Scaling my RE Business as a Principal

I just found this place a recently. Excellent. Excellent!

My trolling over the last few weeks has uncovered interesting and useful information which I'm using to help me formulate my next move for my RE business. I'm making this post in hopes that I can get input on scaling.

A partner and I recently formed a development company. We are currently on our second project. The first project was a 4.5MM office project and the second one is a 6MM retail center. We have a 7MM flex warehouse development in the pipeline as well as a 6MM office redevelopment project we are considering. We both had development and construction real estate experience before starting this company and were able to use our past investors and/or clients as investors to get our first few projects off the ground. We are using a fairly standard syndication GP/LP model which has worked to cobble together the requisite LP capital. If returns are realized as assumed, our investors should be high teens to low 20s irr.

I'm looking to scale.

In order to scale I'm having second thoughts on development and if ground-up asset agnostic location specific development has longevity and can scale. I'm in a second tier market with 1MM population. Has anyone grown a development company from my size to something larger? If so, how did you continually find good investments and were you required to go outside of your market and specify your asset type?

I'm starting to consider if we should scale this company to handle more volume and less risky deals. It seems much more sustainable because of less dependence on the condition of the short-term market. Development is a shitload of work and we just sell for quick gains. It feels kind of like we are house flippers. There are so many advantages to holding real estate long-term. Should we look to bring on partners with institutional background and grow a company that does high volume value add long term deals? My partner and I are both successful entrepreneurs, but we lack any institutional background, so I'm contemplating the idea of finding partners with institutional background who would join our team to grow this type of business. If that is the case, I have a preconceived notion that it would take us having a novel concept in order to give investors a reason to invest with us. Am I wrong in that assertion? It seems like there is a lot of competition giving moderate returns. If we give market rate returns and do what we say we are going to do, is that enough?

There is much more to discuss outside of this initial ramble. Hopefully that will be enough to start a conversation. Any input is greatly appreciated. If you've made it this far, I owe you a beer next time I see you...

 

Welcome to WSO and the WSO Real Estate community.

To be honest with you, a majority of posters here are at the Development Manager and lower, with plenty of associates, analysts, and undergrads. Still, there are people like Ricky Rosay who may have insights that could help you.

You may get peppered with questions about going out on your own more than you'll receive responses, but either way, I'm excited to have entrepreneurs such as yourself here.

Commercial Real Estate Developer
 
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A few thoughts:

  1. With respect to ingenuity, you don't need to be creating the next Apple in order to raise money. Many equity groups have a mandate to allocate their capital; if you have good real estate, a solid execution plan with good market returns, and the experience/credential to back it up (and call sell all of the above in an articulate fashion), you can make it work.
  2. You do need a track record to make this work. That can certainly be accomplished through bringing on institutional partners. At our shop, we brought on fee developer partners to execute the office portion of two projects to give us more "execution legitimacy." That helps immensely with both equity and debt. And, you may require that firepower to get your equity partner to sign loan guarantees if you do not have a lot of balance sheet strength.
  3. The bigger deals are the same amount of work as the smaller ones, with more upside and larger fee dollar values. If you have a solution to the track record question, go as big as you possibly can.
 

CRE mentioned your name and I read through your posts. I appreciate you responding to my message and I'm inspired by your trajectory.

  1. Ingenuity: Understood.

  2. Track Record: We are close to returning capital to several investors on one of my earlier vacation rental projects. Some of these same investors came with me to another project, so I'm encouraged that was we grow, our network of investors will grow. In our current $6MM retail project we raised around $1.2MM from outside investors. We ended up with 12 guys. 12 guys sounds like a bad idea, but I was happy to have a larger number because the more people in the market talking us up, the better exposure we get for potential new investors. The management is cumbersome, but I think in the long run it'll be worth it.

  3. Deal Size: At what size can you get away with non-recourse for repayment? Have you found any deal size that you consider a sweet spot, where you aren't competing with the big boys, but get the best return on time? We are in a smaller market, so if I'm not doing multifamily (I'm not) or office (over supply), then that'd leave me to industrial or maybe mixed use. Industrial is going well in our market and we have a 45,000 sqft flex warehouse development in our pipeline, so I'm excited to get behind the wheel so I can learn the asset class.

You mention staying lean in some of your posts and maineiac42 mentioned that as well. This has been a good reminder of why I like this business. You can outsource a majority of your work. Sometimes my ambition doesn't align with my overall life goals. My goal isn't to be the largest company, BUT I do recognize that you spend a large portion of your life working and I'd like to create an environment that is enjoyable to me while not overly burdensome. Perhaps the balance is more principals and less employees? Sure I won't make as much money, but if you got the right group of principals, it just may be the answer.

 

All of our deals (total capitalization values range from $55M-$300M) are non-recourse with no repayment guarantee, but include a completion guarantee and standard carveouts for bad boy acts and environmental indemnities. However, we have solvent institutional LPs who are able to flash their balance sheet to satisfy lender liquidity and net worth requirements, which is critical to satisfying the completion guarantee portion. We pay them a fee that gets capitalized into the deal for providing the balance sheet strength.

Spreads on non-recourse debt are probably 200-225 bps over their recourse counterparts if you were comfortable taking that risk.

 

Having talked with a few mentors I can tell you that the overhead risk of bringing on employees and staffing up their offices has weighed on them. A couple have said they wish they could just go back to their old ways of syndicating deals from their home office, but now they have people on staff they feel a certain amount of obligation towards.

 

Good point. We third party everything: back office accounting, construction management, and property management, and capitalize it as a project expense. That way, those expenditures don't come out of our pocket, and more importantly, in a recession event we are much more adaptable. Our total G&A is limited to our salaries, health insurance, and office space.

 

When it comes to property management and asset management, this cuts both ways to a certain extent. You can hire an excellent property manager for a fraction of the fee revenue that they could potentially bring in, and those fees are a lot stickier than deal-driven revenue. Asset management will be a bit more expensive to staff but otherwise has the same benefits and probably more upside.

If/when deals dry up, those business units can provide the revenue to keep you afloat on your overhead and ideally leave room for some extra pursuit costs.

 

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