$5M Construction Project :confused

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Topic Author
FD234
Posts: 58
Joined: Fri Aug 22, 2014 2:29 pm

Re: $5M Construction Project :confused

Post by FD234 »

Nate79 wrote: Fri May 14, 2021 11:20 am I didn't see it answered yet but I would want to know what percentage of your net worth that this represented.
This $500K represents 25% of NW
MrCheapo
Posts: 1469
Joined: Tue Dec 22, 2020 2:43 pm

Re: $5M Construction Project :confused

Post by MrCheapo »

Sorry I'm not following you wrote:

"$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"

Which I take it to mean:
Revenue $5M

Cost
Land $1.8M
Construction $1.7M
Misc $0.5M
-------------------------
$4M

you weren't clear but I take it the $500K each you are putting down is used to buy the land?

So that leaves $1M profit split between the two of you but you said he takes a 20% fee of some sort on the profit leaving you with $400K

So how can you say your putting in $500K and getting 80% profit? Seems like you are only getting 80% of your downpayment


FD234 wrote: Fri May 14, 2021 2:51 pm
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.
SubPar
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Joined: Mon Apr 27, 2020 11:48 am

Re: $5M Construction Project :confused

Post by SubPar »

MrCheapo wrote: Fri May 14, 2021 3:32 pm Sorry I'm not following you wrote:

"$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"

Which I take it to mean:
Revenue $5M

Cost
Land $1.8M
Construction $1.7M
Misc $0.5M
-------------------------
$4M

you weren't clear but I take it the $500K each you are putting down is used to buy the land?

So that leaves $1M profit split between the two of you but you said he takes a 20% fee of some sort on the profit leaving you with $400K

So how can you say your putting in $500K and getting 80% profit? Seems like you are only getting 80% of your downpayment


FD234 wrote: Fri May 14, 2021 2:51 pm
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.
$5MM net sale proceeds, less debt payoff of $3MM, leaves $2MM to distribute upon liquidation. $1MM of that is return of capital, $1MM is profit. Friend takes $200K (20%) off the top as a promote, remaining $800K is split 50% to each partner.

This amounts to an 80% return net of promote, gross of tax. 1.8X equity multiple, something like a ~50% levered IRR if that 18 month timeline holds and there are no other material cash flows between investment and liquidating distribution.
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8foot7
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Re: $5M Construction Project :confused

Post by 8foot7 »

So you put in 500k, 25% of your net worth, and you might get (a) it back with (b) an additional 400k?
Nah.

To risk 25% of your net worth over 18+ months, I'd want to 10x the money.
MrCheapo
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Re: $5M Construction Project :confused

Post by MrCheapo »

Okay. Thanks I get it now, he was essentially double counting his $500K deposit.

OP. In a normal economy I would say NO (not enough reward for the risk), in the current economy (with homes being so much in demand) I'd say HELL NO as you may even lose money here.


There is no way this is getting built in 12-18 months and coming in on budget. The building industry is not some clean boy-scout run, some of these contractors is highly cyclic and ruthless and if they have leverage over you (i.e. your paying interest on a bridging loan) then they'll use it. Hard to believe, but I've known plenty of contractors that have been screwed over and have no qualms doing it themselves. It goes with the turf.

Heck, just last month my fence blew down and all the contractors I called were booked solid (big windstorm in the area) and there was a lack of lumber. But this was my fence backing onto a main street (I have a corner lot) so I offered one guy 50% over his bid price and he was there the next day. Somebody got shafted which seems to be the motto of the building industry.
SubPar wrote: Fri May 14, 2021 3:55 pm $5MM net sale proceeds, less debt payoff of $3MM, leaves $2MM to distribute upon liquidation. $1MM of that is return of capital, $1MM is profit. Friend takes $200K (20%) off the top as a promote, remaining $800K is split 50% to each partner.

