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Realtor, General Contractor, and Developer · Redding, CA · Member since 2009 · 7k+ posts · 4k+ votes
We have never participated in a JV partnership before. I have had people contact me to propose different deals in the past. However; how do you know what % of a project to give up? I am posting a link showing what we bring to a project. Using an example of total development costs being $700k ($310 is land) and a value upon completion of $1,200,000 based on current appraisals, may be more) and considering what we add to the project, how much should we expect a financial partner to put in, and what % split would we need to give?
Also, this is a page I am considering using on my website, am I ok as far as SEC? I would be looking for Construction Lenders (using a mortgage broker to do all paperwork, etc.), or J.V. Partners. Our Value
Karen, yes, you need to show the value of your contributions to other investors. If you have a sophisticated investor who regularly deals in RE, they will already know what the going rate is for what you will provide. Assign your value as a % of the MV or sale price.
Generally in business we speak in terms of % not as to dollars, as the dollar amount or value of a deal changes. If you speak in terms of funding X dollars you could have future issues, especially in construction, developments or in rehabs. Big difference in asking you to fund 350K for 42.5% of the deal and asking you to fund 50% of the project costs, as you can have cost overruns. Who pays holding costs in the future on a spec? Or, you may say fund 50% of costs for 50% of the deal and explain what your contribution is as an expense to the project. Charging X% as an expense can have some advantages:
1. With many investors it can be a psychological advantage speaking to them as the owners, referring to yourself as the contractor or project manager. They feel the skin in the game. While I understand funding 50% for 42.5% of a deal, it will sound better to say 50% for 50%.
2. It's easier to market and sell the concept of them being the owners paying expenses and relating their position or contribution to the expected value of the project.
3. In some instances, placing yourself in a position of providing services can limit your liability to those aspects of services provided.
4. Accounting is easier splitting capital accounts of investors to 100% and expensing your earnings.
5. By providing your services to a project without ownership can place you first in line to get paid! You could have an investor head to bankruptcy arising out of that project or from any other business or personal matter. You can be in a lien position and get paid from sale proceeds.
6. Another aspect of liability issues. A participation in a partnership under contract, construction or management, is not a recordable matter. Your name doesn't need to appear in public records as it is a private transaction. If others can't find your assets or sources of income, the chance of them going after you drops. Such contracts can be shown in you financial statements and can be used as collateral as with accounts receivables financing.
A downside is to any tax advantage, if you aren't an owner you won't be taking depreciation. As a service provider you'll have regular income, if your project is placed in service and held, you won't see the capital gains treatment, unless you take a % of ownership*.
Your fee can be negotiated from various angles but you need to explain, to some degree, the value of your participation. Fees can be a flat dollar amount or a % of the deal. You can also take a % of profits as an offset to more favorable fee structures charged, this is a good way to go as you agree to assume some risk to the end and disposition of the project.
It's common for contractors to take on management on a long term basis of a project, like condos or apartments. Management contracts can be compensated with a % of profits in addition to general administrative aspects.
* If you use a Sub-S, you could have a stock option to buy in or create a stock ownership position, the increase in stock value will be a capital gain.
There are endless ways to agree and structure a partnership. Many larger projects are accomplished on leased land with capital improvements. Instead of acquiring the land and selling, the land can be purchased (investors can be used here as well) and then provide a long term lease to the entity of investors holding the improvements.
Any business can be sliced into functions and contributions under a partnership. You can take a financing position inside a partnership agreement, an ownership position or a management position. With the creative use of first right of refusals, secured lending positions, options to purchase, construction contracts or leases you can profit from various positions, long or short term. :)
$700K/amount they put up = % of the deal. ARV/MV is then MV x % = what they get at sale.
Not everyone contributes cash, say you have a contractor's fee of 10% and putting the deal together at 5% or 15%. That means there is only 85% left for others. 700 = .85/% contributed or say I put up $350, 700/350= .50
.50 x .85 = .425 of the MV or total deal. (profits after expenses of course)
You can cut it up any way you like, what ever they agree to. :)
This is a very common question and there is NO one right or wrong answer. Obviously, from your point of view, you want to give up as little as possible and this, you will compare what debt leverage would cost you compared to an equity give.
