All Forum Posts by: Sean Jones

@Ellie Perlman You make some great points. I think what is clear though is that what one investor considers overpaying is not how every investor sees it. Saying that someone or some entity has overpaid for an asset is a subjective determination based on one (or even many) persons particular criteria, circumstances and view of the future. Every investor has different costs of capital, return requirements, risk tolerances, holding periods, tax implications, vision, information etc. Again, you touched on this with respect to foreign investment and 1031 exchanges and @Jay Hinrichs mentioned safe havens. Some people just want a safe place to preserve cash and don't care about cash on cash, IRRs or cash flow. They will be happy to break even and maybe get some asset appreciation.

I like what you put together, particularly the clear explanation of cap rates because most novice investors and even many experienced investors struggle with that concept. I just wanted to point out that the label of overpaying is a subjective one. Only in hindsight, after an investor has exited the investment could you really analyze their entire holding period and determine whether their original purchase was too high, and in some instances this could be decades or longer. 

@Randy G. I think the promissory note with your family member is fine. This would indeed be considered debt and not equity. As mentioned above by @Rick Pozos, since you already have a hard money lender in 1st lien position, your family member's interest is subordinate to that lien, and likely any potential mechanics liens placed by unpaid workers given the specific timing of this transaction with work already taking place. This of course is a non-issue when deals go well and everyone gets paid, not so much when something unexpected happens.

I also want to clarify and differentiate two concepts being discussed as the same concept on this thread, that is "interest rate" and we'll call it "return." When you say you're going to pay a certain interest rate on the money, generally that means the annual return the investor will expect on their investment. Many people above reference 7% - 10%. What that means is the investor would make $7 to $10 for every $100 invested after 12 months time. However, what you have proposed to your family member, if I'm not mistaken, is a 25% cash on cash return in a matter of 30-40 days. 

Let's say your hard money loan carries 10% interest, and someone taking a second lien position would want 25% interest (which I think is quite high) with 3 points:

Three points costs you: $20,000 x .03 = $600

Daily interest: 25% / 365 x $20,000 = $13.70

30 days: 30 x $13.70 = $411 + $600 = $1011

40 days: 40 x $13.70 = $548 + $600 = $1148

I hope this helps to illustrate what I referred to as a very healthy return of $5000 on the $20,000. It's about 5 times greater than a 25% interest rate over the same period. Even if the lender in second position required a minimum 3 months of interest, you would still be better off. 25% is still high for a second position lien, but I understand your desire to treat family differently than a hard money lender.

Happy to provide my thoughts. I view a fund as raising money to do multiple deals, so I think syndication of limited partnership or llc interests would be the likely structure for this type of deal. Entity laws and requirements vary by state, so I would defer to someone with experience in your area local area on that.

That sounds like a very healthy return for the investor considering the projected turn around. On one hand it is their first investment with you and you want to give them a good return to get them to continue to invest. On the other hand, this will also likely set a precedent for future deals on what they will expect, so keep that in mind. 

Hi Flora,

Ground up development can be very complex, but also very rewarding when done correctly. Here are some things to consider:

Find land that is already zoned for your intended use. This sounds simple, but is hugely important as you do not want to try to go through a rezoning process, just not worth the time, effort and cost on a deal of this size. As mentioned above, a local broker who sells land for development would be very helpful as they should know the local jurisdiction's regulations. General contractors may have some knowledge, but it would be more limited to building codes, not approvals for development.

In terms of cost consider the following: 

Land - apart from zoning, is it flat, sloped? Does it have utilities (water, sewer, power) close by or stubbed to the lot?

Consultants: You will need to hire an architect, civil engineer, structural engineer, and likely some other specialized consultants. The architect should have contacts to help with this if they are experienced in this product type.

Fees: Consult your local jurisdiction to find out what the development impact fees and permit fees for your project will be. This can range $20K - $50K+ per unit depending on the jurisdiction. There will also be fees associated with the review of your plans at the city. There may also be separate agencies that need to review and approve you plans such as a water district or the county, which will also have their own fees.

Construction Loan: Will you or your investors qualify for a construction loan? Lenders tend to want to lend to people with some experience in the project type being built. Construction loans are also more expensive than traditional home mortgages. 

Insurance: As a developer of new construction, you will have construction defect liability for 10 years, meaning if there are construction defects that arise during the 10-year period you will need to fix them. Will the contractor be around to fix mistakes and will their insurance cover it? This is not as important when building rental product vs. for sale units, but still something to consider.

Construction costs: To get an accurate bid for the project, you will have to have a decent set of plans prepared by the above mentioned consultants. Otherwise, a contractor will just be estimating and the cost could end up being significantly different (usually more) when they get the plans. Architects are not known for designing plans that consider cost over aesthetics. This means to get an accurate construction cost estimate you will have to spend significant money on the consultants to develop the plans.

If you can buy the land and know you can build the project for much less than you can just buy a duplex, and want to go through the above process, then go for it! In my experience, it's always more expensive than you think.

There is more to it, but that is a good overview, I think. I hope that helps answer your questions.

Hi Randy,

Is this truly a loan? Meaning, do you guaranty repayment of the principal plus the interest even if the deal doesn't make money? Or are they participating as an equity investor with the risk of losing their equity? This matters since one has very little risk and one has the risk of losing all their investment. Rates of return or interest rates should be based upon the level of risk being incurred by the person putting up the money. 

Hey Matthew, this sounds like an interesting opportunity for you. Here are my initial thoughts/questions:

Do you know the approximate value of the land and is it owned free and clear of any debt? (X - $5000) If so, you could simply have the land owner contribute the value of the and as equity into the deal and give them a percentage based on the total equity required for the deal. This as I said is a very simple way to structure it, since you would otherwise have to raise equity and or debt to purchase the property and then have holding costs until the project was fully entitled and ready to be built.

Is the land fully entitled? If it was previously approved, what is needed before you can put a shovel in the ground and who is handling that process? Do you need to re-engage consultants to finalize plans with the city? Architects, engineers etc.

Who will be liable for any debt or construction loans obtained? If the land owner is not going to be signing on any loans you should further reduce their percentage based on the added risk being taken on by you and your investors.

In any case, you should structure the actual "partnership" or entity with you as the general partner or managing member depending on your entity structure, so you have control of the operation.

@Brian Mihaljevich There has already been a lot of good information shared above. Most notably the fact that there are 18 cities plus the unincorporated county areas that make up San Diego County and each jurisdiction has their own specific guidelines on ADUs, or at the very least must follow the state guidelines.

The City of San Diego and the City of La Mesa are two that have the most generous guidelines. I have attended a few workshops and events put on by a company called Maxable Space, they are a local company helping people with everything ADU related and are very knowledgeable on the topic.

https://maxablespace.com

Also note that if you’re looking in the City of San Diego, the code refers to these units as “companion units” or “jr. companion units”.