AMA - Is Development Like a Value Add Deal?

This question comes from Kyle.

I am considering a new construction MF project. My business partner is a home builder and general contractor. Through my research on MF syndication it sounds like the majority of these deals follow the same cycle:

- Value Add Building

- Refinance once units are rehabbed to market value

- Payback investors with refi money

When it comes to new construction how does your deal cycle compare?

Thank you Kyle for a great question.

In many ways you are correct in drawing a parallel between development and a value add deal. Conceptually, they are exactly the same. But where they differ is in the details, and its in the numerous details that the traps can lie.

When it comes to development, there are just a lot of moving parts and any one of them can trip you up.

Like a value add, the goal is the same, to add value, in fact to create enough value that you can refinance the project and recover your initial investment for a long term hold with little to no cash tied up in the project.

In your classic value add project, you perform light remodeling, you add washers and dryers to the apartments, you improve the amenities, and you increase the rent accordingly.

When you move into the world of development, there are just so many moving parts. You may have to hire the engineers to design your site and prove to the city that you are not adding more runoff to the stormwater management system. You may be required to perform a traffic study to prove the existing road infrastructure can handle the increase in traffic. You may have to perform a shadow study to prove that your building won’t cast a shadow on the neighbours property. You will need to make sure the water, sewer, and utility infrastructure has the capacity to handle your project.

Will you be limited by storm water management? Will you be limited by soil stability and the strength of the soil to support the weight of the building? Will the city allow you to get a curb cut to access the property in your desired location?

Will the proximity to other properties limit your choice of building materials? Will you be required to use fire rated doors and windows?

Unless you know the answers to these questions and more, you can be facing substantial cost increases that will completely catch you by surprise.

Apart from quite a few details that can trip you up, it’s exactly the same as a value add project.

Having people on your team who know how to navigate these complexities is key to having a successful development project.

The second area of risk is in construction. Hiring an established general contractor who does large projects is essential. If you’re hiring the smaller GC’s, the ones that I call “2 guys and pickup truck”, your risk of having corners cut and failing inspections goes way up. You might pay a tiny bit more for a more established contractor, but your risk of cost over-runs goes way down. It’s also important to hire a GC who has experience in multi-family. The subcontractors who work on multi-family are completely different. The project management of the subcontractors is completely different from other forms of construction. We don’t have time to go into all those details on today’s show, but you must hire a GC who specializes in multi-family construction.

Finally, you want to hire an attorney to negotiate your construction contract, but not just any attorney. You want someone who has experience negotiating and litigating these types of contracts. These contracts can be filled with landmines and you need a specialist who can spot and correct the risks.