$5M Construction Project :confused

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FD234
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$5M Construction Project :confused

Post by FD234 »

Town house construction project - A friend of mine approached me with this proposal. Buy permit/utility approved (shovel ready) land and build townhomes. Sell them at profit. Property is in SoCal. 15-18 month timeline. He is the active partner and I am silent partner. He doesn't expect me to be actively involved in the day to day work.

$1M for payment towards buying land (split between friend and me, he is putting down half of the downpayment). Rest of the money for land and construction is taken as a loan (from private lender).
Rough math -
Cost of Land - $1.8M
Construction cost - $1.7M
Other costs (Finance/Realtor) - $0.5M
less Sale price of 4 houses = $5M (comps are $1.2-1.3M/house in today's price)
= $1M profit

Active friend takes 20% from net-profit as fees and splits the rest. I trust my friend to execute and finish construction.

Questions -
1. Not sure on how to think of the risk I am taking here. Is there a good analogy/example that can help with perspective
2. I'm seriously considering to invest. What would you do and why?
3. How should I think of risks here. What risks am I missing. Risks I can think of
a. Project execution - Will project go as planned
b. Market 15-18 months from now. Interest rates, hot market
c. Unanticipated construction costs
4. If the project goes bad, I am looking at loosing all of my downpayment right
5. Assuming successful completion of the project, what other risks should I be prepared for (lawsuit etc)

I never invested in anything like this. I am a BH (75/25, Equity/Bond). I am hoping for constructive feedback.

Edit - I should clarify that I asked my friend to tell me the next time he has an opportunity.
This money is from inheritance I recently got (which is not in the 75/25) above.
I am putting $500K and my friend $500K and financing rest of costs. He is open to me putting less than $500K.
Last edited by FD234 on Wed May 12, 2021 10:47 pm, edited 2 times in total.
BillWalters
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Re: $5M Construction Project :confused

Post by BillWalters »

What is the developers experience? Are costs locked in (materials, contractor, etc)? Who guarantees debt? What if more capital is needed? Do you get a preferred return on your investment?

I would run.
txgolfer_19
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Re: $5M Construction Project :confused

Post by txgolfer_19 »

What happens if the townhomes don't sell? Who is covering the ongoing interest on the loan? What if they sell for much less than planned and there is loss on the project--how are the losses split up? Are you on the hook for the loan? You need a written contract with your friend to cover the numerous issues that could arise--you'll need separate attorneys for this.

If it were as easy as he says it is, the land would already be bought up or the person who owns it would be doing what your friend is proposing.
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ResearchMed
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Re: $5M Construction Project :confused

Post by ResearchMed »

Who is the 'private lender"?
Terms of loan? Deadlines for repayment?

Why is he not getting (or able to get) conventional financing?

And VERY importantly, what percent of your net worth - and separately, your liquid holdings - does this involve?
How would you fare if you lose it all (not to mention any possible lawsuit... are you both getting all of the appropriate business protections, etc.)?

NOT a good idea if you've never done anything like this before (like complete renovation of a home, to understand how it works, or doesn't...).
And... probably not a good idea anyway, unless you've got money to lose.
Again, why does he need *your* money if this is such a good plan?

RM
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Normchad
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Re: $5M Construction Project :confused

Post by Normchad »

What is your friends motivation for letting you in on this deal? Why wouldn’t he do this without you and keep all the money for himself?

As written, it just sounds like he’s giving you a half million for no reason.
LivingTheDream
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Re: $5M Construction Project :confused

Post by LivingTheDream »

FD234 wrote: Wed May 12, 2021 8:06 pm Town house construction project - A friend of mine approached me with this proposal. Buy permit/utility approved (shovel ready) land and build townhomes. Sell them at profit. Property is in SoCal. 15-18 month timeline. He is the active partner and I am silent partner. He doesn't expect me to be actively involved in the day to day work.

$1M for payment towards buying land (split between friend and me, he is putting down half of the downpayment). Rest of the money for land and construction is taken as a loan (from private lender).
Rough math -
Cost of Land - $1.8M
Construction cost - $1.7M
Other costs (Finance/Realtor) - $0.5M
less Sale price of 4 houses = $5M (comps are $1.2-1.3M/house in today's price)
= $1M profit

Active friend takes 20% from net-profit as fees and splits the rest. I trust my friend to execute and finish construction.

Questions -
1. Not sure on how to think of the risk I am taking here. Is there a good analogy/example that can help with perspective
2. I'm seriously considering to invest. What would you do and why?
3. How should I think of risks here. What risks am I missing. Risks I can think of
a. Project execution - Will project go as planned
b. Market 15-18 months from now. Interest rates, hot market
c. Unanticipated construction costs
4. If the project goes bad, I am looking at loosing all of my downpayment right
5. Assuming successful completion of the project, what other risks should I be prepared for (lawsuit etc)

I never invested in anything like this. I am a BH (75/25, Equity/Bond). I am hoping for constructive feedback.
I've worked for a construction company (low-level & long time ago), so I have a few opinions. Off the top of my head...
  • carrying costs can make or break this type of project, & can be significant depending on financing terms
  • timing... many things can delay this project (adding to carrying costs), but hard to know how optimistic your timeline is
  • same as above regarding budget
  • re: your #4, I would think downside could be much more than just down payment (total costs, including financing obligations)
  • corporate structure? LLC, partnership, etc
  • I assume that your budget includes significant insurance to cover your #5
  • today's market ($1.2M) could soften over the next 15 months
Re: your "what would you do & why", if I was convinced that my partner was EXPERT in construction management AND I thought the budget/timeline included a large buffer, I would do it (although I would insist on a certain level of personal involvement... trust, but verify)
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Watty
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Re: $5M Construction Project :confused

Post by Watty »

FD234 wrote: Wed May 12, 2021 8:06 pm 4. If the project goes bad, I am looking at loosing all of my downpayment right
Of course you are. :oops:

Not only that but in some situations it is conceivable that creditors could come after you for more money and not only would you be at risk for that but you could be involved in lawsuits and paying lots of legal fees for years. Even if they do not have a strong case for getting more money from you there will still be significant legal fees to defend yourself.

If you proceed with this be sure to get a lawyer before you sign anything to make sure that you will not be liable for any more than your investment.
FD234 wrote: Wed May 12, 2021 8:06 pm 3. How should I think of risks here. What risks am I missing. ....
One risk you may be missing is what will happen to the project if something happens like your friend is hit by the proverbial Mack truck or has a stroke.

It was a different situation but a couple of years ago there was a post by someone who was having a custom house built. They had a great contractor who was doing a great job until he unexpectedly died because of something like a heart attack or car crash. All the sudden the project went into limbo with the house half built and there were lots of loose ends with unpaid suppliers and contractors. The building loan was also a mess. There may have also been a problem with the building permits that the contractor had not being valid for anyone else who took over the project. They could also not find another contractor to take over the project because of all the problems and liability. I never heard how that turned out.
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StevieG72
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Re: $5M Construction Project :confused

Post by StevieG72 »

I would pass, since I don’t know what I don’t know.

Construction costs seem low, how many units?

Seems like the standard expectation for construction projects is for it to take longer and cost more than anticipated.