That said, I place a value (which fluctuates deal per deal, situation per situation) on finding and contracting the deal, managing the deal (plans, construction, resale, etc.) and the actual money.
On a spec build, if a JV partner comes in with 100% of the funds! I would expect to give up around 50% of the deal! possibly more in certain circumstances.
As far as public advertising, and as far as the SEC, you can't legally, so be careful there.
Karen, yes, you need to show the value of your contributions to other investors. If you have a sophisticated investor who regularly deals in RE, they will already know what the going rate is for what you will provide. Assign your value as a % of the MV or sale price.
Generally in business we speak in terms of % not as to dollars, as the dollar amount or value of a deal changes. If you speak in terms of funding X dollars you could have future issues, especially in construction, developments or in rehabs. Big difference in asking you to fund 350K for 42.5% of the deal and asking you to fund 50% of the project costs, as you can have cost overruns. Who pays holding costs in the future on a spec? Or, you may say fund 50% of costs for 50% of the deal and explain what your contribution is as an expense to the project. Charging X% as an expense can have some advantages:
1. With many investors it can be a psychological advantage speaking to them as the owners, referring to yourself as the contractor or project manager. They feel the skin in the game. While I understand funding 50% for 42.5% of a deal, it will sound better to say 50% for 50%.
2. It's easier to market and sell the concept of them being the owners paying expenses and relating their position or contribution to the expected value of the project.
3. In some instances, placing yourself in a position of providing services can limit your liability to those aspects of services provided.
4. Accounting is easier splitting capital accounts of investors to 100% and expensing your earnings.
5. By providing your services to a project without ownership can place you first in line to get paid! You could have an investor head to bankruptcy arising out of that project or from any other business or personal matter. You can be in a lien position and get paid from sale proceeds.
6. Another aspect of liability issues. A participation in a partnership under contract, construction or management, is not a recordable matter. Your name doesn't need to appear in public records as it is a private transaction. If others can't find your assets or sources of income, the chance of them going after you drops. Such contracts can be shown in you financial statements and can be used as collateral as with accounts receivables financing.
A downside is to any tax advantage, if you aren't an owner you won't be taking depreciation. As a service provider you'll have regular income, if your project is placed in service and held, you won't see the capital gains treatment, unless you take a % of ownership*.
Your fee can be negotiated from various angles but you need to explain, to some degree, the value of your participation. Fees can be a flat dollar amount or a % of the deal. You can also take a % of profits as an offset to more favorable fee structures charged, this is a good way to go as you agree to assume some risk to the end and disposition of the project.
It's common for contractors to take on management on a long term basis of a project, like condos or apartments. Management contracts can be compensated with a % of profits in addition to general administrative aspects.
* If you use a Sub-S, you could have a stock option to buy in or create a stock ownership position, the increase in stock value will be a capital gain.
There are endless ways to agree and structure a partnership. Many larger projects are accomplished on leased land with capital improvements. Instead of acquiring the land and selling, the land can be purchased (investors can be used here as well) and then provide a long term lease to the entity of investors holding the improvements.
Any business can be sliced into functions and contributions under a partnership. You can take a financing position inside a partnership agreement, an ownership position or a management position. With the creative use of first right of refusals, secured lending positions, options to purchase, construction contracts or leases you can profit from various positions, long or short term. :)
Around here the standard is the investor gets a preferred return of about 8% and then a split of 70/30. I would think the end result number would matter more than the split. I can get 80% of the profit but if that is only 10% IRR, that is no good. If they can return 30% annually to me with a 50/50 split I might be ok with that split
What an investor doesn't want to see is a bunch of fees so you need to build those in.
The developer gets to collect standard realtor fees on the transactions if they act as realtor and property management fees. But any contractor fees are built into the construction cost that he quotes the investors. He doesn't show much breakdown of that cost so you don't need to have the breakdown of all the in house costs, just the accurate totals. So that construction total is important because you need some profit built in and also you do not want to go over that budget. It is very bad for your credibility to have to come back to investors and ask for more cash because you blew the budget.
