Attractive ROI for private lender on neighborhood development?

Question

Hi all - we are currently submitting plans to the city to start our 2nd neighborhood development. Our first one was in 2015 and is now complete, showing investors a track record of success. At the time, we had no track record and had to give away a lot of equity in the project in order to secure a private lender. Now that we know what we're doing, we'd like to ask for private money at a fixed rate of return and little to no equity. My question is, what is an attractive ROI for a private lender to lend up to $3MM on a 1 year term, collateralized on the land and improvements?

Neil Goradia · Answer

Thanks again for all the comments.

@Rick Pozos, 100%... definitely didn't want to make it sound like I'm a wizard. That's the thing with real estate, no matter how long your career has been, you're always learning something new.

At the same time, our first project was very challenging in many aspects (very political with the city council, wetlands, neighbors remonstrating, construction cutting across an existing neighborhood, extending water main under a state highway, etc) and I believe the only reason we were still successful at it was because we had the right team in place. Our core team is composed of all engineers by trade, many of whom had done development in their day jobs for years but just not on their own. So we did our own surveying, engineering design, city submittal, and construction management...all in house. :)

I also tend to agree that at our early stage we may need to offer something in between 8-15%, maybe closer to 10-12%. What that exact percentage is will depend on a few factors that I'm honing in on now. Thanks again for your insight.

Rick Pozos · Answer

Hey @Neil Goradia I dont want to sound mean, but doing 1 project does not make you a superstar. I am sure that you have learned quite a bit and this next project will be much smoother. BUT there are probably more issues that can come up that maybe just didnt happen on your first project.

There are also many factors that are beyond your control that can affect your project.

The economy is at its best right now. But how are things going to look in 6 months, 1 year or 2 years?? That is the risky part of the equation. Yield curve inversion. Tarriff war. Weak Euro economy.

Most people who got to where they have 500k or 3MM are not going to be good with 6 to 8% and let you make all the money. They are going to want equity. If they are 100% of the reason that you will be able to get the project completed, it goes to show that they deserve equity. I think 15% return is what most people will want for a risky venture of developing land.

Jay Hinrichs · Answer

wow that's incredible  to bring in big dollars like that for such a small return in a junior position..  well played and I assume this can only happen with extensive background and track record.. someone doing their second deal may spend a LOOOONG time finding that kind of money.

Greg Dickerson · Answer

Jay - no different than a private lender.They do not get equity. There are plenty of investors that are happy to receive a straight preferred return no equity. It’s all in how you approach it. Most people aren’t even aware of the equity model. I almost never give up equity on my deals but I have a long history and track record.

By the way I said 6-8% not 6. It all depends on the operator, the project and current rate environment and what the investors are getting from banks etc. could be as much as 10-12 if rates were higher.

Jay Hinrichs · Answer

Greg you mean 6 to 8 % pref PLUS Equity in the deal right  Not hey I need 3 million to do this deal and I will pay you 6% interest and that is all you get.. I mean in this market first position secured lenders get more than 6%  can you clarify.. ?? I think U left the OP with the idea that now he is experienced he could raise 3 mil in equity and only pay 6% total apr on those funds..

Neil Goradia · Answer

Ah yes, this is indeed what we did with the bank on the first development. Thanks again for your guidance!

Greg Dickerson · Answer

Typically the bank will want to keep all the money for each lot sold until they get there money back. As you know developers can negotiate a release fee so a portion of the proceeds from each lot sale can go to them as profit. Instead of taking profits you could use it to pay down the equity so the interest cost is reduced.

Neil Goradia · Answer

@Greg Dickerson wow, that's a lot lower than I thought. Could you explain the equity release part, I didn't quite understand that.

Greg Dickerson · Answer

@Neil Goradia you should be able to raise that 6-8% preferred return easy given your track record and time frame. I would also negotiate equity release percentage with the lender as well to insure that the equity is paid off quickly.