Attracting investors to residential development, LLC and risks

Kevin Z. · 2013-12-28T15:19:50-08:00

Looking for some tips and general advisement, especially on risks and holes in my plan. I am a realtor who wants to form an LLC with various investors whom I have not found yet. Purpose is to buy old property to demolish and build new to sell. I would serve a management role and be responsible for selling the house. Each property will require about 1.6 to 1.8 million dollars start to finish... 800k-900k purchase, 720k construction cost. Finished house normally sells for 2.4 to 2.6 million. (I know of one house this month that cost 1.6, and sold for 2.7 within 2 weeks! Obvious cheap materials usage, but still sold because buyers didn't know better ) The plan is pretty safe in my opinion, even if you couldn't make a $1 million gross profit. Finding people with cash is easy. Persuading them to invest in development is going to be much harder. How would you make a total stranger more likely to agree to invest in this strategy with other total strangers? Brandon just wrote a blog about security in investment. LLC, builder's risk insurance, nearly guaranteed profit.... is that enough security? The risk to reward ratio is low. I would be hiring a reputable general contractor. I would charge a small management fee, making most of my money off commission from sale of the home. Profits will be returned proportionally to the investors. As a realtor, obviously I don't have the cash nor can I borrow from banks, but I'd chip in $50k (drop in the bucket) just to have some skin in the game. I am hoping to make some high-net-worth people into this kind of investor. I have seen some stupid purchases recently made by these people, e.g. buying a $2.7 million old ranch house to rent out for <$4500 per month. After property taxes, they're making almost nothing! I want to convince them that there are bigger profits to be made in development. Currently, a handful of small developers are building one or two luxury homes at a time. From my mls and title research, these guys are buying old homes under an LLC, then somehow getting construction loans that cover the full cost of construction. They sell at a big profit, pay back the loan, and pocket the difference.

Bryan Hancock

Investor · Round Rock, TX · Member since 2010 · 8k+ posts · 4k+ votes

12y

What experience do you have as a developer? There are many risks that developers hedge if the project is orchestrated properly. The developer frequently provides the debt financing for projects too. If you're unable to do this it will be much harder to attract equity investors. Expensive specs like what you're talking about will almost certainly have lender requirements for development experience.

There are literally thousands of threads on BP about real estate syndication and raising equity capital. I'd suggest you read through them and get the basics down. You'll be trying to sell securities when you have several investors investing passively.

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Jeff Greenberg

Real Estate Consultant · Camarillo, CA · Member since 2010 · 2k+ posts · 1k+ votes

12y

As @Bryan Hancock mentioned you will need to in SEC territory and will need to follow the rules.

I am concerned about an attitude that I am seeing in your thread

posted by @Kevin Z. "Finished house normally sells for 2.4 to 2.6 million. (I know of one house this month that cost 1.6, and sold for 2.7 within 2 weeks! Obvious cheap materials usage, but still sold because buyers didn't know better ).

There is plenty of money to be made without taking advantage of someone.

@Kevin Z. "I have seen some stupid purchases recently made by these people,"

Calling potential investors, these people, is not the way to show respect to those that have reached a high net worth. You have just showed two ways not to reach out to potential investors.

it is our job to provide those with an interest in passive investing with an honest investment opportunity. There is no place for deception and attitude. The RE game can and should be Win-Win for all concerned.

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Kevin Z.

OP

Arcadia, CA · Member since 2013 · 5 posts · 0 votes

12y

it definitely should be win-win. I think they can do better.

There's no deception or attitude from me. I just don't sugarcoat. Should I have used a euphemism like "poor" to describe that $2.7million rental? Most people here would agree it's a poor investment with barely a 1% return.

Re: taking advantage of people...... if that's how you qualify it, that's exactly what most builders here are doing. Because I am familiar with building materials, I can immediately see the cheapness when I go to these open houses. But buyers in general don't know any better. That's just how it is.

@Bryan Hancock I have built my own house before as an owner builder. What I plan to do is very similar, but I will use a general contractor to do 99% of the work. I'm confident I can get the whole thing organized and completed if I have the money.

Your talk of syndication, debt financing, and SEC stuff seems to be on a way bigger scale than what I want to do. I just want to do 1 house at a time, with 1-4 other investors max. They will all have a vote/say in how we proceed. It's really a loosely structured group with a common goal.

It's already being done around here with people forming 2-member llc's, one partner funding the whole project with his cash or taking out a construction loan.

It doesn't have to be complicated. or does it?

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Bryan Hancock

Investor · Round Rock, TX · Member since 2010 · 8k+ posts · 4k+ votes

12y

It depends on how you structure it and how the investors are located. From the original context of your post you planned to go out and look for new, passive investors. If that is what you're planning to do then you'll undoubtedly be selling securities in the entity you create; and this will necessitate a private placement. If, however, you really do have a handful of more active investors with real voting rights in the project you may be able to get away with either a LP or some other sort of legal structure like a JV. You really need to seek the advice of an attorney familiar with securities laws.