Interested in what Sandtrap has to say, hopefully he will chime in.
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helloeveryone
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Re: $5M Construction Project :confused

Post by helloeveryone »

run

run

run


if you are a BH investor where is this $500,000 sitting around that you can now “invest” it by going 50:50 with a friend in a real estate/developer type deal that you have zero experience in.

Don’t potentially ruin a friendship by entering into a deal like this. Just say you really can’t part with the money at this time or ever. If he gets pushy just say you are really on track financially and don’t need take this risk. You’re satisfied with average market return.

A real friend will respect your decision to say no.

Also i would think if you go in 50:50 you are on the hook for 50% of debt
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Silly Wabbit
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Re: $5M Construction Project :confused

Post by Silly Wabbit »

txgolfer_19 wrote: Wed May 12, 2021 8:20 pm What happens if the townhomes don't sell? Who is covering the ongoing interest on the loan? What if they sell for much less than planned and there is loss on the project--how are the losses split up? Are you on the hook for the loan? You need a written contract with your friend to cover the numerous issues that could arise--you'll need separate attorneys for this.

If it were as easy as he says it is, the land would already be bought up or the person who owns it would be doing what your friend is proposing.
Classic. "That couldn't possibly be a $100 bill on the floor, someone else would have picked it up already!" It has gotta be someone, right?

Of course it's not trivial, and it comes with risks. Everything worthwhile does.
Last edited by Silly Wabbit on Wed May 12, 2021 10:02 pm, edited 1 time in total.
txgolfer_19
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Re: $5M Construction Project :confused

Post by txgolfer_19 »

Silly Wabbit wrote: Wed May 12, 2021 9:26 pm [quote=txgolfer_19 post_id=6003602 time=<a href="tel:1620868855">1620868855</a> user_id=161362]
What happens if the townhomes don't sell? Who is covering the ongoing interest on the loan? What if they sell for much less than planned and there is loss on the project--how are the losses split up? Are you on the hook for the loan? You need a written contract with your friend to cover the numerous issues that could arise--you'll need separate attorneys for this.

If it were as easy as he says it is, the land would already be bought up or the person who owns it would be doing what your friend is proposing.
Classic thinking. "That couldn't possibly be $100 bill on the floor, someone else would have picked it up already!" It has gotta be someone, right?

Of course it's not trivial, and it comes with risks.
[/quote]

Except in this situation, the $100 bill is already in the current owner’s pocket...nice try though.
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unclescrooge
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Re: $5M Construction Project :confused

Post by unclescrooge »

This can be done profitably.

However, there is a substantial risk of complete loss of capital.

During the last cycle, I invested $25k into two development projects.

In one, the developer had a heart attack and died, resulting in complete loss of capital.

In another, the market turned and the lenders pulled financing half way through the project. The project went belly up. Again, complete loss of capital.

I would never risk more than 10% of investible assets in risky ventures.
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Sandtrap
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Re: $5M Construction Project :confused

Post by Sandtrap »

FD234 wrote: Wed May 12, 2021 8:06 pm Town house construction project - A friend of mine approached me with this proposal. Buy permit/utility approved (shovel ready) land and build townhomes. Sell them at profit. Property is in SoCal. 15-18 month timeline. He is the active partner and I am silent partner. He doesn't expect me to be actively involved in the day to day work.

$1M for payment towards buying land (split between friend and me, he is putting down half of the downpayment). Rest of the money for land and construction is taken as a loan (from private lender).
Rough math -
Cost of Land - $1.8M
Construction cost - $1.7M
Other costs (Finance/Realtor) - $0.5M
less Sale price of 4 houses = $5M (comps are $1.2-1.3M/house in today's price)
= $1M profit

Active friend takes 20% from net-profit as fees and splits the rest. I trust my friend to execute and finish construction.

Questions -
1. Not sure on how to think of the risk I am taking here. Is there a good analogy/example that can help with perspective
2. I'm seriously considering to invest. What would you do and why?
3. How should I think of risks here. What risks am I missing. Risks I can think of
a. Project execution - Will project go as planned
b. Market 15-18 months from now. Interest rates, hot market
c. Unanticipated construction costs
4. If the project goes bad, I am looking at loosing all of my downpayment right
5. Assuming successful completion of the project, what other risks should I be prepared for (lawsuit etc)

I never invested in anything like this. I am a BH (75/25, Equity/Bond). I am hoping for constructive feedback.

Edit - I should clarify that I asked my friend to tell me the next time he has an opportunity.
This money is from inheritance I recently got (which is not in the 75/25) above.
Clarifications:
A. "friend puts in 1 mil. (in cash, in what account?). = half of "down payment". . correct?
B. "you put in 1 mil. (in cash in what account under who's control?) = half the "down payment". . correct?
C. Projected total project cost is 5 million. . .correct?
D. Private lender puts in 3 million to complete the needed total project cost. . correct?
E. Who is the "private lender"?
F. Is the "private lender" experienced with Real Estate Development and has a history of successful 5-50 million projects, and can prove it with financial statements?
G. Is the "friend" experienced with " . . . . . . ". . . and has a successful track record and can prove it with financial statements?
H. If the property is purchased, the cost over runs and delays push construction costs far beyond projected with no end in sight. Who covers the overage?
I. If the construction companies, suppliers, and subcontractors, etc, are not paid or paid late due to cost over runs, permit and inspection delays, zoning things, etc, who is liable?
J. Is there a limitation to your liability for anything that happens on the construction site, unpaid suppliers and contractors, etc?
K. If this project is an awesome project, how come a large R/E Development company hasn't snapped it up already?

What is assured 99% of the time in R/E Development:
A. It will take far longer than projected.
B. It will cost far more than projected.
C. There are more "cans of worms", "land mines", and "quick sand pits" than all but the most seasoned developers can predict.
D. There are more unpredictables that nobody can predict, the larger the project, the higher the dollars, the longer the project to completion and final certificates of occupancy and permit close outs, etc.

To your questions:
1. "C" above.
2. Why are you seriously considering doing this? Really. Why?
2b. Yes. I have done this by myself as a GC. and R/E Developer for projects smaller and much larger. And, so forth, and so forth.
2c. Would I do what you're proposing if I were you on the basis of the info that you've given. No. (not even maybe).
3. Yes. What you have listed times 1000 more. (plus stress and grey hairs and a receding hairline).
4. Yes. And, sometimes 1000 times more. Everything you have, own, and more.
5. Seek your own legal counsel before doing this. (vital).

Real life examples I have experienced in my own company or others related to my company.
1. Height of condo market. Empty land purchased in a prime high end hcol area. Architects and all that hired. 20 story high rise planned and under construction. By the time the project was completed, pre sales (very important) were not as expected so the loan carry was much higher, and the market cooled down significantly. Worked hard to sell the completed half empty condo building to a large corporation for 80% of what was put into the project.
2. Empty land purchased to develop a luxury custom home with a 180 degree view of the entire shoreline below. Perfect views. Heigh of the market. Sitework chewed up 1/3 of the projected funds. Rain delays were terrible. Contractors bailed due to tough site work conditions. The lot was build ready and in perfect condition. 10 acres. Market cooled. Worked hard to sell the developed but unbuilt property for project cost to break even.
3. Townhouse development. 30 units. things happened. . . . broke even. . happy to get out with that. . . .

