Joint Venture Partnership Structure With A Builder: Thoughts?

43 Replies

Good day Biggerpockets,

I apologize if this post is lengthy. I think full context is helpful to receive thorough feedback. 

I live in  Florida and am a licensed real estate agent.  A year ago I had the observation that the modern/contemporary style is not common on new single-family home construction in our market, and ESPECIALLY at an affordable middle price point. I wondered the reason for this lack of market supply in the $300-500k ("affordable") range? I thought of a few possible causes: lack of demand, pricing of modern-specific building materials, lack of builder expertise in this type of construction, or lack of builder desire to create this product when cookie cutter sells so well in this price range.

I have no construction or development background, so I reached out COLD to a bunch of modern home builders in Tampa via email and phone call. Most of these builders built homes in the $700k- $2 million price range. I asked if they had any desire to do similar contemporary homes in the $300-500k price point, a "stripped down" version if you will. A few told me to eff off or kick rocks, but one builder was interested. He said he always desired to build modern homes at an affordable price point, but his clients had dragged his price range UP with custom home jobs.

He said the bottleneck or restriction in moving forward with these plans was A) lack of land opportunities in gentrifying communities, especially off-market (MLS deals typically were overpriced and left little room for profits and B) lack of capital to do multiple projects concurrently and make it worthwhile.

He proposed the following structure:

-I find off-market land opportunities in gentrifying neighborhoods.

-We split land acquisition cost 50/50.

-We use land as collateral to secure the construction loan.

-A 20% developer fee is factored into construction loan.

-I list and sell property with traditional real estate commissions. We split profits 50/50.

For example, a single family project we are currently working on has numbers that look like this:

-Land cost: $110k. (I put in $55k, builder puts in $55k)

-Construction loan : $240k ( $200k cost plus $40k developer fee)

-Projected sales price: $475k (low end.) After 8% closing costs, including commissions and taxes, this nets $437k. 

This means projected profit is = Net sales price - ( land cost + construction cost)

= $437,000 - ($110,000 + $240,000)= $87,000 profit. $43,500 to each party.

From land acquisition to the final closing of completed product averages 8 months. So ROI would be $43,500 on an initial investment of $55,000. A 79% cash on cash return. Is this a scalable business model? What am I missing here, what factors should I take into consideration?

PS. This ROI is not taking into account two key factors. In the stated example, the builder also earns a $40k developers fee. So his ROI is $83,500 on a $55k investment.

I am also not including my real estate commission. At 3% this is $14,250, bringing my total return to $57,750 on a $55k investment. 

Be careful with informal joint venture and partnership structures. Unless you incorporate, you could become jointly and severally liable for the contractor's actions (e.g., an injury to a construction worker). Consider either incorporating or keeping the contractor at arm's length in all your transactions. 

This is not legal advice. Talk to a lawyer licensed in your jurisdiction about your unique situation. 

@Jacob Rhein the builder has done similar joint venture agreements with other investors. They established an LLC for each individual and had a clearly outlined operating agreement detailing the roles of each party and profit distributions after the property was sold.

I looked over one of these agreements and it was very formal. I am in 100% agreement with you, informal structures are recipes for disaster.

@Asad Shaikh Modern design simply costs more, which is why it is not common on lower price points.  Do you really believe that you buyers will pay a premium, and if they are willing to pay, will the appraisers see any value?  I would say no, but you likely now your market the best.

As for the terms of your partnership, its stacked pretty heavily with the builder.  The 20% developer fee is way too much for me.  From what I see, your only saving 50% of the downpayment, but loosing out on almost $44k on profits.  Why even partner with the builder, just contract with him. 

Finally, I would be floored if you could build a modern design house for close to $100/ft2.  I just finished two duplex houses, one very modern in design, one more traditional. Similar interior finishes, the modern house cost me right around 20% more, both houses have the same square footage.

