When I ask folks who want to develop small projects what they are worried about, it’s often that their lack of know how is going to create a problem that is so big that their project will blow up and they will lose all their investors’ money. That is a legitimate fear. The best way to address it is to stay in the safe zone and build your know how until you are ready to ask someone for money.
Safe Zone Stage One – Work it out on paper One of the core skills a developer needs is the ability to understand how a building makes more money than is required to build and operate it. The best way to figure out if you understand your project thoroughly is to write stuff down. Get your plans and ideas on paper so you can test them and communicate them to other people. Do your market study so you understand what people are paying in rent for space that is comparable to what you want to provide. Test your idea for what you want to build on several potential sites. Build your pro forma from scratch, (even if you have access to someone else’s template) so that you understand how the rents, the hard construction costs, the land cost, the soft costs, the operating expenses all interact in a building that makes money. Dig into the hard construction costs so that you understand what the most expensive parts of the building are and what you can do to spend your construction budget where it will have the greatest benefit. If you see a project you like, try to reverse engineer it on paper. (-this is a little like learning how to draw by tracing over another drawing).
Safe Zone Stage Two – Take your paper to your mentors, peers, and colleagues Once you are confident you can describe your project costs, likely rents, likely operating expenses, and your preferred deal structure with your investors, and you have your project down on paper, you are ready to go get other people you trust to look at your work. Better to learn that you have missed something from your mentor or your colleague than from a potential investor or construction lender. Find people who will be tough with you because they want you to be successful in your enterprise. Be sure you do the same for others when they ask. Sit down with your mentor or peer and lay out the project for them. How does the project make money? How much equity are you asking your investor for? When do they get their principal back? What is their return and when do they get it?What kind of debt financing are you trying to get? How is the cash flow after debt service going to be divided? What are the risks in the project? How are you planning to address them? What parts of the proposed project need to be described in more detail? Do you have a one page summary of the deal -or are you expecting an investor to read 23 pages of spreadsheets and site plans and figure it out for themselves?
Find someone who will play the role of your potential investor and practice your pitch on them. Have someone else observe and critique your effort. These should be people with enough experience in real estate that you know you are gaining real ability and confidence through the exercise.
Next Time : Leaving the Safe Zone in Stage Three – Taking your paper to your potential Investors and lenders