A lot also depends on where you plan to raise the money. If the money is all raised in your state the rules will differ from raising money across state lines. Your post lacks the detail needed to give you any sort of adequate advice.

I'm not sure what your capacity is to find equity investors. From your post it seems like this will be a pretty big challenge. Even if you're able to find this capital I think your bigger challenge will be getting a construction loan for the project. I am of course assuming you won't be raising straight equity to finance the project. Again, your post lacks the detail needed to give good advice.

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Jon Holdman

Rental Property Investor · Mercer Island, WA · Member since 2008 · 22k+ posts · 14k+ votes

12y

As soon as you start pooling people's funds you've created a partnership. Period. If you get money from one person and its a loan (usually secured by the property, though that's not a requirement) then you can avoid most of the regulations regarding syndications. If a second person is willing to loan money in second position, you're probably still OK. Or, if a group of people, acting on their own with no input or assistance from you, creates their own company and that company lender you money, you're still probably OK.

But as soon as you form a company and have people invest in that company, yes, it has to be complicated.

You should absolutely never say something like this:

If you do this properly and create the private placement memorandum and LLC operating agreements that you really need to do what you want it will instead say something a lot like this:

These statements protect you if the project goes bad. Up front, you must assume it will go bad and take the necessary steps to protect yourself. If you make glowing promises and things do go bad, those promises will come back to haunt you when you end up in court.

You ask:

The ONLY way you can do this is under the limitations of the new SAFE act regulation. The old exemptions for small private placements (Regulation D, chapters 504, 505, and 506) allow you to recruit investments ONLY from people you already know. Not strangers. The new SAFE act regulation allows soliciting strangers but requires that ALL investors in your pool be accredited investors.

But I think your real question is "how to I make a case to convince people to make this investment?" Show a strong project. Show a successful track record with previous similar projects. Put in a significant chunk of your own money. So, you may have to find one person to do a loan to you on a smaller deal. A "money partner" like you mention. Do a project or two like that, build up a track record and some cash of your own and then move to bigger projects.

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Karen MargraveBusiness Member

Moderator

Realtor, General Contractor, and Developer · Redding, CA · Member since 2009 · 7k+ posts · 4k+ votes

12y

@Kevin Z. I don't want to rain on your parade, but had to respond. "the risk reward ratio is low" nothing could be further from the truth. You want to do "new construction" meaning there is NOTHING securing the investors money until it's completed. You have NO experience in developing projects. You aren't a licensed contractor, nor a construction project manager, meaning you will be dependent on others for everything except the real estate sales and listings. Without real experience you have no idea of what you are looking at, if prices are high or low, design is affordable or not, etc.

The numbers you throw out are based on nothing concrete, only assumptions, and they don't make sense. "Each property will require about 1.6 to 1.8 million dollars start to finish... 800k-900k purchase, 720k construction cost. Finished house normally sells for 2.4 to 2.6 million. (I know of one house this month that cost 1.6, and sold for 2.7 within 2 weeks! " What does that mean? Do you mean you are buying the lots for $800-900? Are there utilities, etc. to the lots, are they finished lots? Do they need curb/gutter/sidewalk? How big will the houses be? How big are the lots?

Believe it or not, developing and building projects isn't as simple as you think it is. The profits you imagine aren't there.

The question any investor is going to ask is "What experience do YOU have?" and "What value do you add to the deal" Everything on a project has value, and you have to be able to assign a number to it.

Most investors are sophisticated, and didn't have their money fall out of the sky. They aren't just lining up to hand it over to inexperienced builder/developers. Even with years of experience, being in a great area for appreciation, etc., it's hard finding people wanting to fund new construction, and we add real value. (We are licensed general and electrical contractors, draw our own architectural designs and renderings, draw site plans, manage projects, we are licensed brokers, and have real on the job experience, plus administrative experience, and 30 years experience, plus much more, etc.)

Then, if you are able to find investors, you had better have things in place to protect their investment as far as how funds are withdrawn, amount out at any given time, regular inspections, etc. Being so caviler about others money is a huge mistake. You should always have the attitude that your investors money and them being paid back is THE priority, and getting subs/materials suppliers paid, etc. comes far ahead of management fees! Get the job done on time and within budget (based on real world costs) and then if you were correct in your cost estimates, etc., (and if you're experienced you should be) you will make a good profit. But... it takes real work, it's not something to do on the side.

If you want to get into developing, learn the business! Good luck.

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Attracting investors to residential development, LLC and risks

Attracting investors to residential development, LLC and risks

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