I must be missing something here.
Developer wants to remove the development fee. Their logic is why would they increase the budget by the amount of the developer fee, when the senior loan is a fixed amount? i.e. they will just need to put in more equity to make up the difference, and then pay interest on it, given that all the equity goes in first.
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The Developer Fee should be in the budget. They aren't increasing the budget, they're trying to hide costs.
Can you elaborate?
For example:
$52mm total cost includes $2mm fee.
Bank loan for $40mm. Sponsor needs $12mm equity. They want to either 1) contribute the fee to equity, or 2) remove it altogether.
They don’t want to contribute the $2mm as equity, just to get it paid back over time as a developer fee percentage of completion.
Makes sense when you are the developer with 2% in the project. These guys will contribute all of the equity themselves.
The Developer Fee is a real cost that needs to be accounted for. It is not included in the property's pro-forma, so it needs to be included in the budget. If they don't want the Developer Fee to be shown in the property level pro-forma or the budget then where is it supposed to come from?
You have sources and uses. Your sources should look something like:
Equity - $12MM
Bank loan - $40MM
Total Sources - $52MM
Your uses should look something like:
Hard costs - $45MM
Soft costs inclusive of Developer Fee - $7MM
Total Uses - $52MM
I mean, if they don't want to take a developer fee, why should they be forced to? Now, if they just don't want to show the cost and will be requisitioning for those dollars through the construction process, that's a way different story.
Usually I see developers contribute their fee as equity, which shouldn't be an issue. Not sure why they wouldn't want to do that... if they push back on that, there is some shady shit going on.
It's abnormal to see a construction loan with no LTC constraints. In the case of developer fee, it usually get distributed from equity or from the loan depending on how the agreement is structured (paid out on an as complete basis etc.). In this case, the developer fee would either have to be paid out entirely from equity or on the back end. Depending on the equity agreement and the splits, I can see there being instances where paying out a developer fee on the back end would be a better strategy.
This, it seems like the developer doesn't want to put up equity to fund the developer fee (which I am assuming he is receiving 100% of). What we've done is defer the developer fee to a back end promote. It's not an unreasonable ask imo, and whenever it has come up, I have always thought "what would I want?". Well I wouldn't want to pay for my own fee.
Could they possibly be taking it out of permanent loan proceeds when the deal is refinanced?
Is the investor a third party?
From the original post it sounds like the developer and investor are the same person. In that case, I think it makes sense that they would leave it out so they could 1) put in less equity and 2) avoid interest expense on that incremental loan amount. That assumes they have enough existing cash flow to keep their lights on, pay themselves and their staff, etc. while the project is in planning and development until the project refinances. All other factors being equal, they would essentially just cash out more money when the project goes perm (since their outstanding loan amount would be lower at that time than if they funded $x developer fee already).
They could also be eliminating it from the dev budget due to construction cost increases. Some developers use the dev fee as a 'plug' and add to or subtract from it as the budget changes. i.e. they know their project should cost $__MM and the G/C budget or whatever is coming in higher than 3Q18 projections, so they make up for by chipping away at the developer fee. I think this is more likely to happen when the developer and investor are the same person.
If the investor is a third party I think you situation is a little strange. Sometimes they structure the dev fee as a promote or sweat equity in the deal (minority stock with $0 par value). If this is a small deal or pro-forma cash flow is tight I think it's reasonable. Regardless, it seems like a third party investor would care how big the developer fee was and how it was getting paid. Depending on the property type, amount of equity coming from either party, and other factors I could see a case for having the developer pay or defer it depending on the circumstances. A guy that won't get paid until a perm. refinance is going to act differently than someone aiming for a 17% IRR when their promote kicks in, and not all developers can wait til the asset is sold to monetize their sweat equity.
TL/DR -- it's not unheard of but certainly worth asking more questions
Guy sounds like a moron.... Typically, the developer has a smaller % of the capital stack, so in essence, by him not taking a fee, he's giving up a lot of profit he would be otherwise getting. Say it's $1M development fee and he is 10% of the cap stack. He is giving up $900k in profits that he could charge to the project. Why the hell would he do that?
Developers make a living on fees & promote. Fees lock in $ to developer (more or less), so the more fees they can get (leasing, management, development, construction oversight, cap markets oversight, disposition, etc. you get the point..) the better as you bake them into the budget. From the developers perspective.. who cares if the project does marginally if they are getting a boat load of fees?
Obviously there are caveats to all of this. Some fees could be held back, and sometimes you can get an amazing JV structure (from the developer perspective) that outweighs certain fees (so developer would be willing to be lighter on the fees in exchange for something like... 50% over x% preferred return. vs. a more traditional WF structure like x% pref ->80/20 to 20% -> 70/30 thereafter).
Sorry, rookie question, but can you clarify the math behind your comment about putting in the extra $1MM in developer fees at 10% of capital stack and walking away with an extra $900k in profit?
Also, in relation to OP’s question, can someone clarify why interest would be payable on the extra $2MM in developer fees? Wouldn’t the loan amount be fixed at $40MM, and the equity would either be $10MM or $12MM, depending on whether the $2MM developer fee was added to the budget?
This is exactly the issue.
The do not want to put in an additional $2MM of equity to fill the cap stack, and pay interest on it, just to pull it back out on a percentage of completion basis.
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