The developers handle everything from acquisition, construction mgmt, prop mgmt, arranging financing if needed, etc etc.
I also look for developers who participate in the deal as limited partner as well as GP. Makes me feel like their goals are more aligned with mine.
The developers I invest with are doing lots of volume so they are always raising cash. If you are just looking to fill a deal here and there, maybe your split can be less attractive but again I think the appropriate split is determined by the expected returns.
If you have a SFD, 1-4, you might go off bid prices. Larger projects can go off bids but usually are done on a cost plus basis to the plans and specs. At 700K, I want to see the materials list, may want to see commitments on deliveries, like 30K in steel roof trusses with price guaranteed to a date. If I'm a lender or in ownership I need to see that we won't have significant cost overruns.
Sophisticated money types aren't going into a larger deal based on bid price alone with other fees on top of that simply because profits are padded in the bid already. Build a 140K spec house or 180K duplex, a bid can be fine. If the contractor provides other customary services after that, customary rates apply. These are turn-key deals, basically the contractor is selling the improvements.
Investors getting into a proposed partnership won't be getting bids from various contractors if that contractor is proposing the project. As a contractor you need to have control over the project before admitting partners in some way. Hold the option on the land for example. Otherwise, what stops investors from buying the property and getting another builder?
In larger projects I want to see a few paragraphs about change orders as well, they should cost more than the same work according to plans in some respects, but a cost plus is the best way to approach these from the investor/buyer's point of view.
Do an office/warehouse and find that another 8" has to be added to a loading dock as a change order. Which brings up another issue:
If you have an anchor tenant, you better get them involved in the plans and specs of amenities. Railways and trucking companies will have loading dock requirements for loading and unloading and door requirements. A pharmacy will have wall requirements for vault areas, there can be security issues as well that effect windows and doors. Most chains will have plans and specs to be met.
Is the lender expected to come in with 100% of the cash ... purchase, rehab, holding, etc?
I don't know what you mean, I am an investor not the lender. Sometimes we also have lenders in the deals.
Depends on the size of the deals. On small deals under say 250K, it is usually just cash. So let's say the property is $175K and the rehab is 75K. The total needed to raise in the syndicate is 250K. Typically the developers I deal with will raise about 200 and put 50 in themselves personally.
On larger deals, they will raise the downpayment and rehab, then take out a mortgage. Again, the developer will usually invest personally as an LP as well as be the GP.
The deals I am in are generally targeted at about 1 year until sale or refi to recover cash invested. Rehab and repositioning of multi family properties.
So in terms of LTV and other typical "lending" criteria, these deals look very risky but these guys have an excellent track record of returning 30-40% returns to the investor.
As I stated above, percentages can vary on profit splits under many circumstances. Eric made a valid point on this very thing when he stated that the actual profit and return on investment has a huge impact on the decision for an investor to get involved. In fact, a 50% split may be better to the investor than a 70% to investor 30% the other way because the dollar amount of the 70% could very well be much lower than the other deal with the 50%.
As far as Bills comments, many different ways to do deals, but my personal opinion and preference is NEVER to do cost plus. It is my view that there is no incentive to the contractor to keep costs down on a cost plus basis.min fact, it is better for the contractor if costs go up as so do their profits.
LOL, the incentive is in the profits at the end. They either do cost plus or they don't do it. There are too many ways for a contractor to screw you, contractor discounts, unrealized expenses, loaded labor and subs, kick backs, the list goes on. Again, building a house is one thing, building a 700K project in the same manner you'd do a 150K deal can be foolish. As the prices go up so do the levels of sophistication of reducing risks. Now, I'm speaking from the investor side, not the promoter's side or the contractor/manager, so the difference in opinion is understood, two sides to most things. :)
I'm speaking from the investor side too Bill and as you also pointed out, many ways for contractors to pad, so in my opinion, why add another opportunity with cost plus!
Getting back to the point though with Karens deal, the vertical is only approx $400k in this example and a total raise including the dirt of $700k. That's not a large deal by any means here in CA, so it would be my suggestion Karen to go with debt leverage on such a project and retain for yourself 100% of the equity. If that is absolutely not an option for you (which I can't see how it wouldn't be), then go for a raise giving equity.
