% per annum over the last 3 years or so. I suspect it is the cost of steel + concrete. It seems to me that the development that makes the most sense in today's market is negatively correlated with the amount of steel + concrete.
Back in late 16/early 17 you could deliver suburban office with structured parking in my market for $260 ish per sq ft. On real costs today, it's probably more like $330-$340. Meanwhile the new deals that have traded cleared in the high $200s. We are at a weird point because its a super tight market, but you have to charge rents that are 20% higher on new development and nobody wants to pay. Even if you do get your building kicked off, when you go to sell, the buyers get sticker shock from the basis and you end up trading 10%-15% below pro-forma. Deals that get done on today will achieve low to mid teens returns, maybe, on a merchant build strategy.
We've been competing with out of state value-add multifamily buyers in our tertiary market. I believe its the same story everywhere but I can't get my head around how the same deal gets sold as "value-add" multiple times in the same cycle and buyers are still lining up to champ at the bit while paying lower and lower cap rates. We've frankly been punished by the market for being "smart" underwriters which has kept many deals from coming our way. Seems most buyers are willing to push their underwriting to get the deal done, banking on a greater fool at the end of the tunnel.
I've been really struggling to handle structuring debt for these deals. When you have a 1978 vintage property in a tertiary location being purchased at a 4.25% cap rate BEFORE the value add is done. It doesn't make sense because the cashflows do not support anything above 65% LTV. Especially when the delta between the purchase cap and interest rate is sub 50bps, leaves a small room for error.
My boss seems intent on pushing the envelope though so he is prescreen UW the bare bone minimums on expenses to help make the deal pencil. Told him I didn't agree, but because it was his name on the deal and not mine, we could go about it however he wants. Can't wait to see this thing fall apart during closing and get re-traded and I get the chance to say "I told you so" to his mug.
My biggest problem right now is updating all of our ARGUS models for 2020 budgets .
A few:
Construction costs are stupid. In my market, it costs as much today to build a surface parked apartment project as it did to build a wrap deal a few years ago. It's not even all on the GCs either. All your subcontractors are driving 2019 Chevy extended cab trucks with a new boat being towed behind it.
Student housing is starting to trade 50 bps higher than market. I'm personally fine with this as I much prefer building market rate to student, but for a while these cap rates were the same, and with that came certain disposition expectations.
My firm is still underwriting everything to a 7 at exit (and maybe 6.75 if you can convince them) while our competitors are out there underwriting to a 6.25 exit. With the above construction price complaint, this makes getting deals done difficult.
All in all though, people are still moving to our markets en masse and there is still a need for housing. Getting deals off the ground is difficult, but leasing them up and selling them isn't at all once you do. There is a ton of money out there, both in the equity and acquisition sides.
weird flex?