Why is GC and Developer so seperate
This is definitely Dunning-Kruger. But why aren’t there more firms with business models that are hybrid developers and GC’s? It seems successful companies are usually one and not the other (Realted Vs. Tutor PERINI) . Where does the difference between roles truly lie? Is GreyStar a “hybrid” or do they do more conceptual construction management like Hines’ Concecptual Construction Group instead of actual boots on the ground GC work
Because ultimately they are two different businesses and the overhead for each business, esp at the institutional level is very costly. A construction firm/GC such as Skanska, Gilbane, Suffolk, etc...are responsible for the actual construction of a project. You tell them what to build and they build it for essentially a fee. They don't really have skin in the game and therefore their risk is limited. As long as they construct the building on time and within quality, they get paid. Big picture wise, the GC is the quarterback of the construction side and is responsible for coordinating the subcontractors and ordering materials.
A developer, on the other hand, is not really responsible for the bricks and sticks construction. They are responsible for getting the structure built in the sense that if they don't, they lose their investment and owe any debts they incurred. A developer's job, at a high level, is recognizing/believing that a property/site is underutilized and taking on the risk of bringing that site to its "highest and best use." Big picture wise, the developer is the quarterback/mastermind for the entire project and is responsible for identifying the site, analyzing its feasibility, acquiring and financing it, designing it via an architect (the architect is the quarterback of the design team such as the engineers), entitling it if necessary, getting it built, and selling/leasing up the property. The developer has skin in the game and therefore has unlimited upside (in theory), but also all the downside if things go south.
There are, but not nearly as many as those that are one or the other. Skanka is primarily known as a construction company, but they do do their own developments. Gilbane is another company that is known as a construction company but also does their own developments. Tishman is a developer but theu bought AECOM, a construction company. For companies that do both (on the institutional level) you'll notice 2 trends: 1.) If the company starts as a construction company, then they can eventually expand into doing their own developments 2.) If the company starts as a developer, then if they want to get into construction they will buy an existing one. The reason for these 2 trends has to do with how technical the skill set for each role is. The reason a construction company can become a developer without buying a company or hiring a developer is because the skill set of a developer is not very technical. Any construction professional can learn that revenue - cost = profit. Any construction professional can learn to look at comps, identify a site, hire an architect, hire an attorney for entitlement, etc... But the reverse is not necessarily true. A developer is typically a big picture thinker and usually doesn't enjoy the attention of details required in construction (construction is incredibly detail oriented...just for example do you ever think about how many electrical outlets you need in your house? Someone had to). So if a developer doesn't know construction, how can they open a construction business line? They can't. So they either buy one (like Tishman did) or at the smaller levels, they hire or partner with someone.
Now why don't more firms do both? Well it depends on what level you are talking about, but at the middle market and lower levels (let's say sub-50 units), it is doable because it doesn't require a whole team to construct a 20 unit building. A developer can hire a project manager/GC to coordinate the subs, logistics, and order the materials. You only need to bring one, maybe two guys on board. My family's business is actually having this exact conversation right now as we want to keep our cost low by keeping the construction in-house. However, at the institutional level, when you are constructing a 500 unit building, you need an entire team on the construction side. You need a Project Manager, assistant project manager, superintendent, assistant superintendent, estimator, some dude who's only job is ordering materials, etc...In other words, the overhead is very costly. If a developer hires all these people, he needs to keep them busy and ensure that the pipeline is constantly full, but that may not always be the case. That's why on the institutional level, it is more feasible for a developer to acquire a construction company. If the developer has no projects for them, the construction company can continue offering GC services to other developers and therefore their employees will continue to have work and generate revenue.
Most institutional developers will have a couple members on the team who have a construction background and they are the ones responsible for dealing with the GC
Thank you for taking the time to write such an in-depth response, I really appreciate your insight and perspective.
Hopefully the electrical engineer when they put the drawings together
Jokes aside, this is a good post.
Because who else would I screw when there are change orders on a project?
Joking aside and echoing what Fredburger said, a lot of it also comes down to risk mitigation. There's a reason there's very few design-build firms or all in develop/design/construction all-in-one packaging. There's an enormous amount of risk and at the end of the day that's a huge reason why there are very few firms that do everything. Same reason for GP/LP/Debt as well. Why don't people just take down entire deals in one fat equity swing? A combination of expertise, risk profile, and diversification.