@Asad Shaikh

We have a very similar structure in place with our partner who is a real estate agent like you (we are the builders), however we are @15% for the build. We do have a LLC and partnership agreements in place for our projects and while @Mike Wood makes a very good point in regards to just hiring a builder and creating more profits for yourself there can be a high amount of value partnering in a deal like this.  Our partner had limited capital and no lending relationships and was hesitant to oversee a build project.  Our first project together has gone extremly well and we are now in the process of buying two additional parcels that will hopefully yield 7 more homes.  

In addition, to echo Mike's point about building modern, you will certainly have a higher per sq/ft build price and a smaller buyer pool.  There is a distinct reason that most modern style homes are contracted custom homes.

@Kyle H. From a builders perspective, what advantages does such a partnership bring to you?  Obviously the required down payment on the construction loan (likely in the 20-25% of total cost range) would be split, but then so is the profit?  You obviously have the relationships with the banks, you have the people and subs, so if you have 50% of the down payment, can you not just get that to 100%?  Or even using some private money as a loan with just interest and no equity stake for the down payment.  

To me, the way I see a builder/investor partnerships make sense is as follows;  

  • investor brings all the required cash and access to the construction loan
  • builder does the construction at cost (no GC/builder fee)
  • partnership sells the house and each split 50/50.

By the GC/builder not taking a fee during construction, it minimizes the construction costs. GC/builder would be guaranteed at sale at least the typical GC/builder fee (around 15% profit).  

But, I don't do partnerships, I contract and manage the builds myself. So the above might not be attractive to any builders.  

@Asad Shaikh - We did a similar deal with a builder charging 10% fee and the listing agent only charged 4.5% listing fee (Listing agent 1.5% and Buyer agent 3%). This way you are keeping project costs low with both bringing your expertise to the table for maximum ROI

Another thing we ran into was that some Builder line items costs also had some margin and they were making way more, apart from their fees. Its better to have an idea on construction costs per line item.

Are you going to compete with national builders in the area? As a local builder you need to provide excellent finish out in the price range so that buyer wants to go with u vs a nationally known builder.

I do agree that modern finishing costs more but there are some items like Stucco vs Brick vs Stone where the price difference are minimal.  Select appropriate features in the price range and you can still build in your budget

Keep us posted on how this goes. Good luck !!!

Originally posted by @Mike Wood :

@Asad Shaikh Modern design simply costs more, which is why it is not common on lower price points.  Do you really believe that you buyers will pay a premium, and if they are willing to pay, will the appraisers see any value?  I would say no, but you likely now your market the best.

As for the terms of your partnership, its stacked pretty heavily with the builder.  The 20% developer fee is way too much for me.  From what I see, your only saving 50% of the downpayment, but loosing out on almost $44k on profits.  Why even partner with the builder, just contract with him. 

Finally, I would be floored if you could build a modern design house for close to $100/ft2.  I just finished two duplex houses, one very modern in design, one more traditional. Similar interior finishes, the modern house cost me right around 20% more, both houses have the same square footage.

Mike, thanks for your valuable insight. Perhaps I wasn't clear with my definition of modern design- I meant a more minimalist, industrial aesthetic. I guess "modern" is a bit ambiguous a term, how do you define it?

In regards to buyers paying a premium-based on previous market studies in the specific market, we are building in-I am confident. They are paying $450k for a cookie cutter product currently, so a $25k premium on top of that for a superior product (in terms of aesthetic, features, and presentation) is achievable. Will appraisers see value? This is a concern of yours I shared, but I have studied the track record of my builder partner in other "emerging/gentrifying" markets, and he has surpassed the previous sales record in a few of these- and the properties appraised for contract price (or low appraisals were successfully contested.)

In terms of the partnership, the builder has said he will negotiate developer fee down when doing multiple jobs at once (say to 15% or so.) What percentage do you think is reasonable? I have no background in managing subcontractors, assessing the quality of workmanship, or taking a project from A to Z.  If it's in the interest of the builder to prevent cost overruns (and not overbill) to secure more partnership business, I think its a win-win. That being said, I have thought about the exact point you brought up-eg. making double the profit. I guess my focus is on building this into a longer-term partnership.

