ARTICLE 2 of 4
In the last article we introduced this series for families who might be considering investing land or money in real estate development. We started with a story that didn’t turn out well, but hope these articles will help families avoid that type of outcome as well as other common pitfalls.
We will address what questions to ask, how to vet the developer, and how to match their appetite for risk to different possible deal types and what your risk tolerance may be. Today’s chapter will focus on how these development opportunities arise and things you should consider in advance.
So how do “development deals” come about?
- You might be selling a property and the buyer asks if you would consider joining their deal by contributing your land instead.
- A knock on the door from a developer or broker. If you have a site in the path of progress, this may have already happened to you, even if you haven’t yet considered development.
- A developer may be referred to you by an attorney, CPA, banker, personal friend, or colleague.
- You may decide on your own to develop your site, and may be looking for a developer to lead the project.
Are we ready to start talking about developing our property?
Before you get the knock or call, it is best to know how you might reply. Think about why you would want to change course from how your current property investment is handled. Perhaps you’re tired of “feeding” a piece of raw land by paying taxes and insurance with no cash return. Or maybe your land bet has paid off, the value has grown significantly, and it’s time to harvest the reward. Or perhaps the income generated by the current building or property use is stagnant whereas property tax increases have reduced the net return.
If any of these scenarios sound familiar, we suggest you consider the following:
- Do you have financial needs that require monetizing the value of the property? Do you need cash sooner than later? What is the timing of those needs? Depending on the type of property and where it is located, the development timeline can be lengthy…up to 5+years.
- What is your appetite for risk? Just like when investing in stocks or bonds, where you put your money depends in part on how comfortable you are with risk and the return trade-offs. We’ll discuss the many risks in a future article.
- You might have a legacy site or building that you want to retain ownership of, but which has a higher and better use if redeveloped. For example, a mobile-home park along a major arterial or a small commercial building now surrounded by mid-rise apartments or office buildings. Perhaps you don’t have the skills or capital to do it yourself and an experienced partner is needed.
For properties currently producing income, you should have a “keep vs sale” analysis prepared. Basically, this looks at the return you are earning on your current asset (“keep the property as is”) vs. what you might achieve in the next opportunity, be that a joint development opportunity or sale. The “keep as is” becomes the minimum rate of return you would accept since you are already earning it. But is it sufficient for your goals? Does it make sense to change course?
- How does this property fit into the overall portfolio? Is it a major component or a small piece? If it has been but was to not produce income for several years, how would this impact the portfolio and its purpose?
- If you have partners in the property, are you aligned on future plans for it? Do you all share the same risk appetite? Can everyone leave their equity in the project for several years?
- Depending on your real estate sophistication, do you have a competent team and/or advisors to assist you in this process?
Knowing the answers to the above questions will provide a valuable foundation before continuing discussions with developers.
OK – we’re ready to talk to a developer – what else should we know?
Before discussing these questions in more detail, there is one term you should know, if you don’t already: “joint venture”, also known as a “JV”. You will hear this term a lot, as in, “Would you like to put your land in a joint venture?”, etc. Basically, a joint venture is a partnership where one or more parties invest land or money jointly with a developer for the purpose of developing and selling a property. It usually implies an “in and out” deal structure and not a long-term hold, although anything is possible. There are many ways of structuring a joint venture, but some standard rules of thumb apply, which will be discussed in a future article.
One of the most critical items when considering to invest in a joint venture is knowing who the developer is. You are betting on their experience, development plan, reputation, and connections. We’ll discuss how to vet that party in the next article.
These articles are written in conjunction with Laura Bachman. Laura is a long time real estate professional in the Greater Seattle Area. Her work centers on taking properties through the design, permitting and construction phases of development on behalf of both private property owners and for commercial developers. Laura brings both an attention to detail as well as a background in finance to each building she brings to life. The extensive list of projects she has worked on can be found at: www.bachman-group.com.