Stack of cash

plywood

If you are a small developer, by the time you approach someone to invest in your project you should have the fundamentals of the project worked out.  You should know how the building will make more money that it will  cost to build and operate.  You should have confidence in your budget for what the hard and soft costs for the building should be and how long it will take to build and lease.  You should have a good working theory on what the terms of the construction loan will be and how much equity will be required.  You should know how much cash you are asking the investor to put at risk, when they will get that cash back and how much of a return the project can pay the investor as consideration for putting their cash at risk.

That is when the investor's cash becomes like plywood.  Like plywood, capital is one of many things you need to build the project, which is available from a wide variety of sources.  You should take care to use the right sort of plywood for the the task. Make sure you have communicated clearly with the lumberyard about the amount of plywood you need and when you need it.  You should also be very clear on the particulars of what you are willing to pay for the plywood and when you will pay for the plywood.   It's the same with capital.  You want the right capital, good terms and good communication.

Frame the investment in the project as a business transaction.  The investor is not making a loan, they are investing equity in the project and they will own a piece of the project until such time as the commitments you make to them are satisfied.  Their capital is at risk.  They could lose all of it if the project spins out of control and the bank, (who did make a loan) takes over the project and sells it to recover the money they loaned for construction.  In consideration for taking the risk of losing their investment you are offering to pay the investor a Preferred Return.  They get their initial cash investment back and they get stipulated rate of return on top of their investment before anyone else gets a distribution of the money the building makes.  They get paid first.  That's the prefered part.  Once the investor's principal and Preferred Return has been paid out, a common deal structure is for the capital partner (investor) and the operating partner to divide the cash flow that the project generates.  This split of the cash flow and the proceeds if the project is sold is established in the Partnership Agreement or the LLC Operating Agreement.  A higher preferred return can be paid if the capital partner is being paid off and removed from the project and the operating partner hangs on to ownership of the project and the cash flow, or if the project is being refinanced or sold after rents and operating expenses can be demonstrated over a year or two and the property is considered "stabilized".

Investors will be comparing your project to other things they might invest in.  They will weigh the risk and the return of your project while considering their other options for putting their capital to work.  As the Operating Partner, it is the developer 's job to design the deal.  It is important to be disciplined when you design a deal structure and to think about that structure being used for more than just one project.  After a couple projects you will see that it is much better to have a fairly standardized approach to what you offer to an investor, rather than building every deal around an agreement that has been highly customized to the investor's needs.  Consider the kind of capital and investors your project requires and go find that capital and investor on purpose.  Make sure the interests of the project and the interests of the investor are aligned and that expectations are well communicated.  The Operating Partner has the authority to replace the Investor's capital at any time, provided that the returns laid out in the agreement are met.  You reserve the right to change plywood vendors when needed, provided that you pay what you promised.

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

In a presentation at Build Maine 2015 , I started off this list with these two bullets:

• Lousy Streets and Lousy Public Spaces make it harder to sell or rent buildings. They drag down the local economy and make the town uncompetitive..
• Contaminated Sites require a lot of extra work.

The first bit about lousy streets and lousy public spaces should be obvious, but it can be hard to really understand the numbers on this issue, and how you got the lousy streets you have now in some parts of town.  Those lousy streets were built to a very specific set of standards  The wrong stuff built with tremendous precision.  It is mind boggling to find out that lousy streets are built to a legal standard, while the best streets in your town may be illegal to build today.  Which brings us to the second bullet.  Contaminated sites require way more work to build upon.  I'm not referring to chemical contamination.  I'm talking about sites that are contaminated by bogus rules and ordinances that just don't work any more, but nobody has been willing to clear them out.  Sites that are Administratively Contaminated need to be cleaned up.  If you wait for the individual property owners or developers to do that clean up, it could be a very long time before your town is competitive.  Towns that can show leadership in cleaning up Administrative Contamination will perform better than their neighbors.  So here is the list of stuff a town can step up and do to show their resolve in making their community better:

An added Note. Comments on Twitter described this post as hopping from the Essential to the Useful, So I have annotated each item as Essential or Useful

Dump Functional Classification ---Replace with NACTO Replacing the grid or network of streets with the stem and branch system required under Functional Classification was a really bad idea.  It produced high levels of congestion with fairly low volumes of traffic by concentrating trips on a small number of really wide and fast roads.  Providing cyclists and pedestrians with a fighting chance with the stupid Functional Classification requirements still in place is blind and wasteful.  Dump the bad rules and adopt the Design Standards published by the National Association of City Transportation Officials (NACTO).(Essential)