* And, the above examples with highly experienced R/E developers and project teams with a long history of success.
So, there's luck and timing and bad luck and bad timing that can't be put in a spreadsheet or projected. It happens often.

* OTOH: these things can indeed do fantastic and the first one becomes a steppingstone to a fun long ride to, sometimes, substantial wealth and a rewarding business. So, that happens as well.

I hope this is helpful to you.
PM me as you wish.
Retired R/E Developer, etc. (IMHO: based on actual experience).
j :D
Last edited by Sandtrap on Fri May 14, 2021 7:07 am, edited 1 time in total.
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chassis
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Re: $5M Construction Project :confused

Post by chassis »

Aren't Bogleheads strictly 3 fund investors? Low cost index funds, to be clear about it. Investing in illiquid real estate projects seems far from the koolaid passed around in bogleland.

If I were you I would ask for a written prospectus, or a reasonable facsimile. I would want to know the terms and conditions. I would want to know if I invest $xx, what do I receive ($yy) and when do I receive it?
Grt2bOutdoors
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Re: $5M Construction Project :confused

Post by Grt2bOutdoors »

You won the lottery, congratulations (my condolences on your loss, it's an inheritance). They say money is fungible, but consider if you had NOT inherited this money, if you had actually worked for it through your labor and you know your friend is successful in this line of work, would you consider such an "opportunity"? They say most lottery winners lose all of their good fortune through investments (usually going into a business they know absolutely nothing about, but also giving money away and accelerated spending).

What percentage of your overall net worth does this $500K represent? It's a concentrated risk if you do undertake it and it sounds like you will be on the hook for alot more than just your initial capital contribution. This is worse than buying a lottery ticket, there you know what you speculate with is the limit of your losses and what the grand prize could be if you do win. As others have said, if the project goes south, your liability could be open-ended. Rarely are things simple when it comes to business arrangements. You should seek competent legal advice from a real estate construction attorney on contractual obligations and potential pitfalls.
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TropikThunder
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Re: $5M Construction Project :confused

Post by TropikThunder »

Sandtrap wrote: Wed May 12, 2021 9:46 pm I hope this is helpful to you.
PM me as you wish.
Retired R/E Developer, etc.
j :D
I was just going to say, what this thread needs is Sandtrap's perspective. :beer
FoolMeOnce
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Re: $5M Construction Project :confused

Post by FoolMeOnce »

I'm confused: are you putting up $1 million or $500k to buy the land? Are you then also sharing the ongoing financing costs on top of that? Either way (but especially if you are putting up $1 million plus), with the risks involved and goal of walking away with a $400k profit in about two years if everything goes perfectly, this does not sound worthwhile.
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FD234
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Re: $5M Construction Project :confused

Post by FD234 »

FoolMeOnce wrote: Wed May 12, 2021 10:40 pm I'm confused: are you putting up $1 million or $500k to buy the land? Are you then also sharing the ongoing financing costs on top of that? Either way (but especially if you are putting up $1 million plus), with the risks involved and goal of walking away with a $400k profit in about two years if everything goes perfectly, this does not sound worthwhile.
I am putting $500K and my friend $500K and financing rest of costs
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Sandtrap
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Re: $5M Construction Project :confused

Post by Sandtrap »

FD234 wrote: Wed May 12, 2021 10:44 pm
FoolMeOnce wrote: Wed May 12, 2021 10:40 pm I'm confused: are you putting up $1 million or $500k to buy the land? Are you then also sharing the ongoing financing costs on top of that? Either way (but especially if you are putting up $1 million plus), with the risks involved and goal of walking away with a $400k profit in about two years if everything goes perfectly, this does not sound worthwhile.
I am putting $500K and my friend $500K and financing rest of costs
Thanks for the clarification.
Even with those numbers, the basic ideas and concepts of what I posted previously still are fairly valid.

Good luck on this.
IMHO (based on actual experience).
j :D
Last edited by Sandtrap on Fri May 14, 2021 7:06 am, edited 1 time in total.
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Topic Author
FD234
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Re: $5M Construction Project :confused

Post by FD234 »

Sandtrap wrote: Wed May 12, 2021 10:51 pm
I am putting $500K and my friend $500K and financing rest of costs
Thanks for the clarification.
Even with those numbers, the basic ideas and concepts of what I posted previously still are fairly valid.

Good luck on this.
j :D
[/quote]

Appreciate your thoughtful response above. You asked above why I am considering this. Simple answer is for the reward and getting my feet wet in RE development.

I understand construction project is very risky compared to buy and hold. So when will you consider a construction project. You have to take "risk" right. How would you determine the right amount of risk for reward.
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ResearchMed
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Re: $5M Construction Project :confused

Post by ResearchMed »

FD234 wrote: Wed May 12, 2021 11:33 pm
Sandtrap wrote: Wed May 12, 2021 10:51 pm
I am putting $500K and my friend $500K and financing rest of costs
Thanks for the clarification.
Even with those numbers, the basic ideas and concepts of what I posted previously still are fairly valid.

Good luck on this.
j :D
Appreciate your thoughtful response above. You asked above why I am considering this. Simple answer is for the reward and getting my feet wet in RE development.

I understand construction project is very risky compared to buy and hold. So when will you consider a construction project. You have to take "risk" right. How would you determine the right amount of risk for reward.
[/quote]

About 'the risk"... does your friend have a background in successful real estate development?
If not, that's not a good way for *you* to start.

And even under good circumstances, it could poison the friendship, although everyone always thinks, "that won't happen to me/us"...

RM
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Sandtrap
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Re: $5M Construction Project :confused

Post by Sandtrap »

FD234 wrote: Wed May 12, 2021 11:33 pm
Sandtrap wrote: Wed May 12, 2021 10:51 pm
I am putting $500K and my friend $500K and financing rest of costs
Thanks for the clarification.
Even with those numbers, the basic ideas and concepts of what I posted previously still are fairly valid.

Good luck on this.
j :D
Appreciate your thoughtful response above. You asked above why I am considering this. Simple answer is for the reward and getting my feet wet in RE development.
I understand construction project is very risky compared to buy and hold. So when will you consider a construction project. You have to take "risk" right. How would you determine the right amount of risk for reward.
[/quote]
I can only answer in the context that I’m a 3rd generation R/E developer, GC, and businessman and also with university business and construction education, etc.
So, having done that as a “career” is far different than your first steps.

One of many options in R/E development: example.
If you have 500k, how about finding a great deal on an existing profitable 2-3 duplex or fourplex rental units on your own with no partner?
Renovate and finish them out nicely, optimize the rent and clientele, then sell them for profit,
If you buy very wisely your odds of success are higher than your other venture. And you have positive ROI from day one vs nothing on the other.

The more you can keep "in house", the more you can control risk and costs, and ultimately, project outcome.
For example: there are many R/E Development companies that are also General Engineering Contractors, Management Companies, etc. Even if a small outfit, this is done "in house". In your case, buying a single "great buy" townhouse in a prime area with outstanding curb value, that needs only cosmetic upgrades to bring up to current valuations, and doing the work or contracting the work as an "owner builder", then reselling, and not bringing in any outside partners, etc, keeps all of your efforts "in house".
This is just one example of this.

There are a lot of ways of making money in R/E and maybe it wouldn’t hurt to look at many options that take smaller bites at first and minimize risk in your case.

