Niche real estate development firm (start up) - Fee structuring questions
All, thanks for reading in advance.
My career has taken some interesting turns and, to make a long story short, I have by happenstance tapped into a large source of deal flow for prospective development projects of all asset types (off-market land located in primary, secondary, and tertiary markets all around the U.S.). The source of land has ongoing needs for cash as well as some appetite to participate in deals via in-kind contributions of their land.
Thus, I have begun partnering with local and national developers on a deal-by-deal basis to build on the sites. Land value varies from $5-50MM depending on the site. I am building a business around these first projects and plan to continue tapping into my source of deal flow for time to come. Considering I have the deal flow, I would like to continue focusing on new deals/partnering with right developers in the future for my business model instead of actually acting as the development operator in the future. I have deal/structuring experience in IB and real estate finance but no pure development experience to speak of other than my exposure in financing take-out deals and my new projects.
With that being said, I want to ensure I am being fairly compensated by my development partners for bringing the deals to the table. So for example, let's say there is a deal where I sourced a $10MM piece of raw land (unentitled). The land owner would like to cash out $8MM from their land value and contribute the remaining $2MM to whatever development happens on-site. I partner with a national developer to develop highest and best use on site which entails a multi-family project for a total deal size of $100MM. How would you go about structuring in my fees on the project?
From what I have gathered, a decent acquisition fee, a small share in the development fee, and possibly a share of the promote are "market". What I don't know is what these amounts should be. I control the deal, manage the relationship with the landowner, and assist in structuring the deal for landowners unique needs (land contribution wise, and their approval for design of what's going on the site). I have been told up to 1% of the total deal size ($100MM) plus up to half the promote is appropriate. That seems high to me so want to survey other folks out there in industry to get a sense of what they would be willing to do, as a development operator, with a partner like me. I don't want my fee share to be de-motivating to anyone but I also want to make sure I am maximizing what is appropriate for me.
Thanks again for your thoughts and for reading. Look forward to hearing from the group.
1% of TDC does seem excessive.
It appears to me like you are a conduit for the Seller and not the developer. Your situation sounds like someone who has developed a close working relationship with a church denomination with a lot of real estate assets, and who is now a trusted partner when they want to dispose of defunct or vacant churches/land/etc. Feeing off of them makes sense; you're helping them dispose of assets without a long and potentially embarrassing marketing process (after all, who wants to admit the mother church organization is cash strapped or has declining membership?). It's more difficult for me to see the reason a developer would pay you a fee for the value they're creating - they're the ones putting up guarantees, applying expertise, beating their heads against the wall to entitle the land, and all that. Theoretically, why are you entitled to a slice of that value creation? Obviously if you can negotiate for it, amazing! And if you are promising them some degree of ROFR for future deals, then obviously that's hugely valuable as well and changes the math.
As I said, you should look for whatever you can get, but thinking about it as a developer on the other side of it... maybe you get paid a fee by the sellers on the raw value of the land, and then have the opportunity to invest in the deal alongside the developer with the same economics. I'm not sure why I'd offer more than that - what are you doing that means you should profit off this deal to a larger extent than they do? Your "acquisition fee" is really the middleman fee you make for facilitating the upfront transaction, but the ability to reinvest that into the larger deal seems like a reasonable ask (including a piece of the development fee, not just the promote).
I haven't been on your side of the table on any development deals, so take this with a pinch of salt. What you are "selling" is access to the development sites. You entire business model is based on maintaining friendly, even exclusive, relationships with the landowners (or that is how I read it). I would be extremely careful to make it clear to them that your incentives are aligned with theirs. Presumably you have no way of enforcing this relationship except by doing a good job, so if you start aligning yourself more with the buyer/developer, you might burn a really lucrative bridge. If most of your upside is coming from the development deal and not the land transaction, the temptation will always be there to slide into undervaluing the land to drive better returns on the exit, and that risks killing the goose that lays the golden eggs.
Agreed, 1% of TDC is definitely excessive if all you're doing is structuring the transaction then walking away. Are you doing any work beyond matching developers to the seller? Any skin in the game?
If the answer to the above is no I don't see why you should be treated any differently than any other broker i.e. you should be getting a percent of the purchase price of the land and that's it.
If you're structuring some long-term value for the developers, such as as Ozy suggests giving them a ROFR on future deals in a given market, then maybe you can demand a % of dev fees or a very small % of profits/promote, but that would still be a pretty tough sell if I was the developer.
Thank you both for your thoughtful responses and insights. Do you both have ground up development experience might I ask?
