Investing with Developers

[Paula Schafer]

Hi there:

I'm looking into investing with developers in a real estate project as a limited

partner. This is my first time - what should I be looking for? What questions should I be asking? I need education in this area. I appreciate any advise from seasoned investors and developers. Thank you.

Paula

[John Blackman]

Hi Paula,

There are a few I would ask.  First off I would look for track record.  Do they have a history of previous successes in the market they are planning to build in?  Have them give you a tour of their completed and in progress projects.

1 - Look at the books.  Do they have a detailed accounting of their budget?  Are there receipts for everything?  Do they have a separate QB file or equivalent for each project?  Will they show you these books without hesitation? 

2 - Transparency.  What are their reporting practices?  Do they sent out status reports?  Do you have access to all of their documentation?  Ask if you can see a file from their previous project.  The truth is in the accounting.

3 - Process.  How do they run their business?  Do they have well defined processes and schedules?  Do they keep a schedule for each project?  How has their past performance matched up to their target schedule?  A good developer will have these well defined so all they have to do is just follow the checklist.  It's even better if they have a sign-off process for each item in the checklist so there is some accountability for each step.

4 - Fees. Is the developer taking a management fee or are they paid based on performance?  I don't like cost plus structures because the GC gets paid more if you use gold paint which doesn't take any extra management.  Fees should be based on real management overhead.  The best kind of fees are none at all, so you are both on the same side of the table and you both get paid based on how much money the project makes.

5- Title.  Be on it if you can.  Some developers may not want you on title, but if you are then you have to sign when you sell the property.  This allows you to have some say in the price.  When selling a spec home though, I suggest speed of sale over maximizing your profit.  A sitting house is loosing money not only in interest but opportunity cost.  I like to be the cheapest new house in the zip code if I can still hit my margin target.

6 - Skin in the game.  How much of the developer's cash is going into the project?  Who is signing for the loan, assuming it is a recourse loan.

7 - Overruns.  When you have them, who is going to pay for them and in what ratio?  To keep these as bay I would pad your budget with plenty of contingency.  However, even the best laid plans don't work out, so prepare for what to do when you need more money and who is going to put it up.  Do not go back to the bank to increase the loan.  This will just end in despair, madness, and agony.

If you explore all of the above topics with your developer, it should produce plenty of very constructive conversations that should give you a good idea of whether or not to move forward.