Finally on cost to build, he is ironing out specific costs and proposals for the first project as we speak. I will be happy to share anticipated cost per sq/ft with you when completed. I'm eager to see what it is projected to be, and what it comes in at once project is done.

Really enjoy the back-forth :)

Originally posted by @Pavan Sandhu :

Hey @Asad Shaikh seems like you're on the right track What are your thoughts @Scott Choppin ?

 Thanks sir. Any specific feedback or holes you can poke in my thought process or the deal I outlined?

Originally posted by @Kyle H. :

@Asad Shaikh

We have a very similar structure in place with our partner who is a real estate agent like you (we are the builders), however we are @15% for the build. We do have a LLC and partnership agreements in place for our projects and while @Mike Wood makes a very good point in regards to just hiring a builder and creating more profits for yourself there can be a high amount of value partnering in a deal like this.  Our partner had limited capital and no lending relationships and was hesitant to oversee a build project.  Our first project together has gone extremly well and we are now in the process of buying two additional parcels that will hopefully yield 7 more homes.  

In addition, to echo Mike's point about building modern, you will certainly have a higher per sq/ft build price and a smaller buyer pool.  There is a distinct reason that most modern style homes are contracted custom homes.

Kyle, thanks for bringing up a key factor! I do not have the building track record nor the ability to secure a construction loan. Let me ask a question, if I just purchased land myself and contracted the builder to build on it- who would get the construction loan? Me right?

Also, Kyle- I am trying to nail this down to specifics so I can learn more. What features of modern homes in particular drive up the price? 

Originally posted by @Vic Reddy :

@Asad Shaikh - We did a similar deal with a builder charging 10% fee and the listing agent only charged 4.5% listing fee (Listing agent 1.5% and Buyer agent 3%). This way you are keeping project costs low with both bringing your expertise to the table for maximum ROI

Another thing we ran into was that some Builder line items costs also had some margin and they were making way more, apart from their fees. Its better to have an idea on construction costs per line item.

Are you going to compete with national builders in the area? As a local builder you need to provide excellent finish out in the price range so that buyer wants to go with u vs a nationally known builder.

I do agree that modern finishing costs more but there are some items like Stucco vs Brick vs Stone where the price difference are minimal.  Select appropriate features in the price range and you can still build in your budget

Keep us posted on how this goes. Good luck !!!

Discounting the listing fee is definitely a consideration if we start doing multiple homes at once and scale this operation. Agreed.

You make a key point on the line item costs as well. What is the best resource for me to cross check with line item construction costs, so I can ensure they are not inflated? I have a few developer friends I can always talk to for advice, but beyond that?

Thankfully, the national builders are not competing in our target areas at all, at least in the single-family home space. Our main competitor is a reputable local builder. 

Here are some preliminary sketches of the product we are building for our initial project. Subject to change of course. In the next post I will share some finished product my builder partner has done.

These are the type of finishes I am referring to when I say modern. Clean lines, neutral colors, no excess, no bulky features etc. 

All photos are from the same house, a project the builder did a while back. I am just struggling to understand how these finishes are more expensive than the average?

This is a great business model, FIG does a similar thing to help investors buy multi family housing with our builder and pay much lower than retail. The biggest difference is that the investor partner is also the end Buyer. Good luck!!

Sam Newell, Real Estate Agent in UT (#6862779-SA00)

@Mike Wood .  You are correct that we don't take a fee during construction and take our fee at closing.  When we build for ourselves locally we are the investor/builder and my wife is our realtor.  This partnership I am referencing is based over an hour away in a new location for us and while we could probably take down the projects as the investor/builder our partner is on the ground finding the land and managing all of the development aspects which takes a large portion of the project startup off our plate and allows us to focus on the build.  In regards to the money, we have a lot of things going on and having additional money available from another partner and the ability to have another person co-sign on construction loans has a fairly high value.