Good R/W development demands deep pockets and staying power and extreme shrewdness and business instinct. IMHO. Like swimming with sharks, it’s not for everyone. "Raw Land" development "seems" to have the highest percentage return (ROI) for an investor, etc, but that's not true in reality.

j🌺
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SubPar
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Re: $5M Construction Project :confused

Post by SubPar »

I also work in a leadership/financial capacity for a full-service developer, GC, management company. I would echo many of the sentiments/questions/risks that Sandtrap posted.

There's about 100 things I could list of the top of my head, but my biggest questions would be:
-You mention that you trust your friend -- do you trust him personally, or professionally? Those are vastly different. What are his development qualifications?
-Who's taking title to the land? If an LLC, Do you have an operating agreement in place to formalize the deal structure, responsibilities, promote terms, etc.
-Is lender requiring debt to be guaranteed during the construction phase? If so, when does guarantee burn down? What does the interest rate and amortization look like in the event you end up holding this longer than anticipated? How is the loan being drawn down (generally you'd only draw as capital is required, thereby minimizing interest incurred during construction). How is interest accrued & paid during construction phase?
-Do you understand tax implications and holding period requirements for capital gains treatment? Depreciation recapture, unrecaptured 1250 gains?
-Does your friend understand the various types of construction contracts (lump sum, Cost+ w/ GMP, etc.). Does friend understand the change order process?
-Has your friend met with GCs? If so, how's your hard cost number being estimated -- an conceptual estimate/architectural fit plan or actual market costs/contractor bids? Lumber and steel procurement & pricing is insane right now (as is furniture, appliances, etc.,). Are those costs being considered in the budget?
-Are you carrying adequate contingencies for other unforeseen costs within the budget? How much of your capital is allocated to covering such costs?
-Has initial surveying been done? Have you had soil samples pulled to ensure there are no contaminants or subgrade bogeys?
-Will you have Builder's Risk (or some other type of insurance) in place to cover replacement cost of property in the event of catastrophic loss? Do you know what type of coverage your GC is carrying (General Liability, Umbrella, Pollution & Professional Liability, etc.), or what insurance GC's subs (if applicable) are required to carry?

My overall sentiment is: there's absolutely money to be made in these type of ventures. But, going straight to developing a multi-million dollar project without appropriate qualifications or prior experience is dangerous territory. There's a lot of ways you can get burned, and I can tell you with absolute certainty, these projects never go exactly as planned. Never.
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David Jay
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Re: $5M Construction Project :confused

Post by David Jay »

SubPar wrote: Thu May 13, 2021 8:39 amThere's about 100 things I could list of the top of my head...
I am reminded of the old NASA line:

When you launch a rocket, a thousand things can happen. Only one of them is good.
Prediction is very difficult, especially about the future - Niels Bohr | To get the "risk premium", you really do have to take the risk - nisiprius
Grt2bOutdoors
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Re: $5M Construction Project :confused

Post by Grt2bOutdoors »

Sometimes you only think you will get your feet wet, instead you wind up taking a bath.
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FD234
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Re: $5M Construction Project :confused

Post by FD234 »

SubPar wrote: Thu May 13, 2021 8:39 am I also work in a leadership/financial capacity for a full-service developer, GC, management company. I would echo many of the sentiments/questions/risks that Sandtrap posted.
........
Thank you Subpar for your comments.
1. trust your friend - We been friends for a while. We go on family vacations together and such. He is shrewd and restarted in RE ~2yrs ago starting from fixer uppers to now doing construction. This will be his first end to end construction project too. He is thorough in his due diligence. He is also putting half his money and he is open to me putting less for down payment.
2. It will be LLC and formal deal structure (I haven't seen the contract yet)
3. Tax - He said it will k-1 distributions
4. cost - without knowing anything I felt cost of $1.7M for building 4 town homes (~1900 sqft) to be low but he is insistent that he factored costs correctly
5. I don't know about contingencies and builders risk insurance. I will find out.

I think it comes down to how much do I trust my friend to execute. Does it make sense to invest a lower amount say $100K or is it all paying with fire and getting burnt.
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FD234
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Re: $5M Construction Project :confused

Post by FD234 »

Grt2bOutdoors wrote: Thu May 13, 2021 9:50 am Sometimes you only think you will get your feet wet, instead you wind up taking a bath.
I get what you are saying. How do you rationalize Risk taking. Without Risk no reward right
Ramjet
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Re: $5M Construction Project :confused

Post by Ramjet »

chassis wrote: Wed May 12, 2021 9:50 pm Aren't Bogleheads strictly 3 fund investors?
I hope not
VT & HFEA
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Re: $5M Construction Project :confused

Post by Normchad »

FD234 wrote: Thu May 13, 2021 10:55 am
Grt2bOutdoors wrote: Thu May 13, 2021 9:50 am Sometimes you only think you will get your feet wet, instead you wind up taking a bath.
I get what you are saying. How do you rationalize Risk taking. Without Risk no reward right
You have to take risk. But you have to fully understand the risk, and be compensated for it.

It sounds like the risk here is a decent likelihood you will,lose your total investment. And a lower, but not zero chance, that you will lose even more than that.

Knowing that, are you being compensated fairly for that risk?

To be blunt, I wouldn’t do this. I don’t think your friend is going to succeed. And you will lose your money, and your friend. I’d rather just keep both.

He is turning to you to join him, because he can’t do it without you. People that know these things, don’t want to get involved with this.
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Re: $5M Construction Project :confused

Post by RickBoglehead »

Normchad wrote: Thu May 13, 2021 11:04 am

You have to take risk. But you have to fully understand the risk, and be compensated for it.

It sounds like the risk here is a decent likelihood you will,lose your total investment. And a lower, but not zero chance, that you will lose even more than that.

Knowing that, are you being compensated fairly for that risk?

To be blunt, I wouldn’t do this. I don’t think your friend is going to succeed. And you will lose your money, and your friend. I’d rather just keep both.

He is turning to you to join him, because he can’t do it without you. People that know these things, don’t want to get involved with this.
This ^^^

Also, this violates a basic tenet that many people follow - Never due business with friends or family. NEVER.

OP, if you hadn't received this inheritance, would you make this investment with YOUR money? If the answer to that is no, that tells you something.
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Re: $5M Construction Project :confused

Post by Grt2bOutdoors »

FD234 wrote: Thu May 13, 2021 10:55 am
Grt2bOutdoors wrote: Thu May 13, 2021 9:50 am Sometimes you only think you will get your feet wet, instead you wind up taking a bath.
I get what you are saying. How do you rationalize Risk taking. Without Risk no reward right
If you spend $2 you got a shot at winning $450 million for Friday’s mega millions jackpot. You know the reward is huge as is the potential even though you know you will most likely just lose the $2 and win nothing. In your example, you are being asked to put up $500k and your reward potentially is 2x your initial commitment right? Yes, you might do really well but when I hear experienced real estate developers like Sandtrap list out in details the pitfalls of such endeavors I listen. I work in the financial field and right now large real estate development is going through a very rough time. Your investment contemplation is a much smaller scale which raises the stakes for you beyond your immediate outlay. I asked earlier if you had not come into this inheritance burning a hole in your pocket would you be entertaining this proposal? As the silent partner you are in a junior position, you realize that right? Those are risks not to be taken lightly, if anything you ought to have more protection built into your contract to protect your interests, do you?
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FD234
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Re: $5M Construction Project :confused

