Best Risk-Adjusted Returns - Acquisitions or Development?

Lending has the highest risk adjusted return anywhere from 30-100% return on equity

I really think it’d be hard to make a case for development having the best risk-adjusted returns. Development is by far the riskiest business in commercial real estate, and it shows in pretty much every single downturn. While there aren’t many ways to get to a 8x equity multiple outside of development, I’d be perfectly happy hitting 50 singles and doubles, and sometimes triples, in the same amount of time it takes to complete a development. Also, personal guarantees in non-opportunistic acquisitions are very rare.

I hear you, and I definitely stress that it depends on where you are in the market cycle. But looking over the last 2-7 years, has there been a better money making strategy in RE than development? I understand, in principle, why development is labeled as the riskiest of strategies. But to be honest, over the course of $2B in resi development I've seen/worked on...not one project imploded in the way that many think of when labeling dev risk. Even in the case of cost overruns and/or delays...the net return in a 3 yr period was significantly higher than any alternative, hindsight, that could have been made.

Ultimately, ownership makes the most money. development - and going from A-Z by yourself and making all the intricate margins throughout that process, makes the most money within ownership. The risk adjusted component to me is the caveat and focal point of this question. It really depends on how much you think you should discount back the promote earned in dev. And to me that is largely dependent upon where you are in the market cycle. 5yrs ago, i think it would be a clear winner. 3yrs from now, im not sure that's where the "smart" money would go. Rather, your best bet would be a high cash flowing / fee generating asset class. Obviously buying high and selling low is noones idea in RE investing. equity ownership at a market high might not bode the best strategy...IF you can find investments or asset management opportunities that are lucrative and do not have the risk associated with ownership. Point being, even acquisitions might not be the best bet for risk adjusted returns...my initial answer was tied to the two choices provided. To me, the best benefit acq would have in the down cycle period was it will give you cash flow. Where you ultimately buy it in the cycle will determine if you make money or have to hold and hope before exiting. As mentioned...for me best risk adjusted during a down cycle would be fee business with a strong credit oriented company / tenant. I made a separate thread to get others thoughts after reading this...but to me military housing privatization offers a huge opportunity during this time. Having a steady asset management fee stream with the government paying as your tenant for a sector (military) that will always be needed...is a great way to earn steady predictable income, with no equity investment up front.

Lending my man.

Let money make money for you. Who wants to deal with the headaches of development? So risky.

Personally, I would lend money to an established and experienced operator/developer on a project I believe in. Basically what Madison Reatly Capital is doing. They seem to have a great handle with their lending. They are involved in very cool and interesting projects. The end goal would be to try and get on their level of knowing operators willing to do business with you.

Now, depending on their capital stack needs, whether it’s preferred equity or mezzanine, I’d lend in the double figure range. Maybe more people can chime in here but I wonder how many deals went sour when lending to a local player who understands the market and has history of getting projects done.

Seems like a fairly good risk adjusted return.

as mentioned Riskadjreturns for RE is, IMO, a bit pointless to quantify. But using some back of the napkin math...

Risk free rate = off the cuff let's say 2.5%

Development: Avg return (lets just use IRR) = 25% to developer (this doesnt include any fees typically paid) STDEV = i think 15% is very conservative for this exercise RAR = (25%-2.5%)/15% = 1.5

Acquisitions Avg return = 13% STDEV = 10% RAR = (13%-2.5%)/10% = 1.05

Lender Avg Return = 4% -- I've never worked in a debt shop...but not including fees, I think any real estate acq/construction loan...a 400bps spread above base instrument is very rich, and honestly a term sheet I would not consider as most construction loans and construction to perm are Libor + 250-325 im seeing. STDEV = 2% -- again, I think this is pretty conservative. To apply a 15% to development and then 2% to the lender on development...that risk profile is a much bigger discount than typically associated between debt and equity rates. RAR = (4%-2.5%)/2% = 0.75

This was my thought on the numerical reasoning for thinking development, as well as the qualitative reasons I outlined above. I did not take into account mezz/pref structures, as when I think of lending that is a much smaller portion of the industry...and I'd just keep it simple here.

This is a silly question. Why? Because everyone has a different tolerance to risk, different preference with regards to investment timeline, etc.

The investor who is investing over a 3-5 year period might pick development while the investor investing over a 30 year period might conclude to just investing in an index of publicly traded REITs. Each may be the best "RAR" depending on how they define it.