Am I giving away too much on this spec deal?

[Account Closed]

Thank you to everyone for your comments on my last spec deal post, especially @J Scott and @Will Barnard.

I’ve worked through the opportunity further, met with local real estate agents and other developers to get their thoughts on the market, etc. I feel comfortable with the opportunity, but wanted to run the proposed deal structure by the bright minds here to get additional feedback.

This would be my first spec build deal so I am partnering with an experienced spec developer/friend and we would use his builder. It is our goal to do several deals together (me & the developer) and grow the business. We are looking at starting with this deal and doing many more in the future if all goes well. I understand I’m likely giving up a bit too much on this one, but he is bringing me a prime site in a great location that’s already tied up to help get me started in the business, in an area that is extremely competitive for new sites. His team is prepared to do this deal in the spring, but they are at capacity right now, but he’s offered me the opportunity to sponsor it to get involved now and get the deal going. He has already begun design working to get permits quickly, before a few regulations on height and basement ceiling height change in our city.

We would like to be in for permits before October 1, with the goal to break ground by early November. If we can accomplish that we feel good about having the home completed by the spring, which is a great time to list in Minnesota.

Here is the proposed structure with some additional notes below.

$325,000 lot (his builder bought a duplex and is offering us one of the 2 lots at cost)

$425,000 construction costs (includes architecture, interior design, staging, etc)

$30,000 financing costs

$40,000 closing costs / buyer’s agent commissions

$820,000 total costs/breakeven number (**we could fire sale the property at this price point in a matter of minutes if needed)

($150,000 equity, $600,000 loan)

$1,000,000 proposed sale price

Pay off:

• 1.$630,000 construction loan (includes financing costs)
• 2.$40,000 closing costs / commission
• 3.$165,000 equity (my group loans the equity to the deal at 10% -- $150,000 + 10%; assumes I borrow all the equity at 6-10% as well so likely no spread to me)

= $165,000 gross profit

45% ($74,250) to builder (he gets paid on profits, no fees, but does not contribute equity)

25% ($45,375) to my friend the developer (he brought the deal, already has the architect engaged and plans almost complete, orchestrates the process, brings the team/expertise to the table)

25% ($45,375) to me (bring the equity, take out the loan, assists on process, etc)

The goal is for me to learn as much as I can on this deal and to hopefully be able to form a partnership with the developer going forward where we are doing several deals a year and both getting paid on all of them. Some he sponsors, some I sponsor, etc.

After this initial discussion, I’ve proposed two things to him:

• 1.We need to negotiate a slight reduction in the builder’s percentage of profits
• 2.Whoever sponsors the deal should take a 5% developer fee from the profits (*he said he has not done this on prior projects)

I have a full time job and am going to be relying on him to do a good portion of the work, but I recognize I’m taking risk by bringing the equity and taking out the loan. He’s said to me he wants to find a structure that works for everyone involved on this and future deals and is hopeful we can have a long term partnership. With that in mind, I certainly appreciate that a great site has fallen into my lap, but also sort of feel like I’m taking too much of the risk and not getting paid enough for that.

Thoughts?

[Lynn Currie]

I agree with what some of the other folks are saying. If the education is worth it to you, do the deal. You'll be getting paid to learn.

The other thing you should know is that the builder seems to be getting paid much more than a normal builder would get paid in this transaction. There may be a very good reason behind it, but just looking at the numbers, it seems off.

And lastly, since it's your money and you're taking all of the risk, you might want to set up an 8% preferred return. You want to make sure that you make 8% before anyone sees a return. To make it more palatable to your partners, you can set it up so that once your 8% is met, the preferred goes away and it's a straight percent split as agreed upon in the original deal. This means that you don't get 8% PLUS the split, just that you're guaranteed the 8% before anyone else makes any money.