I guess what I was really asking is how much skin in the game does the sponsor have. You answered that.
A very important question that all investors should ask. I too would require the promoter to also be a limited partner with cash into the deal. As Eric stated, that helps provide the investor with the feeling that the promoter is financially aligned with the limited partner investors. From the promoter side, I too would also invest capital and be on both the general partner and limited partner side.
@Eric M.
I guess what I was really asking is how much skin in the game does the sponsor have. You answered that.
A very important question that all investors should ask. I too would require the promoter to also be a limited partner with cash into the deal. As Eric stated, that helps provide the investor with the feeling that the promoter is financially aligned with the limited partner investors. From the promoter side, I too would also invest capital and be on both the general partner and limited partner side.
I'm with you on that. If interests aren't aligned, i.e., all parties don't have some skin in the game, things can too easily go sideways. Rehabbers with none of their own money in the deal, syndication sponsors/promoters with none of their money in the deal, non performing notes that depend on "emotional equity" are all examples of what I consider misalignment of interests.
I didn't read all the previous posts Karen, but skimming them here are some salient points:
1. It depends on who brings what value. Will's post about value centers is pretty close to what I'd post if I had more time. Here is what I think adds partner-level value:
a. Cash
b. Signing for the note and leveraging lending relationships (Debt)
c. Procuring deal (Sometimes...could just be broker-level value too if the deal isn't a great one)
d. Diligence - Like what a developer would add
e. Obtaining good contract to design out risk. This is a really big deal in many cases because cities introduce a lot of risk for what can be developed in many locales
f. Ability to execute - Contacts, etc. Like what a developer would have. This includes the ability to get entitlements
Everything else can be purchased for far less than trading equity in many deals. Many of the other services are commodities, but having good builders, architects, engineers, etc. as part of a system to ensure execution with minimal risk adds value for an investor.
Pricing the money is an art form. You want a low cost of capital and something lucrative enough to cause folks to want to invest with you again if you're like most developers. Be long term greedy and not shortsighted.
With all of those disclaimers here are pretty standard terms if someone is putting up most or all of the cash:
-6-8% preferred return
-40 - 60% of equity
For smaller deals I value things like this:
1. Cash counts dollar for dollar
2. Debt counts 70 cents on the dollar
3. No development or management fees to create alignment between we and the investor
For larger deals this probably wouldn't work. If you need to feed yourself from the project and it is long term you're going to want SOME fees. I dislike fees because they create misalignment with investors.
Regarding the SEC comments it IS NOT unlawful to solicit for investors under the new securities laws. You do, however, need to follow the rules and reasonably verify they're accredited if you're doing "accredited crowdsourcing" under 506c. Services like Crowdbouncer can assist with this. If you email me I can make some introductions for you.
You probably want a securities attorney to review anything you present as an offering. Words like "great," "best," etc. should NOT be present in your ads and you should avoid the word "guarantee" at all costs. You can't guarantee anything. Keep in mind that anything you present to find investors becomes part of your offering materials even if you do a private placement or some other sort of sanitized legal paperwork vetted by your attorney. You can spend a lot of money getting those documents right and nullify their utility by saying something seemingly innocuous with your offering on your site. Tread carefully.
Thanks to all of you that took the time to reply and give me well thought out answers, and direction. I think Joint Venture partnerships, unless it were a larger deal, would end up taking far more time to set up and deal with than the value they would offer. For now, I think sticking with loans is probably the best route to take.
@Bryan Hancock You are so well versed on all of this, out of curiosity, what is your background, finance or ? (my @mentions aren't working) I'm sure all of us will be watching your Fundrise with interest. I hope it all goes well.
Regarding the SEC comments it IS NOT unlawful to solicit for investors under the new securities laws. You do, however, need to follow the rules and reasonably verify they're accredited if you're doing "accredited crowdsourcing" under 506c.
I am by no means an expert on this but would comment that it is only lawful IF you do a raise under the 506c option.
