DEAL STRUCTURES in Ground-Up Development w/ Fees
What's the right structure to setup between you, the General Partner (GP) and your Capital Partners (LPs)?
https://twitter.com/ArtemTepler/status/1616864666462072833?s=20
DEAL STRUCTURES in Ground-Up Development
What's the right structure to setup between you, the General Partner (GP) and your Capital Partners (LPs)?
50/50
60/40
65/35
70/30
75/25
80/20
There are many ways to structure deals. When we started, we didn't really know any of them.
We started with a simple: "We'll build the project and split the upside with you 50/50, no GC fees, no developer fees, our interests are completely aligned, we don't make money until you do".
I would NOT do this again. This is not a way to grow a GP platform. To grow a business, to hire staff, the business needs revenue, and when the only money you make is equity, it is not a sustainable way to build a business.
We did a few ground-up buildings on a straight 50/50 split with no fees, we thought we'd get our income from home flipping, but that was not sustainable as the returns in that business compressed.
We also started getting pushback from people wanting to earn a "Pref Return."
So then we started offering a 6% pref return on our 50/50 deals, and one fee, a 6% GC fee. This is where we are today for most of our under $30m deals.
We do not charge a developer fee on 50/50 deals.
If we get pushback and some family offices want to apply a standard 70/30 split or something in that range, then we'll apply all the typical fees of a ground up development project: This will include a GC Fee and Developer Fee and Asset Management Fee.
A typical developer fee is either 5% of Hard Costs or 3-4% of the Total Cost of the project.
As time went on, the more sophisticated our potential investors became, the more pushback we got on our 50/50 splits. Sophisticated investors all wanted to apply institutional terms such as 70/30 or 80/20 on sub institutional deals.
In our view, applying institutional investors terms on sub-institutional deals is not worth the effort, the actual $ amt is too small for all that work, and risk. We provide personal guarantees on our construction loans, institutional developers typically don't.
We typically tried to hit 2x Equity Multiple (EM) deal level with 1.5x net going to our LPs. Now we'll adjust the split for our LPs to hit a 1.5x equity on the pro-forma, which typically turns out to 14-16% IRR, if we were to sell.
Our goal is not to sell in LA, it's to refinance and provide a high Cash On Cash (CoC) for our capital partners.
After the development portion is over, we are essentially "buying our own 4 cap", and we can't do that with 6-8 pref money.
So, what we do is either make the pref drop down to the rate of the first mortgage or run the deal through a "promote crystallization." (see Crystallization post)
A few of our latest projects we did not hit 2x deal level, so my partner and I adjusted
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our split down and took less ourselves for LPs to get the 1.5x we had on the pro-forma.
We have not yet, made anything less than 1.5x for our LPs
Where we are today, is focusing on doing institutional deals with institutional terms, and doing our smaller deals where we can hit a 1.5x EM to our LPs, we adjust the splits accordingly, with initial split being 50/50.
What are institutional terms for ground up development?
There are many as well, but this is what we THINK a “fair” one looks like:
(**Some institutions will never let it go to 50/50 over a 20%, maybe max 60/40, some will)
Schon Tepler Partners - JV LP Equity Terms & Fees
Equity Commitment: 95% LP Investors (“LP”) / 5% Schon Tepler Partners (“STP” together with “LP” will be referred to as “All Members”).
• Distributions: Cash flows to the JV would be distributed as follows:
o First, 100% Return the capital invested by both “All Members” pro rata per their respective capital accounts (excluding any Preferred Equity)
o Second, 100% to STP until it receives 100% of certain cost overruns funded by STP or an affiliate.
o Third, Pro rata to “All Members” until “All Members” have achieved a 10% internal rate of return on its investment.
o Forth, 80% to All Members and 20% to STP until All Members have achieved a 15% internal rate of return on its capital contributions (excluding any Preferred Equity);
o Fifth, 70% to All Members and 30% to STP until All Members have achieved a 20% internal rate of return on its capital contributions (excluding any Preferred Equity);
o Thereafter, 50% to All Members and 50% to STP
FEEs:
CM Fee: 1.5-2% of Hard Cost (Construction Management)
Asset Management & Prop Management Fees: 4% combined ( could be 3% PM, 1 % AM or 2.5% PM /1.5% AM)
Dev Fee: 3% of Total Costs or 4%-5% of Hard Costs or 4-5% of Hard and Soft Costs
Ideal: 20% of the Dev Fee will be paid at construction loan funding, with the remainder to be paid monthly during construction as % of project completion.
Cost Overruns
STP will contribute the first 100% of cost overruns that are equal up to ½ of the Dev Fee to the project as a member loan or preferred equity by STP at 10%. Any cost overrun above ½ of the developer fees will be contributed on a pro-rata basis.