Vertical integration in RE

Someone asked me this question and I just wanted to check my answer. 


Why don't more real estate developers bring construction in house (like JDS).

I said it was probably because they didn't want the liability of being a builder but just wanted to make sure I had the right thinking. 

 
Most Helpful

It’s not a very high margin business. In my HCOL city, GCs charge a 2% fee (on cost). To many developers, it’s just not worth the headache and risk plus extra staff you need to do with everything that comes from construction. The low fees are also the reason there is so much corruption in construction and the ‘bad’ bills get placed through the General Conditions line item. 
 

The dev fee is 4% and you can have 1 development manager, (maybe 1 associate tied to the development manager) 1 project manager (maybe a junior person too), and your accountant. If you add a GC in house, you need additional staff, but the fee is less. Also if it’s a large enough project, developers can pass back the cost of their salaries for the employee tied to the project. So that increases the developer’s profits further. 

 

100% with pudding....you're taking on a lot more risk and much more overhead for a slim margin.  Most GC's/CM's make more money on the insurance side than the fee these days (general liability, worker's comp, etc)

However it's not unheard of for larger development shops to self-perform.  Related Co.'s Boston office has built up its own CM division over the past 5+/- years and they do it all from cradle to grave.

 

You could ask the same question about other aspects of the business. Real estate development is unusual in that the scale of a firm's operations has very little correlation with the number of employees that it has. There are development companies that have only a tiny number of senior rainmakers in house and outsource everything. Others have in-house GCs, OPMs, leasing, marketing, sales, property management, back office, etc.

One downside to doing things in-house is that, once you build up a big team, you need to keep it together. So you may have to start doing marginal, risky deals just to keep everyone busy in a downturn. There is also just the ongoing headache of managing people- turnover, bad employees, etc.

I've found that the personalities of the company's owners can play a role in some of these decisions. Some people are natural performers who like an audience, and they tend to gravitate to hiring people. Others don't want the headaches and like to keep things lean and mean.

 

I guess I just ask because I'm seeing small firms having construction arms. Granted these are small firms but even a big Dallas firm like Harwood International has a construction arm.

 

It depends a lot on the scale.  For example at the large scale end of the spectrum you have firms that can easily get the attention of the large GCs, while the smaller shops have to compete for access to high quality GCs which drives down their returns as they have to pay more.  So to bring that in house they can reduce the GC costs, or at least that is what they tell themselves.   I am not so sure it actually boosts returns because on a risk adjusted basis their returns are likely lower than if they just paid more for the GC work.

 

Champagne Sipping

I guess I just ask because I'm seeing small firms having construction arms. Granted these are small firms but even a big Dallas firm like Harwood International has a construction arm.

Can you be a little more specific on “construction arm”? Is it an actual GC, going out managing all aspects of contractor relationship/financial management? Or is this a construction management team who oversees a GC/external contractors? Some firms literally own the GC and can control costs and contractors better, so even if it’s a small margin they recognize the value through better or more transparent contracting/management. When I was at Westfield, they had an entire Construction vertical that was a construction management team, that oversaw all GC related functions, but wasn’t the GC. It was to ensure a fixed price contract across a billion plus dollars of construction and multiple projects. They used their expertise to price, engineer and manage every single aspect of the construction process, but werent physically responsible for hiring every trade and negotiating everything. They were experts in the field and were able to “keep the train on the tracks” and roll that up through the separate entity outside of the REIT structure (big time profits)

 

I think location is also a big thing. If you are a big developer you are doing projects all over the country. Are you going to stand up a construction team in every metro? What happens to the team when you are done with the current project, are you always going to have an ongoing project in that city? By outsourcing, you hire the team when you need them and can build wherever you want, not just where you have this pre-existing construction team.

for smaller companies that only focus on a small area, it makes more sense.

 

Dolorum modi error tempora. Et nisi ut consequatur voluptatem. Placeat aut ut est dolorem eius.

Career Advancement Opportunities

March 2024 Investment Banking

  • Jefferies & Company 02 99.4%
  • Goldman Sachs 19 98.8%
  • Harris Williams & Co. (++) 98.3%
  • Lazard Freres 02 97.7%
  • JPMorgan Chase 03 97.1%

Overall Employee Satisfaction

March 2024 Investment Banking

  • Harris Williams & Co. 18 99.4%
  • JPMorgan Chase 10 98.8%
  • Lazard Freres 05 98.3%
  • Morgan Stanley 07 97.7%
  • William Blair 03 97.1%

Professional Growth Opportunities

March 2024 Investment Banking

  • Lazard Freres 01 99.4%
  • Jefferies & Company 02 98.8%
  • Goldman Sachs 17 98.3%
  • Moelis & Company 07 97.7%
  • JPMorgan Chase 05 97.1%

Total Avg Compensation

March 2024 Investment Banking

  • Director/MD (5) $648
  • Vice President (19) $385
  • Associates (86) $261
  • 3rd+ Year Analyst (13) $181
  • Intern/Summer Associate (33) $170
  • 2nd Year Analyst (66) $168
  • 1st Year Analyst (202) $159
  • Intern/Summer Analyst (144) $101
notes
16 IB Interviews Notes

“... there’s no excuse to not take advantage of the resources out there available to you. Best value for your $ are the...”

Leaderboard

1
redever's picture
redever
99.2
2
Secyh62's picture
Secyh62
99.0
3
BankonBanking's picture
BankonBanking
99.0
4
Betsy Massar's picture
Betsy Massar
99.0
5
dosk17's picture
dosk17
98.9
6
CompBanker's picture
CompBanker
98.9
7
kanon's picture
kanon
98.9
8
GameTheory's picture
GameTheory
98.9
9
DrApeman's picture
DrApeman
98.9
10
Jamoldo's picture
Jamoldo
98.8
success
From 10 rejections to 1 dream investment banking internship

“... I believe it was the single biggest reason why I ended up with an offer...”