Our ultimate goal is to no longer have to build custom homes which is where our main source of income comes from at this point and transition solely to building for ourselves (spec and rentals).  I am a pretty firm believer that it is better to have 50% of a deal than 0% of no deal. 

I am pretty sure you could find builders who would be very interested in your outline of a partnership and to be honest I would be very happy to find someone who could fill that role as investor.  Being the investor/builder in our town of 1600 we have had to wear every hat involved in the process.  Moving to a actual metropolitan area will hopefully change the game so to speak for us and open other opportunities.

@Asad Shaikh .  I would venture a guess that you would be on the hook for the construction loan.  I also think you are on the right track in finding a partner for your deal even if it means less on the back end.  I personally don't believe that a new construction project is a good first project to tackle without any previous building experience.  

In regards to the pricing of features that drive up the end cost, I will reference my personal experience and add what I can see from your renderings.  

Generally it will be more expensive to frame a modern house due to roof lines, bumpouts, and cantilivered spaces.  Roofing and siding material that are considered modern are more expensive than shingles and lap siding(most common in our area).  Speaking from experience and looking at your renderings you will have a larger budget for fixed glass windows and higher end doors, straying from stock sizes and common styles always cost more.  Interior finishes follow the same thought process, items needed to make the home not have a cookie cutter look in general will cost more.  

I like the design of your renderings, I wish you the best of luck with the project.

Here are a few pictures from a "mountain modern" spec house we are finishing up.  

Originally posted by @Sam Newell :

This is a great business model, FIG does a similar thing to help investors buy multi family housing with our builder and pay much lower than retail. The biggest difference is that the investor partner is also the end Buyer. Good luck!!

 Sam, can you dive a bit further into how they structure the deals? Who pays for land acquisition, who secures construction loan, and what is the incentive for builder to offer their product lower than retail to the investor?

Originally posted by @Kyle H. :

@Mike Wood .  You are correct that we don't take a fee during construction and take our fee at closing.  When we build for ourselves locally we are the investor/builder and my wife is our realtor.  This partnership I am referencing is based over an hour away in a new location for us and while we could probably take down the projects as the investor/builder our partner is on the ground finding the land and managing all of the development aspects which takes a large portion of the project startup off our plate and allows us to focus on the build.  In regards to the money, we have a lot of things going on and having additional money available from another partner and the ability to have another person co-sign on construction loans has a fairly high value.

Our ultimate goal is to no longer have to build custom homes which is where our main source of income comes from at this point and transition solely to building for ourselves (spec and rentals).  I am a pretty firm believer that it is better to have 50% of a deal than 0% of no deal. 

I am pretty sure you could find builders who would be very interested in your outline of a partnership and to be honest I would be very happy to find someone who could fill that role as investor.  Being the investor/builder in our town of 1600 we have had to wear every hat involved in the process.  Moving to a actual metropolitan area will hopefully change the game so to speak for us and open other opportunities.

I agree w/ the 50% of a deal statement wholeheartedly. I came into this first deal with 0 knowledge of the building process (maybe a bit of an exaggeration), but have picked up a lot of hands-on insight since then. I've worked with the City zoning counselors, urban planners etc. to ensure all our plans are to code and that we have no hiccups in the coming months. Learning how to navigate this bureaucracy with an experienced partner by my side is invaluable.   

@Pavan Sandhu   Thanks!

@Asad Shaikh

In your initial post, there are some cost items missing:

1. Development impact, school, park, and permit fees

2. Soft costs - arhcitect, strucutral, MEP engineers, soils engineering, survey and setting grade stakes. In our markets we have HERS rater costs and other new requirements like that.

In your follow on posts:

1. Simple design that looks great, straightforward framing, flat roof (sloped).

2. Can he build for $100 /ft with those cabinets, countertops and bath fixtures. The tub is beautiful. 

We are building in Los Angeles, a plain and simple rental product, at around 100 per foot. But we don't have any of the nice items, cabinets, high end tubs, etc. Just check that the builders had actually delivered recent past projects at that cost. 

