Joint Venture Structure with Builder (development projects) Is this a fair structure?

[Kyle Doherty]

I've started working with a builder locally on our first Development/Build Project. Essentially I am finding and procuring the land/lot via traditional financing and funding everything through the development phase until we get to Construction Loan. 

The structure we landed on was as follows:

- Fixed Builder fee of $300k (each project varies but are 2-6 units, and 5,000-9,000 total finished sq ft)

- Fixed Return on all my initial capital invested of 50% (plus return of 100% of initial capital)

- Remaining Profit Split of 60/40 (60% to me, and 40% to him)

I understand a lot of this hinges on how accurate the proforma is and how close we can get to actually hitting our development costs estimates, build cost estimates, and sales per sq. ft. estimates. But assuming I feel extremely confident in the proforma numbers, does the structure seem fair for the risk and requirements from each party? This should be a win/win for both of us.

Would love input/opinions on this structure and if there are other ways I should be looking at it. Thanks in advance!

[Chris Seveney]

Quote from @Kyle Doherty:

@Chris Seveney - Do you mean basically what happens if the property ends up losing us money after sale?

We are in the Seattle market, so reality is that demand so significantly outweighs supply that on new construction you aren't really at risk of not selling, its more for at what price per sq ft it will end up selling for.

But one mechanism build in is that there is a $100k buffer where he will hold at least $50k of his build fee until after house is sold. So if we underperform the pro forma and we end up losing up to $100k on the deal, he would share in that $50k loss and I would eat $50k of the loss.

Is that what you mean?

Does the rest of the structure look fair?

 That is what I mean. Your mindset is the same as "I have a girlfriend and we will never break up because we are in love". Newsflash, people break up all the time and money is lost in real estate more than it is made and saying that the market will "always" go up - my guess is you were not around from 1999-2002 or 2007-2010...

[Chris Seveney]

Quote from @Kyle Doherty:

I've started working with a builder locally on our first Development/Build Project. Essentially I am finding and procuring the land/lot via traditional financing and funding everything through the development phase until we get to Construction Loan. 

The structure we landed on was as follows:

- Fixed Builder fee of $300k (each project varies but are 2-6 units, and 5,000-9,000 total finished sq ft)

- Fixed Return on all my initial capital invested of 50% (plus return of 100% of initial capital)

- Remaining Profit Split of 60/40 (60% to me, and 40% to him)

I understand a lot of this hinges on how accurate the proforma is and how close we can get to actually hitting our development costs estimates, build cost estimates, and sales per sq. ft. estimates. But assuming I feel extremely confident in the proforma numbers, does the structure seem fair for the risk and requirements from each party? This should be a win/win for both of us.

Would love input/opinions on this structure and if there are other ways I should be looking at it. Thanks in advance!

 What happens if a property does not sell and carrying costs exceed all costs? 

[Kyle Doherty]

@Chris Seveney - Do you mean basically what happens if the property ends up losing us money after sale?

We are in the Seattle market, so reality is that demand so significantly outweighs supply that on new construction you aren't really at risk of not selling, its more for at what price per sq ft it will end up selling for.

But one mechanism build in is that there is a $100k buffer where he will hold at least $50k of his build fee until after house is sold. So if we underperform the pro forma and we end up losing up to $100k on the deal, he would share in that $50k loss and I would eat $50k of the loss.

Is that what you mean?

Does the rest of the structure look fair?

[Chris Seveney]

Quote from @Kyle Doherty:

@Chris Seveney - Do you mean basically what happens if the property ends up losing us money after sale?

We are in the Seattle market, so reality is that demand so significantly outweighs supply that on new construction you aren't really at risk of not selling, its more for at what price per sq ft it will end up selling for.

But one mechanism build in is that there is a $100k buffer where he will hold at least $50k of his build fee until after house is sold. So if we underperform the pro forma and we end up losing up to $100k on the deal, he would share in that $50k loss and I would eat $50k of the loss.

Is that what you mean?

Does the rest of the structure look fair?

 That is what I mean. Your mindset is the same as "I have a girlfriend and we will never break up because we are in love". Newsflash, people break up all the time and money is lost in real estate more than it is made and saying that the market will "always" go up - my guess is you were not around from 1999-2002 or 2007-2010...

