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?

[Account Closed]

I wanted to thank everyone on this thread again for the great insight and input.

After further thought and discussions with my lender, partner and builder, I've decided to pass on this deal.  In the end, I decided taking on $750,000 of recourse to make $40,000 was not worth it.  Granted, the project may go well and everyone involved make good money, but it didn't feel like the right structure for me at the end of the day.

I have a lot of real estate development and acquisitions experience and while I've never specifically built a spec home, the education was not worth the risk in my opinion.  Without getting into too many personal details, it came down to the fact that I make a very good living in my day job (multifamily acquisitions for an investment fund), was offered an opportunity to be a partner on a large apartment complex deal I put together for my company in Nashville and allocated a good chunk of my equity towards that, and the fact that I've realized at this point in my career while I am still building up, I am not comfortable putting myself in a position where any one deal can wipe me out.  In the end, it didn't make sense to me to leverage everything I've built up over the past few years on one deal where I might make $40,000.

One of the main things from this thread that stuck in my head was @Kenneth Bell saying I could make similar profits by taking on a much smaller deal with less downside risk.  I've looked at some entry level housing in my city and run numbers and he was right.  I'm now looking at doing a flip project where I can cover my downside pretty easily.   Going upside down on the $750,000 on the spec deal that was intended to be a "side project" would have sunk me at this point in my career. Down the road, I will take on those larger deals, but not until I have greater means to protect my downside.  

Regardless, this is has been a fantastic learning experience on many fronts.  Thanks again to all!

@Lynn Currie @Douglas Dowell @J Scott @Account Closed