Regarding the SEC comments it IS NOT unlawful to solicit for investors under the new securities laws. You do, however, need to follow the rules and reasonably verify they're accredited if you're doing "accredited crowdsourcing" under 506c.
I am by no means an expert on this but would comment that it is only lawful IF you do a raise under the 506c option.
Funny how folks take some comments, guess they try to make something that isn't there just to make a point.
No, my comment above was to the risks involved in raising capital without compliance of SEC, not that anything is illegal, it's that you can quickly get off into illegal activities if you don't comply. And, there are many ways to structure capital other than the 506c option, it's just that most will require lots of money and brain damage, but it can certainly be done.
Another note, cost plus is the safest way to hold a contractor's feet to the ground and not have costs padded. Costs may not even be paid by the contractor, costs are verified, in fact the contractor may not even acquire the materials. If a contractor bids 65K for a foundation, he can pad materials and labor and show a contractor's profit of say $6,500. Cost plus can mean he oversees the work, all subs are paid with lien waivers, materials as well, the costs are audited and the contractor is paid on the expenses, he may never touch the accounts or know who may provide the excavation, concrete and finish work on some contracts, generally the contractor will have his crew and that's fine. If you're up on your labor market you'll know what a hauler gets, so it's not like the labor guy can overcharge and kickback taxable income to the contractor.
You'll also find that many small contractors won't talk to you on cost plus for that reason. They will take a job when they need to. Building the relationship and paying fairly will go a long way.
My experience? Hmmm, have no idea where to start Karen. Just doing business, subdivisions, financing of commercial ventures, government contracting, auditing.....whatever :)
Bill, no clue what you are talking about. Both those comments mentioned above by you were between Bryan and I, not you, so neither of us were trying to make a point in argument to anything you have stated. In fact, I agree with your posts in this thread, not counting this misunderstanding you posted above.
@Eric M. I don't know why any developer would bring in the down payment, do all the work (find the property, negotiate the purchase, design a project, do all the up front work for entitlements, manage the project etc.) and then give away the majority of the project. Why wouldn't they just get a HML for the construction loan? You can get a HML with 20% down (we've had lenders fund 100%) pay 4 points and 12%.
Money has value in a deal, don't get me wrong. However; there are far more people with money than profitable deals in an area with high demand. Putting together a project with healthy profit margins is not as easy as it seems.
No one said the developers bring the downpayment. The investors put up the downpayment. Sometimes the developer also invests.
I guess I don't really understand your point. If you are certain HML is better than JV or syndicates then do that. You asked about JV terms and I answered.
I think it is clear that most significant RE developers take outside equity investment rather than go HML. There must be a reason why. Pretty much every significant financial business from stocks to REITs to hedge funds and mutual funds to bond funds to oil and gas partnerships to anything else follow the model of raising money from investors and paying out 70-95% of profits to investors. All these operators have to work and manage the projects and do all the things to operate the business just like you do...and they pay out most of the profits to investors. Many billionaires have been made by people employing this strategy of "Parlaying" outside investments into significant income for themselves. Obviously you are stuck on the perceived value of what you bring to the table. Maybe that is an obstacle you need to overcome to get to the "next level" as it were.
Why are all these people willing to give the majority of the profit away? I don't know. I guess part of a large pie is better than all of a small pie. But they are and they do quite well generally. Maybe it means they can grow faster or with less red tape. Maybe they want less risk if a deal goes south. There might be many reasons. The companies I partner with are doing quite well for themselves.
All I am telling you is what the existing market looks like in my area which is a major city with lots of sophisticated investors and operators. These are not hypothetical, it is what the market is doing. If you can't bring yourself to pay that price or to see the value, that is up to you. I don't care. But most apparently do see the value.
Seeing as developers are forever raising money and crowdfunding is being pushed as another new way to raise money and a majority of the posts on BP are about figuring out how to raise money...I really doubt that your assertion that there is more money than deals is really true.
In my experience and from every outward appearance, it is the exact opposite. If that were really true I don't think you would have made this original post. You would be busy breaking ground on your project, HML in hand.