This amounts to an 80% return net of promote, gross of tax. 1.8X equity multiple, something like a ~50% levered IRR if that 18 month timeline holds and there are no other material cash flows between investment and liquidating distribution.
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Nate79
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Location: Delaware

Re: $5M Construction Project :confused

Post by Nate79 »

With leverage comes risk. A slip of the schedule, increased building cost or lower sales lrice and you could have zero profit.
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cchrissyy
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Location: SF bay area

Re: $5M Construction Project :confused

Post by cchrissyy »

FD234 wrote: Fri May 14, 2021 2:53 pm
Nate79 wrote: Fri May 14, 2021 11:20 am I didn't see it answered yet but I would want to know what percentage of your net worth that this represented.
This $500K represents 25% of NW
oh damn that is way too much of your net worth to be betting on this.

remember, you could lose more than you put in.

everybody has to start somewhere. but this is too much "tuition" to pay for your first project given your net worth.

i agree with the others that in order to make such a large bet on something that could go wrong in countless ways, you would need a proven team - not just someone you trust as a friend - and even then it needs higher expected profit.
60-20-20 us-intl-bond
Allan
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Location: Houston

Re: $5M Construction Project :confused

Post by Allan »

I am an active custom home builder, I routinely build spec homes in the 3-6 million$ range. I use my own capital and equity and secure construction loans from banks. No partners. This deal might work, your friend might be totally ethical and competent, but knowing what I know about building houses (45 yrs experience), I would never invest in this kind of deal in an unsecured non-1st lien position. Too much unsecured risk for that amount of money. I would not do this.

Allan
Allan
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Location: Houston

Re: $5M Construction Project :confused

Post by Allan »

Another note on this, I know a builder who gets partners for an occasional spec home he builds. What I've noticed over the years is his partners never come back for a 2nd deal. There is a reason.
Topic Author
FD234
Posts: 58
Joined: Fri Aug 22, 2014 2:29 pm

Re: $5M Construction Project :confused

Post by FD234 »

Allan wrote: Fri May 14, 2021 6:18 pm I am an active custom home builder, I routinely build spec homes in the 3-6 million$ range. I use my own capital and equity and secure construction loans from banks. No partners. This deal might work, your friend might be totally ethical and competent, but knowing what I know about building houses (45 yrs experience), I would never invest in this kind of deal in an unsecured non-1st lien position. Too much unsecured risk for that amount of money. I would not do this.

Allan
Hi Allan - Can. you expand on unsecured non 1st lien position
Allan
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Location: Houston

Re: $5M Construction Project :confused

Post by Allan »

FD234 wrote: Fri May 14, 2021 7:05 pm
Allan wrote: Fri May 14, 2021 6:18 pm I am an active custom home builder, I routinely build spec homes in the 3-6 million$ range. I use my own capital and equity and secure construction loans from banks. No partners. This deal might work, your friend might be totally ethical and competent, but knowing what I know about building houses (45 yrs experience), I would never invest in this kind of deal in an unsecured non-1st lien position. Too much unsecured risk for that amount of money. I would not do this.

Allan
Hi Allan - Can. you expand on unsecured non 1st lien position
You said in your 1st post "$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)."

I would assume the private lender who is funding the majority of costs is in a 1st lien position, superior to your and your partner's position. And there might be a public bank behind that private lending, if so they would for sure be 1st lien lender. And while I said you would be in an unsecured position, even if you do file a deed of trust to secure your loan you would be in a 2nd and inferior position to the 1st lien lender. If there is a default on the 1st lien loan you could be wiped out, no security.
chassis
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Re: $5M Construction Project :confused

Post by chassis »

I wouldn’t put 25% of my net worth in an illiquid risky real estate investment. If real estate is “your thing” and you are financially independent with the other 75% of your net worth, and you accept the potential of losing your principal in the real estate investment, go for it.
Last edited by chassis on Sat May 15, 2021 12:56 pm, edited 1 time in total.
rotorhead
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Location: Florida

Re: $5M Construction Project :confused

Post by rotorhead »

OP, I'm not a construction expert; but I do have a couple of things to say about this proposed venture.

You said your friend has about 2 years experience in construction / refurbishment. Do you have reasonable assurance he has the experience / knowledge to pull this project off as planned? If you are not absolutely certain he does, then you shouldn't do it. Simple as that.

Is his planning accurate enough, and does it contain a large enough contingency margin to protect both of you in the event construction costs soar out of control. I'm not in the business; but in my area there is a lot of home refurbishment and new construction going on right now; and I'm hearing horror stories about how the price of plywood, 2/4's, etc. have skyrocketed this year. Be very cautious.

As much as we all like to realize some extra income from our investments; this is one I would take a pass on, & especially in the current economic environment. While we are all hoping for a happy outcome to the Covid pandemic, it's not written in stone that it will happen. I think it's a time to be very cautious with our investments; and have acted accordingly.

Good luck whichever way you go.
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