My boss always says it’s beneficial to us as developers if land owners are willing to contribute their land into the deal as equity vs paying cash outright. Is there really any difference to project IRR and multiple whether the land is contributed or paid for (same month in both scenarios)? I would think total development cost would remain unchanged.
If I’m mistaken, can someone help me understand the intricacies of modeling the contribution as equity? I typically handle this on the waterfall tab and keep track of Land guys returns (and all other equity investors) once I’ve solved for the project level levered return prior to this point. If the land contribution DOES affect the project level IRR, then I’m certainly modeling the deal incorrectly.
A few thoughts...if there is an equity raise fee, it will be lower as there will be less equity to raise via land contribution. Also, carry costs (pref accrual) will be held off if current owner holds land until shovel ready . There are intricacies here depending on circumstance, but these are some general items I can think of.
You give them a credit for a capital contribution (generally in your waterfall) but the deal does not have to pay for it. Will raise you deal-level returns and they get to participate in the deal rather than getting a chunk payment.
It sounds like you’re doing it right.
So if I’m understanding you correctly, the total development cost would NOT include the land if it is contributed? I.e. the 55% LTC construction note does not calculate off a total cost that includes the land value?
Since equity goes first in the draws, wouldnt buying land outright vs it being contributed to as equity maintain the same equity total in either situation, and thus make no difference? If it’s completely backed out (or omitted) from the project budget in the first place which you may be alluding to, I think I get it....
No you should still be able to get credit for the appraised land value when sizing the loan. In the bank’s eyes contributing the land is just an equity contribution. So from a modelling perspective, add the land value to your total dev cost and apply your LTC to that sum to size your loan. But in your actual cash flow you don’t run any land cost, thus reducing equity to close.
Total development cost includes the contribution of land as when you go for financing, the LTC is on total development cost which is inclusive of the land contribution.
When a land JV occurs, the landowner contributes the land often times a 90% of the equity (traditional 90/10). You as the sponsor contributes 10% of the equity into the deal assuming land owners is ok as a passive investor into the deal.
If landowner wants to contribute land into the deal, in addition to equity that can be done as well. Assuming total development cost is $100MM. Id assume 60% LTC, leaving $40MM of equity required. Assuming land is worth $50MM, they can elect to split that into both GP and LP. Equity gap can be filled in with pref or mezz.
How I think of it -- You are correct in that the PROJECT IRR will be the same.
However, the benefit for your boss (developer) is not having to put up the cash to buy the land. Or raise the equity then pay preferred return on it. The land owner is in the deal with you. So the DEVELOPER IRR should theoretically be more favorable.
I get this is an old post, but I feel like the answers above are somewhat wonky...
It's a simple matter of reducing equity that needs to be raised (i.e. cash the developer has to put in the deal).... esp. if senior debt is used and landowner takes equity that is subordinated to the new loan.
Basic mechanics...
1. Land owner "contributes" the land to the JV
2. Full value of the land goes on as a "project cost" (i.e. appears full as a "use" of funds)
3. Lender values project at X% LTC.. including the contributed land value (assumes lender agrees with value and terms of course)
4. On the "sources" of funds, value of land contribution is deducted (or shown as equity investment, same thing) as are other equity sources and the loans
5. Developer puts up remainder of cash (or raises difference), which is now reduced by whatever credit is given to land owner
6. Project completes, senior loan is paid off, and remaining profits split with landowner and equity investors per deal terms (note, the "value" of land is probably treated as a "return of capital" just like cash invested into the deal by developer and others)
So, you treat/model this as any other equity JV. Another "side" benefit is the developer will typically compute and charge development fees on total project cost (incld. the contributed land value)... those come off before equity splits (or however agreed upon). Clearly, more ways to setup structures and terms (like make the landowner a subordinated debt, debt like, or mezz equity holder instead of full LP or GP equity owner). But that is the general idea. It's like "raising money" from the land owner with a contribution in lieu of cash.
What are the benefits for the land owner who contributes the property to the JV? Obvious ones would be that they can contribute their property at fair market value and participate on any upside of the development. But they are not receiving any cash at close, and taking development risk in terms of any potential cost overruns, default risk, market risk, etc.
Any thoughts on this and why they are not better off not selling their land fee simple to the highest bidder?
So, clearly this boils down to a lot of unique details of the land, the owner/seller, and the developer/buyer... but my "list" of benefits.. (all potentials, but not always present)
- Get higher price/value for the land (assuming developer would otherwise "discount" for all-cash close)
- No reason for a "zero" cash at close, can split into immediate cash amount vs. amount contributed for equity
- Wants to maximize value/benefit from selling land via development (mean wants to get more value via taking development risk)
- Similar to above, wants to be part of development process and have some decision power in what happens (this is more common than you may think)
- Also, land may need entitlements or sig pre-dev work, owner doesn't want to spend cash to do this (or deal with it), but doesn't want to sell for just "raw land" price (these deals can allow for land owner to get some benefit of the uplift on the land)
- They have tax/estate issues, and this structure helps (can be structured to avoid realization of taxes, cap gains, etc. or can segregate from those wanting to "cash out" vs. those wanting to "stay in" in the multi-owner situation)
Just a short list of what I could think of. But I will say, I feel like it is as common for the land owner to seek/desire this as it is the developer. Trust me, a lot of time the development group would rather just pay cash and get rid of this "partner".
This is very similar to the actual deal we are doing. What I cannot seem to grasp is how to show the actual sources of cash to fund closing. We (developer) are contributing land for an equity value of $2MM. We are 15/85 with Investor. Closing is $8MM. Typically, with closing that includes land acquisition, Investor would fund 85% cash to close and developer would fund 15% cash to close, however, if we are given credit for $2MM in equity, how does that work at closing (and subsequent development draws)? Total project cost $80MM
As a lender, I usually only give credit to the cash cost of the land and not appraised value. I want my LTC to be on a cash basis. If the land purchase took place a substantial period in the past, lets say 10+ years then some credit for appreciation is given.
We just did this on a project. Land was valued at $15,000/unit a door and we got ~ 200 units, so $3m land value contributed as JV equity at a 50/50 split over an 8% pref.
Total equity requirement was $9 million, but $3m was already "raised." So, we only had to come up with $6m.
There was no impact to the pro forma. Loan amount the same, IRR the same, etc. It just meant less cash we had to put up AND helped us win the deal.
In fact, we did a participating loan .... so only need about $1 million of our cash as lender took us to 90% LTC.
Wait how’d you get to 90% LTC exactly??
What were some of the terms for the land contribution? Currently negotiating one, so curious what kind of "outs" did you give the land owner/contributor if the development fell through. Also, did you treat the agreement similar to a typical land purchase - due diligence period, permit period, etc.?
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