AMEND the International Fire Code for local use--Repeal 20’ Clear and Appendix D  The International Fire Code is hazardous to the communities it is intended to serve, because it is the source of overly-wide streets which promote faster car movement and result in more serious vehicle injury accidents and more people getting hit by cars getting maimed or dead.  Appendix D in the Fire Code requires 26' clear for streets fronted by a single building greater than 30 feet tall (even when that building has fire sprinklers. (Essential)

Stop Using the Wrong Damned Ambulance --Firefighters should not design streets.  If 80% of emergency responses in your town are medical and only 20% are vehicle and structure fires, why roll fire engines to medical calls (just in case the first responders have to continue on to a fire).  The second part got me into some trouble with local folks.  I am still pissed off that in the town I lived in for 15 years, (Chico, CA) The starting salary for a firefighter with a high school education and some time at the Community College Fire Academy is $90,000 plus pension and benefits.  This is going on in a place where the Area Median Income (AMI) for a household of four is $43,752.  The firefighters I know are operating building companies on the side in addition to their generous salary and benefits.  The last time a position opened up for an entry level firefighter, there were over 600 applications.  I should have checked on the local situation in Maine where firefighters in Auburn and Bangor start at about 70% of AMI.  So I upset some folks by being wrong on the local situation.  We can argue about the pay scale for firefighters  but it is more important to recognize they have done a lousy job designing streets in communities across the country.  Relieving them of that authority will help your town. (Useful.  Be mindful of where you invest your political capital.  Taking on the Fire Department will bring forward all sort of nostalgic and heartfelt -but irrational reactions from the general public.  Get some of the other stuff on this list done first and the problems presented by having the fire marshal control the design of your streets will come into sharper relief).

Overhaul your Off-Street Parking Requirements, Manage your Public Parking Properly,--Dump ITE Manual / Read Don Shoup  Municipalities are tremendously bad at guessing how much off-street parking should be required for a given building.  The closest thing to an object standard they can point to is a collection of tables with decimal points published by the Institute of Transportation Engineers.  Those tables were developed by surveying single use suburban parking lots and are being mistakenly applied to downtown settings which also have on-street parking.  Somebody asked me where spending $1200 would do the most good in Municipal government. It would be a book club formed from the City Council, Planning Commission and Senior staff assigned Donald Shoup's book The High Cost of Free Parking.  At $30 a copy that's 40 copies.

For an explanation of why the ITE parking numbers are quite bogus, check out Shoup's paper Roughly Right or Precisely Wrong? (Essential)

Come to Terms with your Zoning Code. Is your zoning code a collection of amendments and post-it notes that tarted in 1958 with an off the shelf ordinance from some outfit  in Atlanta?  Do it prohibit the worst possible thing from happening and allow the next to the worst possible thing to be built as-of-right?  How many special exceptions and variances does it take to build stuff that you say you want in you Comprehensive Plan? (Useful -but only because as tangled as some zoning codes are changing the rules can be a needlessly drawn out process.  Essential that you get started, but less critical than changing the off-street parking requirements).

Provide an Alternative to your Current Process for Building Permits, Inspections, Plan Check –Self Certification When an Architect or Engineer stamps a set of building plans they are taking personal liability for any failure to meet the building code or established professional standards of practice.  When a municipal plan checker approves a set of plans for construction or if a building inspector approves the building for occupancy, the municipality has no liability.  If you are the architect stamping the drawings and a city staffer tells you to change something or the building permit won't be approved, what do you do?  What if you know the requested change is outside the requirements of the building code?  Some communities have passed ordinances recognizing where liability for code compliance falls and have allowed Architects and Engineers to certify their work subject to some peer review. This would be a way to reduce the time, expense, and frustration in the building permit processes of many towns. (Useful -but hey come on, as long as you have the hood up do this thing too.)

Be Rigorous about Municipal Finance –Do the Math.  Many towns do their books without considering the cost of repairing and replacing infrastructure that will be wearing out.  They don't have a good handle on what parts of town generate the most revenue per acre, or the most cost per acre.  Without those numbers, it is hard to see the reality of how the wrong pattern of development can be really expensive.  Take a look at the work that StrongTowns is doing in Lafayette, Louisiana.  See how your town measures up when you do the math.  (Essential)