Subdivision Development--How Much To Give Investors?

Question

I am a part of a family-run construction and real estate development company. My dad is a Civil Engineer, he and my brother are also contractors, and I am a real estate agent. We currently have the first option to buy 13.4 acres in the middle TN area, a suburb outside of Nashville, for $315,000. The property is zoned R15, so we can fit 38 lots there. The property is fairly level, but it does not have a ton of road frontage. We are going to have to cut a road through it. The after development cost (including road, water, sewer, electric, etc.) is around $18,000-$20,000 per lot, so $684,000-$760,000. We will assume the worst case of $760,000. We will be building houses in the 1500-2000 sq ft range. In our area, new construction is going for $130-$140 /sq ft. It should cost us $105-$110 /sq ft to build, which fits in with our 20% profit rule of thumb. Keep in mind that we can also "pay ourselves" to do all of the engineering, site development, construction, and real estate work.

Based on what I have shared above, let's say that we profit close to $40,000 per house. Starting in the spring (after site development is done), we plan on building the houses in bundles of 6, with hopes to complete 18 per year. With 38 houses, this comes out to a little over $1.5 Million over 2.5 years. Here is my question:

We are currently talking with an investor for the project. We would split the financing 50/50, plus we found the deal and would do all of the work. I was thinking a 60/40 split in our favor would be very fair to the investor. We might could do the project ourselves, but it would stretch us pretty thin. This person also has strong connections at the bank and could streamline the project financially. What do you all think would be a fair share for the investor?

Sean Davidson · Answer

We take 25% of the profits of our townhouse development deals, giving the money 75% of the return. We backed into that number by ensuring that our investors get at least a 33% annual return on their capital based on conservative projections. We always invest alongside our investors, in which case we just get a proportional piece of that 75%. We don't charge any additional development fees or give any preferred returns or waterfalls. Most of our investors prefer the simpler solutions. Also, remember that there is no such thing as a standard deal. Whatever two parties agree to is all that matters. That being said, if I was your equity investor, I would want rates and limits for your time to be set in the partnership agreement up front. I would want to ensure that you doing the work saved me money rather than costing me more. You want to be very careful with conflicts of interest when you are paying yourselves out of shared funds. Hope that helps.

Dereck Ho · Answer

@Joshua Fann,Came across this thread - seems like the types of projects we find ourselves in lately. Would be interested in hearing more how this deal is panning out!

JD Martin · Answer

My suggestion: go back and listen to @Jay Hinrichs' podcast and see which side he suggests should get the bulk of the cut. The people putting up the cash should always get the best part of the deal, because they hold all the risk. So you might suggest reversing that split or even enhancing it further. Put another way: developments are risky, even in hot areas. They fail all the time. If I was investing in your project, and I was putting up all/most of the cash, without any collateral, I would want better than an even split for my risk. And you're actually getting paid twice, because you're getting your investment plus your labor, which may or may not be better than market rates.Alternatively, I might suggest we form an LLC together for the purposes of the project, and then split normally, but at the same time bid out everything including your services.

David Miller · Answer

Is the 20% fee off the top in addition to what you pay yourselves to do all of the engineering, site development, construction, and real estate work?

Joshua Fann · Answer

@Sean Davidson I appreciate your input! We're basically looking at doing something similar, except taking a 20% fee off the top, then splitting the remaining 80% proportional to what each party put in. Since we each are putting in half, then we would split that evenly (40% each which adds up to the 80%). That 40% plus our 20% fee is where I came up with the 60/40 split. We've done work for this person in the past, but you are correct--we need to document everything carefully with the potential conflict of interest. @Jay Hinrichs The banker I spoke with probably misspoke and meant 75% Loan to Cost rather than Loan to Value, as I would agree with you. That 75% Loan to Cost would leave us with 25% of $760,000, which puts as at a $190,000 down payment that the two parties would split evenly. If we put all the profits from each house into paying for the land, then the break-even-point comes at 14-16 houses depending on taxes at end of the first year and if any emergency draws are needed out of the profits. Thank you for your input Jay! I may contact you with more questions if that is okay. I know that most deals always look the best the first time you look at them. Hopefully this one will continue to look pretty good.

Jay Hinrichs · Answer

It may work that way for you.. but in land development I would be shocked if the loan committee at that bank allowed 100% or 90% LTC.... out our way and what I do in Charleston I always need at least 30% cash equity.. plus I want it in there any way so I have a cushion.then my bank will want accelerated paydown on the lots.. IE last 10 to 15 lots would be free and clear. I like that too because those are nice big fat proceeds checks they feel good.

Joshua Fann · Answer

@Jay Hinrichs Well Jay I hate to sound uninformed, but I'm not 100% sure on the cash yet. See the bank will loan up to 75% on the land's appraised value after developments. The after development value should be well over $1 Million. Let's pretend it is exactly $1 Million, then 75% of that is $750,000, which is the cost of the development. By that logic, we wouldn't need a down payment at all. It usually works that way on our construction loans, I'm just not sure if it works that way on land development because we haven't done one this big yet. For the sake of the argument, let's say we each put down $75,000 cash for a down payment (we split all costs 50/50). What would you expect as an investor in this kind of deal?And yes, we were pretty happy to find this one. In this area the median home is about $180k, but since Nashville keeps pumping that figure goes up everyday.

Jay Hinrichs · Answer

plus your lucky we pay 40 to 45k per lot to do infrastructure out our way.. we are usually in the dirt close to 100k before we can do a dig out.. ergo NO house anymore in the NW that is new can sell for under 300k and pretty much 400k these days.

Jay Hinrichs · Answer

what is the investor putting in and how much cash are you guys putting in.. that's the question. always good to have partners in case you need to punt or hold..