Investing in development deals

10 Replies

If you were going to be an investor in a spec home building project (either one or a few SFR's or townhomes) what types of due diligence would you do? What are the top questions you would be asking the sponsors to mitigate your risk? I have never done development myself and therefore do not know a lot about it, but I have some opportunities to invest in some projects. I have been doing as much reading as I can to learn more, but wanted to get responses from BP. Thanks

Great questions Rob,

Depending on the percentage you are investing into a project usually dictates how much control you can secure.  

Here are a few to start:

1) Where are they in the process/timeline of getting approval to build (zoning, permits etc.)

2) What measures of control are available to the investor(s) if the sponsors don't meet the milestones needed to complete construction and arrive at a marketable project.

3) If there are delays, cost overruns etc., anything affecting the profitability of the project, Will there be an adjustment made to the profit participation of the investors?

4) If the project is a failure what can I hope to recoup from my investment & what is the process?  How long would it take?

5) If the project is a success, how will I receive my distribution & how is it calculated?

Ellis San Jose, Real Estate Agent in CA (#BRE01855039)
(805) 852-7418

Thanks @Ellis San Jose for the excellent info.  I will digest this and try to come up with some more questions on some deals I'm looking at investing in.  There are a lot of threads on this forum from the principles/builders standpoint with development projects.  But there aren't many threads from the prospective of passive investors looking to invest in development deals.  

Any one out there make hard money loans on spec building projects?  What are some main bullet points on your checklist before deciding to fund a spec building project?

Hi @Rob Cee

As a lender, we would mainly be concerned with the LTV of the loan, timeline and schedule of draws. It is essentially a construction loan, most lenders like ourselves would need to be in first position, and there would need to be some value in the land as collateral against the loan. Assuming there is equity in the land, financing 100% of the construction usually is very doable, as long as the loan is less than the lender's max LTV % vs the sales price of the total development. For example, if it costs $500k to build and the exit sales price was $1,000,000, or a 50% LTV, which would meet most lender's criteria for maximum LTV %.

Hope this helps. Good Luck!

Ben

Originally posted by @Ben Stoodley :

Hi @Rob Cee

As a lender, we would mainly be concerned with the LTV of the loan, timeline and schedule of draws. It is essentially a construction loan, most lenders like ourselves would need to be in first position, and there would need to be some value in the land as collateral against the loan. Assuming there is equity in the land, financing 100% of the construction usually is very doable, as long as the loan is less than the lender's max LTV % vs the sales price of the total development. For example, if it costs $500k to build and the exit sales price was $1,000,000, or a 50% LTV, which would meet most lender's criteria for maximum LTV %.

Hope this helps. Good Luck!

Ben

Thanks for the comments Ben.   For construction projects you lend on, do you do due diligence on the builder before you lend on projects (former client references, credit reports, cash reserves)?   I imagine you need the permits to be done before you will lend anything?  Do you use a 3rd party to manage the builder/project review and the draw process or do you do that in house?  Do you get an appraisal on the "as completed value" before you lend?

@Rob Cee

  from a non builder private passive investor construction loans are the most risky one could do...

the risk is builder fails in the middle or ( like a builder I know ) built a home 3 inchs out of plumb.. caught at framing stage only way to fix was to tear it all down and redo it.

he chose to finish it... and it looks like it should be at the Mystery spot.. doors crooked etc. house value to some one but steep discount.

Liens  like here in Oregon properly filed mechanics liens are super liens...

Etc etc.

In my mind its all about builder rep and experience.. lots of credit brusied builders need HML ... great experience but thrown back into the private realm. you can find some really top builders these days. That's whats important

Yes @Rob Cee we look into all points you mentioned regarding the background experience and borrowing strength of the contractor. 

Yes, permits would be needed before draws were sent.

No, we handle all construction draw requests in house. 

Yes, we require an ARV appraisal to be done prior to any funding of the loan.

I was doing some research and many large banks and national lenders outsource their construction loan review and management to to Granite Loan Management.  So I was reading their guidelines on their web site and below are some of the things they do to mitigate risks of their lender clients.  Lenders are generally looking to mitigate risk similar to passive investors so I thought it was good info.

Here are some things  they do to mitigate risk for lenders that outsource construction loan mgmt to them:

-they check AND track expirations on contractor licenses, all insurance (workers comp, builders risk, etc...)

-the do full due diligence on the builder (former client references, subcontractor and supplier references, contractor credit report, criminal background check, business credit report, drivers license and w-9)

-they do a through pre-loan analysis of the project reviewing plans, budget, contract, appraisal, permits

-after each draw inspection is reviewed, they make recommendations on if the bank should make the next draw

-they ensure home is built free of mechanic liens

@Rob Cee

  On my bigger build jobs IE subdivisions I hire  Risk management firm. Not a lot of money but they track all the detail as you just laid out. 

Banks are better at this as they got hammered last go around.  And at least here on the West coast subs are used to being paid one time a month.. so you have time to keep things in order.  Lien's are what can bite you.. need to stay on lien release's.. some lenders don't but I do... we get release's from all subs and the GC

Originally posted by @Jay Hinrichs :

@Rob Cee

  On my bigger build jobs IE subdivisions I hire  Risk management firm. Not a lot of money but they track all the detail as you just laid out. 

Banks are better at this as they got hammered last go around.  And at least here on the West coast subs are used to being paid one time a month.. so you have time to keep things in order.  Lien's are what can bite you.. need to stay on lien release's.. some lenders don't but I do... we get release's from all subs and the GC

 I think for a passive equity investor in these projects it may be add some layer of safety if you are investing in a development project where there will be construction lending from banks.  Then you know the bank likely did a thorough DD on the builder and project.

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