Post by FD234 »

Grt2bOutdoors wrote: Thu May 13, 2021 11:37 am
FD234 wrote: Thu May 13, 2021 10:55 am
Grt2bOutdoors wrote: Thu May 13, 2021 9:50 am Sometimes you only think you will get your feet wet, instead you wind up taking a bath.
I get what you are saying. How do you rationalize Risk taking. Without Risk no reward right
If you spend $2 you got a shot at winning $450 million for Friday’s mega millions jackpot. You know the reward is huge as is the potential even though you know you will most likely just lose the $2 and win nothing. In your example, you are being asked to put up $500k and your reward potentially is 2x your initial commitment right? Yes, you might do really well but when I hear experienced real estate developers like Sandtrap list out in details the pitfalls of such endeavors I listen. I work in the financial field and right now large real estate development is going through a very rough time. Your investment contemplation is a much smaller scale which raises the stakes for you beyond your immediate outlay. I asked earlier if you had not come into this inheritance burning a hole in your pocket would you be entertaining this proposal? As the silent partner you are in a junior position, you realize that right? Those are risks not to be taken lightly, if anything you ought to have more protection built into your contract to protect your interests, do you?
How should I think about fair compensation for the risk I am taking. is it >2x return, say 5x return or am I missing the point here. Isn't it almost impossible to find a 5x return.
59Gibson
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Re: $5M Construction Project :confused

Post by 59Gibson »

Does not mean it's a terrible biz deal. You just need to have your eyes wide open..one other risk may not have been mentioned. Prepare to possibly be a landlord. 12-18 mos many things can change(witness last 15mos) Market turns, mortg rates go up...etc. You may be renting 4 townhouses in SoCal.
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Re: $5M Construction Project :confused

Post by mikejuss »

Ramjet wrote: Thu May 13, 2021 11:00 am
chassis wrote: Wed May 12, 2021 9:50 pm Aren't Bogleheads strictly 3 fund investors?
I hope not
Yes, many--including myself--are strict three-fund investors.
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Re: $5M Construction Project :confused

Post by SubPar »

FD234 wrote: Thu May 13, 2021 10:49 am
SubPar wrote: Thu May 13, 2021 8:39 am I also work in a leadership/financial capacity for a full-service developer, GC, management company. I would echo many of the sentiments/questions/risks that Sandtrap posted.
........
Thank you Subpar for your comments.
1. trust your friend - We been friends for a while. We go on family vacations together and such. He is shrewd and restarted in RE ~2yrs ago starting from fixer uppers to now doing construction. This will be his first end to end construction project too. He is thorough in his due diligence. He is also putting half his money and he is open to me putting less for down payment.
2. It will be LLC and formal deal structure (I haven't seen the contract yet)
3. Tax - He said it will k-1 distributions
4. cost - without knowing anything I felt cost of $1.7M for building 4 town homes (~1900 sqft) to be low but he is insistent that he factored costs correctly
5. I don't know about contingencies and builders risk insurance. I will find out.

I think it comes down to how much do I trust my friend to execute. Does it make sense to invest a lower amount say $100K or is it all paying with fire and getting burnt.
No problem, happy to help. I'll try to not get overly technical or preachy, but a couple follow ups:
1. New construction design-build is completely different than renovation of an existing structure. Not even the same ballpark, to be honest. Are you willing to foot the bill for your friends learning curve if you realize he's in over his head?
2. Great, good start. If you move forward, I would highly(!) encourage you to understand all terms of that operating agreement. Seek independent counsel to the extent necessary. They are usually quite comprehensive (rightfully so), and there are a lot of different ways to structure. All relevant terms need to be defined -- e.g., you mention your friends promote is 20% of net profit. How is net profit defined? Gross sale price, less transactional costs, less project costs? If so, what's all included in the project costs? Who's keeping the accounting records? Is it open book, meaning do you get to independently inspect? You get the gist.
3. K-1 is just the tax form that passes activity from the entity's Form 1065 (assuming it's a Partnership for tax purposes, which is should be), but that doesn't govern the actual tax treatment for what's happening in the LLC and being passed to you as a member/partner...if that makes sense. You may want to work with a CPA to the extent you're uncomfortable here. There's lots of real estate specific circumstances to consider: your share of recourse in partnership liabilities will impact your basis, passive activity limitations if you're not a Real Estate Professional under IRS regs, holding periods for capital gains treatment once the buildings are placed into service, yada yada yada.
4. That's concerning. Cost should be based on a contractor's bid, including appropriate contingencies, and not a layman's estimate. Moreover, it's not solely about getting a price estimate, but also procuring materials at this point. It's not exactly easy to come across lumber, structural steel, etc.
5. Run away if there are not adequate reserves to hedge the unknown or if pre-construction due diligence has not been performed. Also, the project absolutely, 1,000% needs to be insured. That said, I don't know a bank that would lend against an un-insured/under-insured project. Construction financing will usually come with a whole slew of stipulations. Don't buy the property until you have financing locked. In virtually every instance, we close on the real estate transaction simultaneously with closing on construction financing.

Lastly, you're probably not going to be selling this thing the day it's completed (and, further, completion is not like flipping a light switch in that you don't go from "under construction" to "100% finished" overnight...there's ALWAYS punch list stuff that seems to drag on). Sorry if I missed it, but are these being sold as permanent residences or income/rental property? If permanent, who services the debt if it's slow to sell? If rental, who operates the property between finishing and sale? Any idea on what market rent and/or an operating budget looks like? Knowing what kind of property will succeed in the right location can make or break whether this will be attractive when taking to it market.

Don't get me wrong, there may be plans for all of this stuff, and if so -- great. But, my $.02...proceed with an abundance of caution.
Last edited by SubPar on Thu May 13, 2021 12:55 pm, edited 3 times in total.
mikejuss
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Re: $5M Construction Project :confused

Post by mikejuss »

Dump the $500,000 into your brokerage account at your desired asset allocation--and never look back. :wink:
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Re: $5M Construction Project :confused

Post by Grt2bOutdoors »

FD234 wrote: Thu May 13, 2021 12:02 pm
Grt2bOutdoors wrote: Thu May 13, 2021 11:37 am
FD234 wrote: Thu May 13, 2021 10:55 am
Grt2bOutdoors wrote: Thu May 13, 2021 9:50 am Sometimes you only think you will get your feet wet, instead you wind up taking a bath.
I get what you are saying. How do you rationalize Risk taking. Without Risk no reward right
If you spend $2 you got a shot at winning $450 million for Friday’s mega millions jackpot. You know the reward is huge as is the potential even though you know you will most likely just lose the $2 and win nothing. In your example, you are being asked to put up $500k and your reward potentially is 2x your initial commitment right? Yes, you might do really well but when I hear experienced real estate developers like Sandtrap list out in details the pitfalls of such endeavors I listen. I work in the financial field and right now large real estate development is going through a very rough time. Your investment contemplation is a much smaller scale which raises the stakes for you beyond your immediate outlay. I asked earlier if you had not come into this inheritance burning a hole in your pocket would you be entertaining this proposal? As the silent partner you are in a junior position, you realize that right? Those are risks not to be taken lightly, if anything you ought to have more protection built into your contract to protect your interests, do you?
How should I think about fair compensation for the risk I am taking. is it >2x return, say 5x return or am I missing the point here. Isn't it almost impossible to find a 5x return.
You should ask Sandtrap what he believes fair compensation should be assuming all the stars align in your favor. You have to think it's more than $500K on the line here and why do I say that? There is an opportunity cost that is substantial if the deal goes against you, it's not just $500K, depending on your time horizon you are looking at a cost of $1-3 million in lost wealth and that to me is the 2 to 5 bagger you say is impossible to find and it is in the short run if you don't win the lottery but not over a normal investment horizon. Quick scores, sounds great which is why so many play the lottery but the reality outside of entertainment value is that money would be better put to use if it were invested wisely. (I play it for entertainment value).