@Eric Michaels I don't know why any developer would bring in the down payment, do all the work (find the property, negotiate the purchase, design a project, do all the up front work for entitlements, manage the project etc.) and then give away the majority of the project. Why wouldn't they just get a HML for the construction loan? You can get a HML with 20% down (we've had lenders fund 100%) pay 4 points and 12%.
Money has value in a deal, don't get me wrong. However; there are far more people with money than profitable deals in an area with high demand. Putting together a project with healthy profit margins is not as easy as it seems.
Just to follow up, I had in my head an article I had read about this some time ago and I found it HERE.
Interesting tidbits from scanning it again
"While the developer’s skill, tenacity, and vision often are critical to a project’s success, the developer’s return typically is subordinate to both the lender’s and the equity investor’s."
"A traditional payout split gives the equity investor a preferred return of 8 percent and the developer a preferred return of 7 percent, and they agree to a net profit split of 75/25 percent."
The article gives tips to the develop how to structure a deal to appease the equity investor but give the developer more upside.
ALSO more....from a book entitled RAISING MONEY FOR RE DEALS (hmm, why is there a book if so much money is floating around??)
How have the average terms changed since the financial crisis? Use the chart below to see how terms have evolved and to benchmark your business against this data.
Key term
2007 trend (pre financial crisis)
2011 trend
Waterfall structure
Mostly deal-by-deal returns
Seeing an increasing trend toward full pooling of returns as opposed to deal-by-deal returns, which were
common on the legacy funds
Carried interest
80/20 the typical structure, with a 50/50 distribution to get to the agreed-upon profit split
80/20 the typical structure, with a 60/40 or 70/30 distribution in favor of limited partners (LPs) to get to
the agreed-upon profit split becoming increasingly prevalent.
New trend — carried interest to be reviewed by auditors before payment
Preferred returns
Mostly 9%
Should be calculated from the day capital is contributed to the point of distribution.
Average of 8.8%
Target returns
Levered returns of 20%+
Levered returns of 16%–20%+
Investment period
Average of four years
Generally now being scaled back to three years
Overall fund period
Eight-year period, with option to extend for two one-year periods
Evidence suggests shorter fund durations, now six years on average vs. the typical eight year-term precrash,
with the option to extend for two one-year periods
Clawback provisions
Generally did not extend beyond the term of the fund
The period should extend beyond the term of the fund, including liquidation and any provision for LP giveback of distributions
General partner (GP) commitments
Standard of 1%
LPs are expecting aggregate GP commitments to be meaningful. This should be contributed through cash and not through the waiver of management fees
Management fees
Average of 1.5% of capital commitment during investment period and invested capital after investment period
Based on actual costs incurred by the GP on a cumulative basis and capped — with many having .5% on committed capital and 1.35%–1.75% on invested capital, but can go lower depending on size of committed capital and can vary based on commitment period and investment period
@Eric M. First off, I'm not saying that the terms you stated aren't typical in a Joint Venture project, and that's why I originally posted, to get a variety of viewpoints on what is a typical split in the various regions, niche properties, etc. As you mentioned, more often than not the split most often mentioned here on BP is 50/50, and I wasn't sure if that was a standard or not, and wanted to find out. I appreciate you taking the time to weigh in.
You're correct that it was me that originally posted, doing so in order to be able to compare the pros and cons of Joint Venture partnerships vs. Loans. You're also right in stating that there are always people on BP looking for money, and there never seems to be enough money for the deals. At the same time, I read daily of people on BP with money wanting to know how to loan it out. The fact is, there is a lot of money that people are sitting on, waiting to put it somewhere and earn a good return.
I understand that every deal is different, and there is no stock answer. As you know, It's about risk, reward, and weighing the quality of the project, local economies, etc. Every region and area isn't equal, and some areas draw more interest from lenders than others due to the strength of the market, type of property, local economy, etc. as all of those things affect values.
More often than not, my posts are so that I can gain information, and also are a response to questions I have seen on the posts most often, therefore; I try to get a broad base of questions answered on the subject matter, to benefit more members.
I appreciate the attachment on your post, it definitely provides some good information to consider.
