Owner / Investor Contract Strategy with GC

[Everett Stephens]

Greeting! Many thanks in advance for your input. I'm a residential / SFR investor in the Memphis TN region. I'd appreciate some suggestions on fair deal structures between a GC and a land owner (me). I'm currently planning on developing around 40ish upscaled townhomes on a parcel my partner and I own. We had a GC approach us proposing he builds the development and we'll split the profit three ways (GC, me and my partner). The current suggestion is we, the owners, secure the construction funding, the GC builds, and profit is split equally. The GC is also requesting the right to sale the units as he owns a brokerage. At first glance, this seems somewhat reasonable. But, it could get out-of-balance if the GC fees are high and he takes both an equal profit share plus sales commission while we carry the finance. How would you recommend structuring this deal to keep things fair? Thanks again!

[Allan Smith]

I'm a GC and I've also developed new construction I owned. The GC is getting a screaming deal here if he gets some of your profit for... doing his job. He presumably doesn't get a builder fee, which keeps everyone's costs lower until it sells. When it sells instead of getting a builder fee he gets a cut of profit.

A typical builder fee on that many houses is probably 12% of the total construction cost. So you'd want to run your own numbers. For example, if a 1/3 of the profit ends up being the same as a 14% builder fee, I'd say you are still getting a good deal bc holding costs will be lower (smaller construction draws without having to pay builder markup). But I'm guessing that it's much more than 14% to where you are giving quite a bit away. Also, in my experience when the builder joins in on the equity, it's common for him to be signing the loan. Although in most cases the owner (you) cover the down payment which is probably just buying the land in cash.

In my humble opinion unless you've known this GC for 10+ years, it's mostly better to keep a clean separation and let him build it for a fee, get paid, and you collect profit with your partner. 

Speaking of keeping clean lines, it might work out to have his brokerage list the houses but first you want to make sure he's GREAT at selling houses. And second, you want to negotiate his commission up front. It should be very competitive with your market. Around here, 6% was the going rate, but many agents are discounting to 5%. Plus, agents have always offered 5% to investors as they tend to get volume instead.