Would your "friend" take you on as a partner if you were only able to part with $100K? If he doubles your money, you are up $100K but if the losses are more than $100K you still have the "deep pockets" to shield you from even worse losses. You don't say your total financial picture, other than you are 75/25 so let's consider this example. You are 75/25 and a $100K-$500K speculation creates a new allocation of what? It's not 75/25, you know the numbers so you should put pen to paper and write it down so you understand fully just what you are contemplating here besides altering your asset allocation.
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Re: $5M Construction Project :confused

Post by Independent George »

How many of the people commenting have actual experience with construction projects of this type? How many are familiar with development in CA?

I have absolutely no knowledge of either, and therefore can add nothing, but it seems like many comments are dismissing it outright rather than citing specific risks to the project, or suggesting additional terms to be added to the deal.
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Re: $5M Construction Project :confused

Post by snackdog »

Run away.

Your friend is inexperienced and is either going to take all your money or run into difficulties. The friendship will be ruined and you will regret it. Hard pass!
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Re: $5M Construction Project :confused

Post by Sandtrap »

Some random considerations as you go forward on this project:

1. While you can draw up excellent legal contracts, etc, to ensure; transparency (on a schedule) and accountability (recourse), as well as a payment and disbursement schedule to pay a % of interest and % disbursement of profit, etc (from the day you give your money), enforcement is another thing altogether.

2. While you may take someone to court for $5 and receive a judgement to collect. After that process. . . you must collect.

3. If, for example, you were to put $100 in Vanguard Total Stock, you would have an expectation, to some degree, of a minimal regular return. Much like a retirement market based portfolio at 60/40 allocation has a "reasonable" expectation of sustaining a 3-4% withdrawal rate. And, you would have a certain level of risk of principle associated with that. Also, there's a degree of controllability, you can withdraw your funds at any time.

However, if you invested in other various things with the risk of losing 100% of your principle with zero controllability and perhaps unable to withdraw all of your money at any time, what eventual return on your investment ROI would you expect?

4. If a pawn shop, legally loans "X" dollars to you for a certain length of time, how much interest do they legally charge you for that? Do you pay all of it at the end of the contract period, or do you have to make payments over time from the day you borrow the money?

5. Can you financially sustain either a complete loss of your money invested, or a much longer than expected return of your money with marginal to zero profit?

6. Do you have any input on the project and how your money is used proportional to the percentage of your investment to total project value?

7. Is the main R/E project developer able to get a construction loan through normal channels for this project based on securing the loan on existing company assets and a strong track record of success, and also loan repayment?

8. Can the main R/E project developer produce verifiable documentation for your examination to include:
Company financial statements, profit and loss statements, etc, etc. (The same that they would need to produce to obtain a bank construction loan)?

Good luck in your efforts and a successful and profitable project.
j :D

*dislaimer: IMHO based on actual business experience as a R/E developer and businessman. Lot's of different experiences in these things amongst many many people so input varies.

Some successful real life examples I have personally known:
1. Fellow contractor goes into partnership with a buddy. They each put in $300k and buy a "flipper" SFH. They work all thier free time to bring the "flipper" up to market condition. That includes a very extensive renovation, almost a complete gut and redo. As they are both tradesman and licensed contractors, electrician and a plumber, they are able to do everything from rewire to repipe to HVAC systems redo. A roofer is hired to put a great roof on. They also put in time to do landscaping, etc. The total project takes 2 years. Final sales is just South of $1.2 million. After taxes, each gets back nearly double their money. The project turned out so well that they do it again and also profit but not quite double thier money.

2. Three businessman form a partnership to build a 10 story high rise, 50 unit apartment building on a business, mixed zoning lot that one of the partners owns free and clear. Total project time is 4 years from concept to occupancy. All are experienced R/E developers and 1 is a licensed G.C. with experience building these types of buildings and so forth. All have a strong track record of success in these things. All have "deep pockets" to sustain the project. Financing is obtained. The partners continue to collect annual income from the building over a period of over 40 years.

3. Seven people form a partnership to buy 400 acres of prime land that is agricultural and soon to be rezoned to mixed use in an UHCOL area that is growing rapidly. They are able to pay cash on a winning closed bid for the property in an estate/bank auction. The sum is absolutely huge. There are only a few bidders that could have afforded to buy the property. All of the partners are successful businessman and business "families" with "deep pockets and staying power". Nothing is done to the property as the city expands and land values skyrocket. It remains agricultural and somewhat of a historical landmark area for the next 50 years. Current value, priceless. AFAIK, the property is held in a complex family trust amongst heirs to the original 7 business partners.

cheers.
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Re: $5M Construction Project :confused

Post by 8foot7 »

I would be the first to admit the seeming majority of folks on this board don't have much idea what real entrepreneurial risk looks like, with some very notable exceptions (many of whom have already posted in this thread). Sometimes you have to lay a lot on the line for the big payout. I am sure the folks posting about the 3-fund instead mean well, but I would not put a lot of stock into that advice.

Instead, I'd look at maximizing the reward to be sure you are fairly compensated for what is a pretty substantial risk of losing your entire investment. In this case, if the reward is 1M on your 500k investment, I think I'd pass. If that were 4:1, 5:1, something better, it's worth having a look and structuring a deal out on paper to see if you can stomach it.

Also: everyone has to have a first something. The trick is to line everything that you can control up in your favor, backstop it with cash and insurance, have plans B, C, and D already thought through. And then...take the risk if the reward is adequate. (Based on your current numbers, I don't think this is the case.) There are about a million different ways to configure and participate in this project in between "dump your 500k in and ride or die" and "buy VTSAX."
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Re: $5M Construction Project :confused

Post by Sandtrap »

8foot7 wrote: Fri May 14, 2021 7:45 am I would be the first to admit the seeming majority of folks on this board don't have much idea what real entrepreneurial risk looks like, with some very notable exceptions (many of whom have already posted in this thread). Sometimes you have to lay a lot on the line for the big payout. I am sure the folks posting about the 3-fund instead mean well, but I would not put a lot of stock into that advice.

Instead, I'd look at maximizing the reward to be sure you are fairly compensated for what is a pretty substantial risk of losing your entire investment. In this case, if the reward is 1M on your 500k investment, I think I'd pass. If that were 4:1, 5:1, something better, it's worth having a look and structuring a deal out on paper to see if you can stomach it.