I think in a theoretical sense I agree with you both. In practice, at least in my own experience in the marketplace (RE or otherwise), "buyers" are much more attracted to non-competitive offerings for obvious reasons. Since we are tying up the land as "developer" and then we go and pick out a partner best suited to actually develop the project, it then makes sense that whoever wants to "partner" with us on the deal should give us the best terms.
I can't speak for CREnadian, obviously, but yes I do.
Buyers are attracted to "non-competitive offerings" because they think there is an information asymmetry. Practically speaking, there is a lot of dumb money that is chasing deals and offering a site up to the market for bidding means you are going to get a lot of people who offer insane terms in order to win but then can't close (waste of time for the buyer) or who have non-economic reasons to do a deal (which means sane buyers get priced out) or any number of other reasons.
The extent to which a buyer offers you a lot of money to bring the deal to them is obviously correlated with the degree to which they're underpaying for the land. Which is exactly why I was warning you against the practice of taking huge payouts from the buyer instead of smaller ones from the seller - once you align your incentives with the buyer, you've put your whole business at risk (and no, you aren't a "developer" you're a broker). If you truly have a huge runway here, then that might be a really foolish move. If you've got 2-3 sites left, maybe you try and maximize your payout.
Makes sense. Thanks again for your comments. You also mentioned above the following, "the ability to reinvest that into the larger deal seems like a reasonable ask (including a piece of the development fee, not just the promote)". Can you explain what you mean here? Are you getting at that investing a piece of the development fee into the GP equity capital stack would be even better than just getting some of the promote?
Separately but related, what is a typical required cash-on-cash return for GP equity contribution from developer? I have heard around 3x. So if I roll in a portion of my fee into the GP equity capital stack (with no guarantee or capital call requirements), then I can "expect" a 3x return if all goes well and the deal is market? Obviously lots of assumptions here and oversimplifications as well, but for the sake of asking a question.
I got a lot of MF deals done at 1.5-2x and 18%-22% IRR for the LP partner and 2-2.5x and 25-30% IRR for the GP. You can get 3x, but I wouldn't count on it.
In line with my other posts though, you can certainly ask to be a GP with no guarantee or capital call requirements, but I'm not sure why anyone would give it to you. There are some strange people out there though, so who knows.
I'm in a similar situation currently- Just sourced co-GP equity for a ~250mm dev deal (total project cost). If you are close with the seller, try and get the first deal under contract by yourself then shop the equity to other developers as co-GPs. If you control the project and the land is attractive enough, you should have no problem getting a co-GP who can help raise the additional money and assist with executing the business plan. If you play your cards right, you should be entitled to: acquisition/asset management fees and a meaningful slice of the back end promote.
Let me know if you want to chat.
Love it. We’re in a very similar boat. Let’s chat for sure.
You actually contribute beyond site selection though, no?
Correct- We'll have meaningful ongoing responsibilities. If I was just involved in site selection it would be much harder to push for AM/Dev fees
As a developer, I wouldn't be inclined to give you any dev fee unless you are actively involved in developing the project and providing real value to the horizontal or vertical process. That doesn't mean you shouldn't ask, because different developers have different priorities, but that's the first thing to get redlined for me, both on a conceptual basis (you aren't developing; I am) but also because dev fees are often only like 2.5%-4%, so 1% is a massive cut of that. That is the money that is paying my rent, or my employees, or funding future pursuits. I'm not wiring you a large % of that every month for two years just because you brought a site. Likewise, you are absolutely not getting half of the promote, or any of the promote, unless you are actively involved in the process. I would offer you the option to contribute your acquisition fee, which you are entitled to, as LP money, and maybe you could convince me to consider it GP money and thus have promote opportunities, but you aren't taking a substantial amount of the upside for finding the site.
Essentially, you are providing a fee service here but asking to participate as an owner. It doesn't really work that way. You are bringing a site that may work, while I'm out here spending months, if not years, getting it entitled, sourcing debt, sourcing equity, spending hundreds of thousands of dollars in design, legal, and environmental, signing up a GC, most likely putting my entire life at risk by guaranteeing completion, overseeing two years of construction, overseeing one year of lease up, hitting rent and occupancy benchmarks, and then finding a buyer. I'm happy to pay you for your time, but IMO if you want to be an owner you need to either contribute outsized value or contribute outsized money. I can always go find another site, or if I'm a big enough dickhead, just cut a deal with the land owner that cuts you, the middle man, out.
I don't mean to be a downer here - "dirt dogs" are legitimately valuable and, who knows, you may get someone to pay you exactly what you are asking for. But to me, if you want to get paid like a developer, you need to be a developer.
Hit the nail on the head.
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