Very good point, thank you!
As others have said, they are different businesses. A general contractor is ultimately in the service business - they are providing the service of constructing a building to real estate developers, public and private institutions, companies, etc. This is essentially a volume game. The more business they procure, the more fees they generate. They do not really care if the underlying project is successful after they have completed construction, and they themselves are not particularly capital constrained. Last point - if you are a GC and volume is the game, do you want to run the risk of losing business because potential clients view you as a competitor?
A developer is in the investment business, by and large (fee developments would be an exception). They take on a tremendous amount of risk to complete these "investments", so while real estate development is also a volume game, it is less so. No developer solving for an economic return would take on a development they thought was poor. Developers are also capital constrained.
So why don't the majority of developers get into the GC business? Very few developers have dependable, consistent volume, or enough volume even in good years to support the type of infrastructure that a good GC will have. Most developers want to stay lean, and a construction company is usually the opposite of that.
Thank you for bringing these points to my attention, I appreciate it
Fred Fredburger and CRESF both gave really excellent answers, so I won't cover that aspect of it, but if you actually think about the business consequences of having both a GC and a developer under the same corporate aegis, you can begin to see some massive issues in terms of alignment of incentives.
Lets say I'm a developer who wants to start a GC arm of the company. Sounds great! Now I can capture all that additional value and have more control over the day to day of the construction. Lets even assume I don't have a massive runway where I'm hiring an entire team but they aren't actually doing a ton. How do I prioritize between the construction arm of the business and the development arm? When I'm bidding on a site and getting my underwriting in order, the temptation for the development team is going to be to squeeze the GC in order to be more competitive on buying the site. If I'm the GC, and I know my developer is basically captive to my pricing, I'm going to want to do the opposite because no one else will be bidding. If every single person involved is a W-2 employee then maybe all this is moot... but generally, senior folks on both ends are going to have carry or other forms of ownership and are not going to want to shave their own margins just for the benefit of the guys who sit on the other side of the office.
Not a reason not to do this, but I've seen this exact situation blow up at a couple hybrid firms and I know a couple others where it's been a major point of hesitation to embark on starting a GC arm
Good answer. To add to it, even with perfect alignment up front, once you are in the construction period, how much incentive does a developer/GC hybrid have to find cost savings? Negotiate change orders? Not to mention all of the issues an LP would have if the GC arm was not performing.
Oh, for sure, there is an entire universe of problems relating to the non-arms length relationship there from the perspective of investors. Think about how fucking difficult it is to replace an underperforming GC if they're a third party! This is an order of magnitude worse.
For project types where the construction is simpler, it's more common, and even the norm, for developers to be the GC. Single-family homebuilders, even the ones who do huge projects with hundreds or thousands of homes, GC the work themselves. Developers like AvalonBay have in-house GCs and will build their suburban garden-style and midrise apartment deals themselves, but will hire third-party GCs for urban high-rise projects that are more technically complicated.
When it's feasible to GC a project yourself, the market tends to force you to do so. If you try to develop a couple of spec houses as a side gig, you'll find that you can't make any money if you hire a third-party contractor to GC them. Since those deals are simple enough for contractors to do themselves from beginning to end, the land is priced accordingly. If you try to layer a GC's fee into the dev cost, you'll either be outbid for the land by a contractor who doesn't need to double-dip, or you'll do the deal for free.
As a SFH developer/GC, This is absolutely correct
What type of single family home developments do you do?
No one has seemed to mention that construction firms may not take risk in the sense of equity risk and downside of a development - but they do take risk in the sense that if they provide a GMP and blow thru the total cost plus their own contingency (GC Contingency), the GC technically should foot the bill. Now…this all becomes a dance and the developer usually covers some or all. But the GC gets a 2-4% fee but takes all the downside risk in their fee if they blow the budget. Plus, you need a balance sheet to become bondable so that you can deal with liens. It is not ‘capital light’ at all times.
So why don’t all developers start a GC business. Simply - they are very different businesses. Many developers will start a CM business. But that is pure fee. Whereas a GC business needs capital which is generally better served being invested in lieu of being held for balance sheet bonding.
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