3. Check the builders past LLC partnerships? Did they go well, are the people satisfied, would they do another deal with him again? Be very grounded in your assessment of him, his past historical deal performance, past build costs, etc. It's much lower cost to do that before you get LLC married, then after you in the deal.

For the rest of the post:

Reaction to the developer fee is that 20% is high. It is a small deal, so the % should be higher generally relative to the size of the deal, but not 20%. Think of it this way, what % would you have for profit on a GC contract 4-10% max. Like someone said, maybe 15% is OK. 

Who found the lot? If you did, you should get some value for that, that has value right, that took time right? Get paid for it.

Many time we build in an acquisition fee 1-3% , depends on the deal and if it can handle the additional cost of acq. fee. Sometimes you can represent the buyer (yourself and him) and get part of the listing brokers fees, but that's hit and miss. At this level, small lots, most listing brokers are hell bent on keeping all the commission. I regularly pay outside land finders 3% on the buyer's side to find me more or better land parcels.

Also, pay attention to time when you each get paid. A developer fee is usually paid right up front or drawn monthly. Your commission gets paid at the back end. What if the deal does not sell for enough and you have to reduce or eliminate your commission, he gets fee and you dont? No. Maybe have all fees paid as a priority or preferred return out of profits, that way if there is a cost reduction issue, and fees have to be reduced, you make them up as priority payment from profits, then do the splits afterwards.

You need to take into account imperfect execution scenarios, or market down turn scenarios. It's so easy to set everything up in the beginning, everyone's feeling good and the market is solid (honeymoon period), and so it's easy to give away too much profit, or allows too many fees to others, or except too much responsibility compared to the other partner.

Originally posted by @Kyle H. :

@Asad Shaikh.  I would venture a guess that you would be on the hook for the construction loan.  I also think you are on the right track in finding a partner for your deal even if it means less on the back end.  I personally don't believe that a new construction project is a good first project to tackle without any previous building experience.  

In regards to the pricing of features that drive up the end cost, I will reference my personal experience and add what I can see from your renderings.  

Generally it will be more expensive to frame a modern house due to roof lines, bumpouts, and cantilivered spaces.  Roofing and siding material that are considered modern are more expensive than shingles and lap siding(most common in our area).  Speaking from experience and looking at your renderings you will have a larger budget for fixed glass windows and higher end doors, straying from stock sizes and common styles always cost more.  Interior finishes follow the same thought process, items needed to make the home not have a cookie cutter look in general will cost more.  

I like the design of your renderings, I wish you the best of luck with the project.

Here are a few pictures from a "mountain modern" spec house we are finishing up.  

That's what I figured. I don't have the balance sheet or past experience to qualify for a construction loan, especially one at a competitive rate. My end goal is to do 5-6 of these single-family projects with this builder, create a system to maximize efficiency and marketing/sale of the end product, and then scale to larger land parcels for building "mini-communities." Then it will be time to raise outside capital.

Thanks also for your insight into what makes the modern home more expensive. I didn't know what a cantilevered space was, so I googled it- and found this article.

p.p1 {margin: 0.0px 0.0px 0.0px 0.0px; font: 12.0px 'Helvetica Neue'; color: #e4af0a}

https://www.homedit.com/20-beautiful-cantilevered-buildings-world/ (Def not cheap. LOL)

If you are comfortable, could you dive into some of the numbers on your mountain spec house? If not, maybe some general points about how you found the deal and how you decided what product to put on it?

Originally posted by @Kyle H. :

@Asad Shaikh

We have a very similar structure in place with our partner who is a real estate agent like you (we are the builders), however we are @15% for the build. We do have a LLC and partnership agreements in place for our projects and while @Mike Wood makes a very good point in regards to just hiring a builder and creating more profits for yourself there can be a high amount of value partnering in a deal like this.  Our partner had limited capital and no lending relationships and was hesitant to oversee a build project.  Our first project together has gone extremly well and we are now in the process of buying two additional parcels that will hopefully yield 7 more homes.  

