Joint Venture Partnership Structure With A Builder: Thoughts?

[Asad Shaikh]

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. 

[Scott Choppin]

@Pavan SandhuThanks!

@Pavan Sandhu@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.