How I Structure Land Development Deals
I break land development deals down in 12-month increments. As a rule of thumb, I structure deals so I never have my money tied up in the deal more than 12-months. As a second rule of thumb, I try to lock in my return on capital at least 200% IRR. Finally, I look to reduce my risk exposure in a deal as much as possible.
1) The 12-month to 20-month Seller JV. I like to offer sellers a very low cash now offer let's say $400,000 and then a much higher 12-month to 20-month short term JV at let's say $500,000. Whether the JV is for 12-months or 20-months depends on how long it will take me to get entitlements done and get permits issued.
I like urban 3-story townhouse development in Seattle because it only takes 16-months from acquisition to sale. The permit review period is 10 weeks (although right now with delays it is taking 18-weeks). So here is how I structure these deals ideally. I offer the seller a 12-month JV at the higher price where I put down $10,000 EM and will cash them out for $500,000 in 12-months.
Why do I structure it this way? I will come in with the hedge fund and pay for $50,000 in soft costs including survey, architecture, engineering, geotech if needed, land design and permit intake fees. I am looking for a deal where I can cash out $150,000 (roughly a 200% IRR) in 12-months from the original $50,000 investment. What I will do is get a partner on the deal right before permits are issued. They come in with $300,000 ($140,000 for 25% downpayment to cash out the seller and $150,000 to cash me out plus closing costs) in exchange for 70% equity in the project.
By structuring this way, I locked down a 200% IRR and the new partner takes all the risk. I am sure to do it in exactly 12-months and one day so these profits are taxed as capital gains versus ordinary income. The new partner now takes all the risk of the project and loan guarantees the construction loan. I have eliminated my risk. I to structure these deals so they will make $600,000 on their $300,000 investment in 9-months (pretty good return over 90% IRR). I then will make an additional $150,000 cherry on top profit with my 30% equity and make another $150,000 as the builder/GC and $60,000 as the listing agent.
2) Luxury Development. I like to structure luxury development projects where I will subdivided 5 acres with a view on a seller JV. My strategy would be to sell two lots for $750,000 each and then use the $1.5 million proceeds to pay cash (no construction loan) on a 7500 sq ft luxury home at $165 per sq ft. The reason why I do this is because if the market crashes, I don't want to pay 1% interest per month on a $1.3 million construction loan. $13,000 per month times 4 years to wait out the market would kill me. Plus, extension fees every 90-days. Even if I rented out the 7500 sq ft house at $5000/month, I would still lose $750,000 in a market crash. That's what most builders don't. I would only build luxury if I can subdivide, sell the lots and get the first build for free. Then wait to sell the first house at $2.5 million and then build house #2.