Also: everyone has to have a first something. The trick is to line everything that you can control up in your favor, backstop it with cash and insurance, have plans B, C, and D already thought through. And then...take the risk if the reward is adequate. (Based on your current numbers, I don't think this is the case.) There are about a million different ways to configure and participate in this project in between "dump your 500k in and ride or die" and "buy VTSAX."
Excellent points.
And, very true when it comes to one's lst steps into these kinds of things.

For example: my lst "project on my own" was while I was working 24/7 at my construction company. I bought a condo/apt 1 bedroom "fixer' upper" (very loose definition), for all of $65,000 which was a fortune back when. I paid in cash, nearly all of my savings. After doing a full renovation myself (after which I was "broke"), I rented it out, then 3 years later sold it for double. Then, I did it again, and again, no partners, no other workers except for some cash work here and there and friends as they could help out.
As your example above about controlling what one can, in my example above, I was a finish carpenter and a G.C. and surrounded by others who were also in the trades, business mentors, and so forth. While there was no financial "safety net" at first, there was a wealth of other resources far more experienced than I was that guided and helped me.

IMHO: even when everything is in place, it still takes a lot of luck, timing, and a whole whole lot of grit for things like this.
j :D
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mikejuss
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Re: $5M Construction Project :confused

Post by mikejuss »

Sandtrap wrote: Fri May 14, 2021 9:56 am
8foot7 wrote: Fri May 14, 2021 7:45 am I would be the first to admit the seeming majority of folks on this board don't have much idea what real entrepreneurial risk looks like, with some very notable exceptions (many of whom have already posted in this thread). Sometimes you have to lay a lot on the line for the big payout. I am sure the folks posting about the 3-fund instead mean well, but I would not put a lot of stock into that advice.

Instead, I'd look at maximizing the reward to be sure you are fairly compensated for what is a pretty substantial risk of losing your entire investment. In this case, if the reward is 1M on your 500k investment, I think I'd pass. If that were 4:1, 5:1, something better, it's worth having a look and structuring a deal out on paper to see if you can stomach it.

Also: everyone has to have a first something. The trick is to line everything that you can control up in your favor, backstop it with cash and insurance, have plans B, C, and D already thought through. And then...take the risk if the reward is adequate. (Based on your current numbers, I don't think this is the case.) There are about a million different ways to configure and participate in this project in between "dump your 500k in and ride or die" and "buy VTSAX."
Excellent points.
And, very true when it comes to one's lst steps into these kinds of things.

For example: my lst "project on my own" was while I was working 24/7 at my construction company. I bought a condo/apt 1 bedroom "fixer' upper" (very loose definition), for all of $65,000 which was a fortune back when. I paid in cash, nearly all of my savings. After doing a full renovation myself (after which I was "broke"), I rented it out, then 3 years later sold it for double. Then, I did it again, and again, no partners, no other workers except for some cash work here and there and friends as they could help out.
As your example above about controlling what one can, in my example above, I was a finish carpenter and a G.C. and surrounded by others who were also in the trades, business mentors, and so forth. While there was no financial "safety net" at first, there was a wealth of other resources far more experienced than I was that guided and helped me.

IMHO: even when everything is in place, it still takes a lot of luck, timing, and a whole whole lot of grit for things like this.
j :D
Is buying a house for $65,000, gut renovating it over, say, a year, and selling it for double really worth one's time? Couldn't a person just work a fairly low-stress office job and make $65,000 in a year? I don't really understand the mechanics of flipping from an income standpoint. It's a lot of work with no guaranteed return, and, at best, doesn't seem to yield much more than a regular nine-to-five.
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Re: $5M Construction Project :confused

Post by Sandtrap »

mikejuss wrote: Fri May 14, 2021 10:08 am
Sandtrap wrote: Fri May 14, 2021 9:56 am
8foot7 wrote: Fri May 14, 2021 7:45 am I would be the first to admit the seeming majority of folks on this board don't have much idea what real entrepreneurial risk looks like, with some very notable exceptions (many of whom have already posted in this thread). Sometimes you have to lay a lot on the line for the big payout. I am sure the folks posting about the 3-fund instead mean well, but I would not put a lot of stock into that advice.

Instead, I'd look at maximizing the reward to be sure you are fairly compensated for what is a pretty substantial risk of losing your entire investment. In this case, if the reward is 1M on your 500k investment, I think I'd pass. If that were 4:1, 5:1, something better, it's worth having a look and structuring a deal out on paper to see if you can stomach it.

Also: everyone has to have a first something. The trick is to line everything that you can control up in your favor, backstop it with cash and insurance, have plans B, C, and D already thought through. And then...take the risk if the reward is adequate. (Based on your current numbers, I don't think this is the case.) There are about a million different ways to configure and participate in this project in between "dump your 500k in and ride or die" and "buy VTSAX."
Excellent points.
And, very true when it comes to one's lst steps into these kinds of things.

For example: my lst "project on my own" was while I was working 24/7 at my construction company. I bought a condo/apt 1 bedroom "fixer' upper" (very loose definition), for all of $65,000 which was a fortune back when. I paid in cash, nearly all of my savings. After doing a full renovation myself (after which I was "broke"), I rented it out, then 3 years later sold it for double. Then, I did it again, and again, no partners, no other workers except for some cash work here and there and friends as they could help out.
As your example above about controlling what one can, in my example above, I was a finish carpenter and a G.C. and surrounded by others who were also in the trades, business mentors, and so forth. While there was no financial "safety net" at first, there was a wealth of other resources far more experienced than I was that guided and helped me.

IMHO: even when everything is in place, it still takes a lot of luck, timing, and a whole whole lot of grit for things like this.
j :D
Is buying a house for $65,000, gut renovating it over, say, a year, and selling it for double really worth one's time? Couldn't a person just work a fairly low-stress office job and make $65,000 in a year? I don't really understand the mechanics of flipping from an income standpoint. It's a lot of work with no guaranteed return, and, at best, doesn't seem to yield much more than a regular nine-to-five.
That's very true from an employee wage earner point of view.

I've seen countless licensed contractors (self employed businessman in the business of construction) and trades workers working hourly do "flippers" in addition to their daily income stream, for the purpose of getting ahead, because it's a natural tangent to the skills of their career, much like an office or institutional wager earner has a profession and skills related to their career.

The comparable might also be someone who is an engineer and a wage earner, employee, doing outside consulting and work on his own for additional income streams to get ahead.

There are a lot of approaches to these sorts of things based on each person's education, skills, profession, ambition level, stress tolerance, and general mind set, which makes it all interesting.

j :D
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mikejuss
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Re: $5M Construction Project :confused

Post by mikejuss »

Sandtrap wrote: Fri May 14, 2021 11:01 amThat's very true from an employee wage earner point of view.

I've seen countless licensed contractors (self employed businessman in the business of construction) and trades workers working hourly do "flippers" in addition to their daily income stream, for the purpose of getting ahead, because it's a natural tangent to the skills of their career, much like an office or institutional wager earner has a profession and skills related to their career.

The comparable might also be someone who is an engineer and a wage earner, employee, doing outside consulting and work on his own for additional income streams to get ahead.

