Development with no margin

Dumpster Fire Yuppie

Might be more of an issue with keeping the lights on than anything else. Construction companies will take jobs at super low margins in bad economies just to keep people staffed and keep the doors open. At it's simplest, companies need enough volume to justify their overhead, need fuel to keep operating, and firing/hiring is expensive and difficult.

Not an expert in luxury hotel development by any means, but it sounds like they might just be trying to keep the wheels turning in hopes for a better time at this point.

This is a development study from a developer point of view, not builder/construction company. I think the reason is the developer take long term view on holding return which should be measured by IRR not just development margin.

FutureCEO3

What everyone cited above is true for construction companies, if not more so for developers. General contractors charge a GC fee which comprises their back office expenses as well as their profit margin (unless the GMP has a contingency split). 

Developers can charge an acquisition fee (fee paid as % of purchase price), a developer fee (typically % of project cost less land and financing), a guarantor fee (50-100 bps of loan amount), a property management and/or asset management fee (% of ongoing operating cash flows, can be before/after debt service) - pretty much you name it and a developer can load a fee onto it to pay themselves earlier or on an ongoing basis if the equity partner will let them (I’m saying this as someone who uniquely sits on both the equity and developer side). The franchise and asset management fee are more important for this particular example as hotels are a very operationally intensive as an asset class.

The two big elements/context you might be missing here are capital sources/cost of capital as well as a younger vs seasoned developer. These deals don’t seem to make sense until you realize it’s a REIT or operator backed by institutional private or public equity who are using other people’s money looking for a +100 bps spread over Treasuries for their capital. Younger developer plays a role as when you are starting out in the business and trying to make a name for yourself but have very little money you can be a “fee developer/builder” where you are putting very limited equity and executing the project for a fee but limited to no back end ownership so there is no “spread” for them.

I am analyzing this from purely developer point of view. Builder/contractors profit is irreverent to this analysis. In terms of capital cost, yes we analyze the equity IRR which includes all leverage cost. And its super low with <4% equity IRR.

Ozymandia

Does the developer own the land?  What have they paid in precon fees?  They might be millions of dollars in the hole - going forward may actually net them capital, as if the deal is breakeven then they technically recoup pre-development costs, which are probably expensive for a large hotel project (I have no idea, but we generally spend six figures on diligence on deals we're going to transact on, and that's for affordable housing projects!).  If they own the land, it means not paying carry on something that clearly is now worth less than they paid.

Do you know their underwriting standards?  Perhaps they're being extremely conservative in this new COVID environment, and they think that an optimistic scenario actually gets them to a decent return.  And as others have said, fee income helps keep the lights on and keep talented and knowledgeable staff in house during downturns

No, its a 70 years leasehold..meaning developer build and operate then keep all the profits but not the land and structure after lease ends. This is not in the US. Its another western country, I cannot disclose the location too specifically. Equity IRR is <4% which is ridiculously low.