In addition, to echo Mike's point about building modern, you will certainly have a higher per sq/ft build price and a smaller buyer pool.  There is a distinct reason that most modern style homes are contracted custom homes.

 Just to be clear, Kyle, when you say you are at 15% for the build, does that mean your contractor fee is 15% addition to whatever the overall rehab budget is?  Or do you mean 15% of net profit upon sale of said project?

Also, from your perspective - say I am trying to partner in a similar way with a local GC...in fact, we’ve already talked about such a partnership, and for the same reasons you said.  50% of multiple solid deals is better than 100% of no deal, and for him, same boat as you where though he has other rate/term private lenders available, it’s also nice for him to have other money available as well when needed.  Here’s my situation: I do have the ability if needed to fund the entire purchase and rehab cost up to a certain number.  However, I like to leverage, therefore would much rather use my cash as down payments for hard money/local rehab loans etc. to maximize return and also be able to do multiple deals at once.  I would still be funding the entire thing, no costs whatsoever for the contractor.  My question to you: what is your definition of net profit?  Would you calculate it only after I get paid back all my initial closing costs and carrying/interest costs?  Or do I just have to eat that cost out of my portion of the profit?

Tae C.

    @Tae C.

    I would say our arangement might be unconventional due to our structure.  Our contractor fee is based solely on construction costs (cost of build plus 15%).  Our partners commision is based on sales price.  Our agreement basically splits the contractor fee 3 ways between myself, my partner in the building company and our company overhead.  The 5% my partner and I in the building company each recieve on the build is roughly equal to the commission earned by our additional partner in the builds on the final sales price, however if our partner has both sides of the listing one half goes back to the net. 

    I am not quite sure I am interperting your question on net profit correctly, but our contractor fee, realtor commissions, building expenses, lending expenses and all other costs are deducted from gross sales price to get to our net profit which is then split three ways.  I would not want you to eat those costs out of your portion of profit, but that is just how we are set up.  The way I look at it is the project needs to be self sustaining.   Meaning if I was just an investor and finding and funding the deal, and contracting a builder and hiring an agent to sell, my project still creates a profit.  The only difference in our scenario is each partner is receiving payment for services they are rendering to the project, before profits are distributed.  

    Hope this helped, be happy to answer any other questions related to this if I was unclear.

    @Asad Shaikh   As mentioned by @Kyle H. , there is lots of items that help to drive up the cost, but for me, it was mainly the items related to the design of the house like framing, roofing, windows, doors & drywall costs.  My interior finishes (flooring, trim, cabinets, bath fixture, etc were pretty much the same costs for me). Below are exterior picks of each of my last two builds.

    They are approximately the same size, the more contemporary house is a 2/1.5 duplex at a total of 1,953ft2, the regular house is a 2/1 duplex at a total of 2,028.  The contemporary house cost me 20% more in build costs.  

    As for the builder fee, I agree that 15% of costs is a reasonable GC/builder fee.  Just to be clear, that is not 15% times the costs, but worked up as follows; builder fee ($) = build costs ($) - {build costs($)/[1-GC fee (%)]}.

    @Kyle H.

    Thanks for the clarity, exactly what I was asking.  More specifically, the lender costs is what I was wondering about.  That is one of the questions I will have for this contractor, as I am unsure if he would recognize those costs (or any other holding costs like insurance, utilities etc.) as pre-net profit.  As mentioned earlier, he typically works with rate and term private lenders that have their own cash to fund the whole thing, but he could always benefit from access to more cash.  Again, I would rather leverage and leave myself the ability of running multiple projects at once rather than tying up all my cash into one project at a time.  I’m curious to hear a bit more about how you’ve structured the agreement in terms of contractually/legally etc.  Do you mind if I direct message about the more detailed stuff?

    Tae C.

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