Developer Returns
Curious to see what irrs developers are hitting on multi family and industrial deals? If returns are higher than why are bonuses higher on the lp side for junior employees…
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They're showing LPs mid to high-teens and hoping they get high teens low twentys.
Because the pimple-faced development analysts aren't taking the massive amount of risk that the principals are. Our industry rewards the folks whose nuts are on the line on a deal and see it through to the end... that ain't the analysts; they're getting paid in experience and they get rewarded handsomely once they start running their own deals.
So why do analyst at lp make more?
LP analysts typically have better credentials, LP analysts do more rigorous financial analysis and there's a lot fewer LP capital providers than there are GP developers. Thus LP analysts are paid better.
If "returns are higher" on the GP side that is because risk is greater, why should an analyst with nothing at stake benefit from someone else's risk?
There’s just more money to go around at an LP than a GP. If you’re investing a $500MM fund with 1.5% management fees, that’s $7,500,000 in fees to pay for overhead, offices, etc. You can have a staff of 8-12 managing that money. If the fund than gets into its promote, there’s just a lot of nominal dollars to go around because the fund size was large to begin with. Pay is more about AUM and fees than where you sit (LP or GP).
On the GP side, let say it’s a $50MM development. 95%/5% split. 65% leverage. The developer is going to put in $875,000 of capital. Even if the developer does 5x their money, there just isn’t as many nominal dollars ($4,375,000). And the money is all in the carry. Property management and asset management fees are slim - they are enough to keep the lights on. The dev fee would be 4% of total dev cost - so $2MM. But that’s also going to help keep the business afloat. This is part of why GPs usually are small offices. They staff enough to keep things moving but can’t afford much more.
An LP could be investing out of one $500MM fund, and have two more $500MM funds which they are managing / harvesting. The same 12 people could be managing that and clipping fees. Again, just more money to go around.
It’s part of the reason more developers do office than anything else. In addition to acquisition, PM, AM fees, construction management fees are larger because office buildings are larger (so budgets are bigger). Plus, if you do leasing in house, you get the brokerage fees. Which is actually where much of the money is made. Lastly, some office developers also own the security and cleaning companies which manage the building.
The math of fee income shows the economics of development is much slimmer than fund management until you take into account the promote (if you hit it). But you best believe you’re not getting access to that promote unless you invest money yourself or drive tons of value.
Analyst bonuses are higher on the LP side because LPs pay to attract talent from IB, most GPs are hiring straight from school or from brokerage and know they're typically attracting different candidates than LPs so they aren't necessarily trying to compete on comp, but moreso on the exposure to asset-level work. At the associate level it starts to balance out more.
Right now in multifamily, typically seeing project-level IRRs between 20-30%, investor returns from low teens to high teens/low 20s. RoC is the biggest obstacle, untrended yields are absolutely brutal so almost every deal depends on being in a market with strong rent growth expectations. If you're really optimistic about cap rates being sub-4 for the foreseeable future then you're probably finding more deals, but we try to underwrite conservatively so most secondary markets we're underwriting between 4.25-4.5%.
This comment just made my day…conservative is a 4.25-4.5 in secondary markets. Thanks for the laughs brotha
Welcome to 2021 my man. Phoenix, Denver, Dallas/Houston/Austin, etc. are all seeing sub-4 transactions on the regular for new product. We've seen other GPs underwriting 3.5 caps on stuff, its stupid.
I haven't seen a single multifamily deal underwritten higher than 4.75% from anyone in any viable market in the last 2 years.
What are you seeing for untrended RoC in new, ground-up MFR?
We target 6%, but realistically will settle for 5.75%. One or two projects are currently hitting 6.2% on proforma, but they're prime jewel locations, the run-of-the-mill ones are seeing a lot more cost pressure without the same rent upside.
Returns and firm profitability are certainly components of bonuses and salaries, especially at the senior level and above but even down to entry level analysts, BUT they are far from the only item of consideration. There are big differences between development and equity fund investing (presumably what you mean by LP side)....
- Development analysts probably are not working 80+ hrs a week very often (sometimes sure), but if you work for an equity fund, could be almost every week
- Developers get those IRRs and payback all at once upon disposition/recapitalization, which can years down the road... An equity fund can charge fees to its own LPs even during investment years and thus have recorded profits (and cash) to distribute... developers may still be going out of pocket and thus salaries/bonuses are true expenses
- As said above, the equity fund world is more "high finance" and thus is legit looking for people from BB I-banks with fancy Ivy pedigrees, they cost more. Developers probably could care less most of the time (notable exceptions for sure), so salaries more in line with opportunities open to the people of who they hire.
- In the equity fund world the analysts legit do a lot of heavy lifting to do deals and underwrite (like powering through millions of OMs and vetting models).... by comparison, the value of development is more likely a function of the deal making prowess of the execs/project leaders, and frankly, the analyst just doesn't offer the same level of value creation on a relative basis.... thus less justification for the big bonuses.
This is pretty spot on.
Development shops tend to run a lot leaner than equity investment vehicles - deals are fewer and further between, and take years (instead of months) to execute on. And as others have said, cash flow is choppier, so it makes sense to be understaffed rather than the reverse.
I would argue that even if junior people at development shops are doing less work in terms of hours, they're doing more complex work. Which is one reason you don't see a ton of junior people at development firms. If so, they're there to be seasoned to take on a more important job, not to run models all day.
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