[Kyle Doherty]

@Chris Seveney - understand your point. What recommendations would have to improve our agreement structure to account for the risk? Any resources you'd recommend I research?

And apart from that side, assuming the project goes well, does the cost and profit share elements look fair? And recommendations there?

[Ed O.]

If you're paying a builder fee, there's no reason to give away upside too, unless you're getting a massive break on the builder fee. 

The more I read these posts, the more I think I should try and build for investors here.... they give away too much...

Pay the builder. Keep the asset / upside. 

Who feeds the bank if you're upside down and have to carry it? Who covers the overages. Investor/contractor partnerships run into the ditch quite often for many reasons. 

[Robert Ellis]

Quote from @Ed O.:

If you're paying a builder fee, there's no reason to give away upside too, unless you're getting a massive break on the builder fee. 

The more I read these posts, the more I think I should try and build for investors here.... they give away too much...

Pay the builder. Keep the asset / upside. 

Who feeds the bank if you're upside down and have to carry it? Who covers the overages. Investor/contractor partnerships run into the ditch quite often for many reasons. 

 agreed here but in our market we do more than just build we entitle, attend zoning meetings, we sell the asset, we provide rental comps, we negotiate financing structures, very little of the actual process is building. floorplan design, style, etc local knowledge trumps all. Columbus is an under built market I don't know what market this is in but I'd agree if all they do is build 

[James Hamling]

Ok, brutal honesty @Kyle Doherty.......

I got a feeling you showed up to a gun fight with a spoon when negotiated with this builder. I truly think they are a league, if not 2+ above your weight. 

It's an AMAZING deal, for the builder. Nothing but upside. 

For you.... Your living on a hope and a prayer. 

So you put everything together, make everything exist, and deliver a project on a silver platter to the builder. That's 1st value point I don't see being accounted for here. 

Than, you fund the everything, risking your capital. Value point #2. 

Builder does what they normally do. Ok.... not seeing any partnership in this facet of any kind. 

Than split profits after because builder is "only" getting $300k on it..... Are these $30m builds? $300k sounds like a hell of a windfall profit. What is this builder "sacrificing" that endears them to a profit split???? 

A structure a LOT more "fair" would be: 

You hand deliver the project on a silver platter WITH an assigned value for this, that will come right off the top of profits to you. 

IF you cover site development, all costs AND profits of this via improved value of build ready site market value, comes to you right off the top of back end profits. 

Than, builder EITHER covers 100% build costs, and get's that back plus 20% for O&P. WITH open book accounting to confirm.     -OR- with open book accounting you and builder split build costs 50/50, recoup on back side and builder get's 20% for O&P. 

And then, after all deductions made, remainder profits are split 80% you 20% builder. 

Because reality is, builder isn't bringing much to the table is he. No. 

And now, if builder brings a deal on silver platter, ok, he will get that silver platter $. 

I simply don't see the value here. It reads to me like your desperate for a builder and think they should clear bizonkers margins. 30% net is a BIG profit margin for a builder. That's what they strive for in normal business, taking on the normal risks.     Here you are making it uber simple for them and think you owe them..... I don't get it. 

I guarantee you can find a younger, more upstart builder in your market who would be over the moon to have a PARTNER in things to pump up volume in a rapid sense, and would cut a far better deal. Something with open book accounting and a much more fair accounting of values. 

[James Wise]

Quote from @Kyle Doherty:

I've started working with a builder locally on our first Development/Build Project. Essentially I am finding and procuring the land/lot via traditional financing and funding everything through the development phase until we get to Construction Loan. 

The structure we landed on was as follows:

- Fixed Builder fee of $300k (each project varies but are 2-6 units, and 5,000-9,000 total finished sq ft)

- Fixed Return on all my initial capital invested of 50% (plus return of 100% of initial capital)

- Remaining Profit Split of 60/40 (60% to me, and 40% to him)

I understand a lot of this hinges on how accurate the proforma is and how close we can get to actually hitting our development costs estimates, build cost estimates, and sales per sq. ft. estimates. But assuming I feel extremely confident in the proforma numbers, does the structure seem fair for the risk and requirements from each party? This should be a win/win for both of us.

Would love input/opinions on this structure and if there are other ways I should be looking at it. Thanks in advance!

 Why partner at all? Why don't you just pay him to build the building and call it a day?