There are a lot of approaches to these sorts of things based on each person's education, skills, profession, ambition level, stress tolerance, and general mind set, which makes it all interesting.

j :D
That makes sense to me. The way flipping is sometimes presented is as some kind of high-paying full-time profession, when, as you note, for most people, it's more likely just a side hustle. Nothing wrong with that.
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Nate79
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Re: $5M Construction Project :confused

Post by Nate79 »

I didn't see it answered yet but I would want to know what percentage of your net worth that this represented.
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Sandtrap
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Re: $5M Construction Project :confused

Post by Sandtrap »

mikejuss wrote: Fri May 14, 2021 11:09 am
Sandtrap wrote: Fri May 14, 2021 11:01 amThat's very true from an employee wage earner point of view.

I've seen countless licensed contractors (self employed businessman in the business of construction) and trades workers working hourly do "flippers" in addition to their daily income stream, for the purpose of getting ahead, because it's a natural tangent to the skills of their career, much like an office or institutional wager earner has a profession and skills related to their career.

The comparable might also be someone who is an engineer and a wage earner, employee, doing outside consulting and work on his own for additional income streams to get ahead.

There are a lot of approaches to these sorts of things based on each person's education, skills, profession, ambition level, stress tolerance, and general mind set, which makes it all interesting.

j :D
That makes sense to me. The way flipping is sometimes presented is as some kind of high-paying full-time profession, when, as you note, for most people, it's more likely just a side hustle. Nothing wrong with that.
There are many types of R/E "flipping".
1. R/E Developer buys several 20-30 unit low rise apartment buildings in an area of the city that that is mixed residential and there are several high rise luxury condo's going up, etc. The developer does a condo conversion to the apartment buildings (takes time, lot's of money, and savy), then flips the individual units to condo sales.

2. A commercial and residential G.C. that is doing well invests in duplex, triplex, etc, sixplexes rental units that are in an upcoming area. He keeps his crews busy on them (which he now owns) when they are not on the regular jobsites such as custom homes, shopping mall build outs, food courts, franchise builds, etc. Over time, the G.C./Businessman either keeps the rental units and rents them out after the complete reno's, or sells them depending on the market, then does 1031 exhanges to larger or other R/E income property units, etc. So, in this way, the 2 businesses, R/E Development, and Construction, are synergistic.

3. Commercially, a R/E Developer/businessman, buys or leases a large area building next to low rise shopping malls, etc, then does build outs and complete reno's for either business offices, or food courts, etc, depending on the upcoming area. If it is mixed zoning, then it depends on the zoning. Etc. So this is a "flip" of initial use and design to another purpose and market.

4. Etc.

Most people are familiar with residential SFH "flipping" because of the books for sale and the TV shows. But, there's more to things than that although it makes for good TV to some. Or, a carpenter friend or handyman trying to do a "flipper". Or, a wage earner looking to hit it big.

******(back to the OP and on topic)
For the OP: the point of the matter is that depending on one's budget and inclination and skills and so forth, there are lots of ways to get into the R/E development thing. And, sometimes it seems like the opportunity lst presented is the only one, but sometimes that's not true and all options should be looked at, including the options to do nothing at all.

j :D
Last edited by Sandtrap on Fri May 14, 2021 1:33 pm, edited 1 time in total.
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harrychan
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Re: $5M Construction Project :confused

Post by harrychan »

FD234 wrote: Wed May 12, 2021 8:06 pm Town house construction project - Property is in SoCal. 15-18 month timeline.
I've invested in 4-plex and other properties across SCAL. Helped my FIL flip his fixer upper 3,000 sq ft home. Zero chance this happens in 15-18 months.
FD234 wrote: Wed May 12, 2021 8:06 pm less Sale price of 4 houses = $5M (comps are $1.2-1.3M/house in today's price)
= $1M profit
There are not a lot of places that could demand $1M+ on condos. And these place typically do NOT like permitting multiplex or CUP. Places that have exceptions are flooded with condos. Most people who can afford $1M+ homes would prefer SFH. If they do go for condos it is because it is 1) exceptional quality, 2) location (school), 3) appreciate new. They don't care about maintenance as they can pay for it at SFH. If you go for subpar quality to maximize profit, you won't get $1M profit and it will eat away at your ROI.

Examples:
https://www.redfin.com/CA/Arcadia/316-C ... /175107059
https://www.redfin.com/CA/Arcadia/128-D ... /174463242

If you can't beat these, don't bother.
Last edited by harrychan on Fri May 14, 2021 12:56 pm, edited 2 times in total.
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MrCheapo
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Re: $5M Construction Project :confused

Post by MrCheapo »

To summarize. You have to invest $2M with a return of ($1M - $0.2M) / 2 = $400K to you. So a net return of 20% over 18 months so about 13% PA

Is that right?

Many others have gone over the risks and they seem serious for such a low return on a passive investment. Remember that being a passive investor can be a bad things as you have no say in the control of the process. Lots of money in building is made not from the sales price of the properties but padding receipts etc from materials.

FD234 wrote: Wed May 12, 2021 8:06 pm Town house construction project - A friend of mine approached me with this proposal. Buy permit/utility approved (shovel ready) land and build townhomes. Sell them at profit. Property is in SoCal. 15-18 month timeline. He is the active partner and I am silent partner. He doesn't expect me to be actively involved in the day to day work.

$1M for payment towards buying land (split between friend and me, he is putting down half of the downpayment). Rest of the money for land and construction is taken as a loan (from private lender).
Rough math -
Cost of Land - $1.8M
Construction cost - $1.7M
Other costs (Finance/Realtor) - $0.5M
less Sale price of 4 houses = $5M (comps are $1.2-1.3M/house in today's price)
= $1M profit

Active friend takes 20% from net-profit as fees and splits the rest. I trust my friend to execute and finish construction.

Questions -
1. Not sure on how to think of the risk I am taking here. Is there a good analogy/example that can help with perspective
2. I'm seriously considering to invest. What would you do and why?
3. How should I think of risks here. What risks am I missing. Risks I can think of
a. Project execution - Will project go as planned
b. Market 15-18 months from now. Interest rates, hot market
c. Unanticipated construction costs
4. If the project goes bad, I am looking at loosing all of my downpayment right
5. Assuming successful completion of the project, what other risks should I be prepared for (lawsuit etc)

I never invested in anything like this. I am a BH (75/25, Equity/Bond). I am hoping for constructive feedback.

Edit - I should clarify that I asked my friend to tell me the next time he has an opportunity.
This money is from inheritance I recently got (which is not in the 75/25) above.
I am putting $500K and my friend $500K and financing rest of costs. He is open to me putting less than $500K.
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FD234
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Re: $5M Construction Project :confused

Post by FD234 »

MrCheapo wrote: Fri May 14, 2021 12:50 pm To summarize. You have to invest $2M with a return of ($1M - $0.2M) / 2 = $400K to you. So a net return of 20% over 18 months so about 13% PA

Is that right?

Many others have gone over the risks and they seem serious for such a low return on a passive investment. Remember that being a passive investor can be a bad things as you have no say in the control of the process. Lots of money in building is made not from the sales price of the properties but padding receipts etc from materials.
Both of us together are putting $1M in the project. Net return is 80% over 15-18 month horizon. Most likely it will be say ~20% for the time horizon. How should I value the new learning for this construction project. Just the return by itself is not prompting me. Return + learning something new.
Last edited by FD234 on Fri May 14, 2021 2:58 pm, edited 1 time in total.
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