

בחסות
Ed Earl and Paul Sanneman, both previous guests, share the reasons why they like cost-plus contracts. As a fixed-price builder myself, I wanted to get the perspective from the other side of the aisle.
If you want to learn more about Paul and Ed's work, visit https://residentialcontractorservicesgroup.com.
Enjoy the episode!
“The wise man knows exactly what value should be put upon everything.” — Seneca
Over my 15 years to date of structuring real estate development deals, I’ve screwed up many a deal. I’ve left money on the table. I’ve shouldered too much risk. But luckily, on close to 100 projects I’ve sponsored, I’ve only ever lost money one one. The rest have performed well, and a good many surprisingly well (listen to my story in Episode 57).
What has been the single biggest improvement I’ve made in how I structure my deals? I’ve started thinking of the deal components as separate “Value Buckets.” As a result, I have a much easier job identifying an equitable deal for everyone and easily selling it to my investors.
Value Buckets in a Nutshell
To use value buckets, think of deal structuring as an accountant would. Each deal is a new company in a sense, and that company will have assets, liabilities, and equity that each of the parties to the deal should value at some notion of fair market value. This sounds basic, like a foregone conclusion, but many people miss this point. And when they start thinking of projects through Value Buckets, what seemed like a reasonable deal may no longer be.
Most Common Value Buckets
I establish up front a fee between 7-8% of a deal’s projected sale price, depending on the size and complexity of the project. This fee is paid out to my company with the construction draws from the bank. This fee covers my company’s overhead in the deal but not my general contractor profit, which I defer to the end so that my investors and I are better aligned.
The back-end profits I’m expecting to receive should be enough to account for both my role as general contractor and separately as developer. If the projected profits aren’t sufficient in that sense, I either restructure the deal or pass on it.
Beyond that, there are a lot of other factors that determine what a fair return is for your investor. If you are a brand new builder, you represent more risk than someone with decades of experience. You need to be offering a little higher return. Or vice versa.
I structure my deals with investors like this: first, I offer an 8% simple annual preferred return on their investment to account for the opportunity cost of capital. Then, I split profits with them, usually 50/50. This profit split bucket represents their return for the extra risks I mentioned above.
If you notice both with my fee I charge the project and the preferred return I offer investors, I’m structuring the deals such that we try to value and cover our respective costs first, and then profits we split on top of those costs should be a more accurate representation of profitability.
If I see newbies make one mistake, they fail to account for the true cost of their overhead in the deal and they end up having to pay for it with their supposed profit split at the end. I made this mistake for my first several years.
I ask all our partners to guarantee the loans we obtain, including myself. This way we spread the risk. I compensate my investors for this additional risk they assume via higher targeted returns. In other words, most of the projects I sponsor target IRR’s in the low 20% or higher. If I wasn’t asking for loan guarantee support from my investors, I believe the high teens would be a fair return to target for them. And I would accomplish that by shifting the profit splits whatever amount necessary to keep the target returns in that range.
Conclusion
Those are the typical value buckets as I see them. They are just a general framework and can always be amended as necessary. Seeing the individual components of a deal, the assets and liabilities as I mentioned in the beginning, helps create a much clearer baseline from which to structure and negotiate.
What you decide is fair is between you and your investor, but having these value buckets and general reference points of fair market value for each one will take you 90% of the way.
106 פרקים
Ed Earl and Paul Sanneman, both previous guests, share the reasons why they like cost-plus contracts. As a fixed-price builder myself, I wanted to get the perspective from the other side of the aisle.
If you want to learn more about Paul and Ed's work, visit https://residentialcontractorservicesgroup.com.
Enjoy the episode!
“The wise man knows exactly what value should be put upon everything.” — Seneca
Over my 15 years to date of structuring real estate development deals, I’ve screwed up many a deal. I’ve left money on the table. I’ve shouldered too much risk. But luckily, on close to 100 projects I’ve sponsored, I’ve only ever lost money one one. The rest have performed well, and a good many surprisingly well (listen to my story in Episode 57).
What has been the single biggest improvement I’ve made in how I structure my deals? I’ve started thinking of the deal components as separate “Value Buckets.” As a result, I have a much easier job identifying an equitable deal for everyone and easily selling it to my investors.
Value Buckets in a Nutshell
To use value buckets, think of deal structuring as an accountant would. Each deal is a new company in a sense, and that company will have assets, liabilities, and equity that each of the parties to the deal should value at some notion of fair market value. This sounds basic, like a foregone conclusion, but many people miss this point. And when they start thinking of projects through Value Buckets, what seemed like a reasonable deal may no longer be.
Most Common Value Buckets
I establish up front a fee between 7-8% of a deal’s projected sale price, depending on the size and complexity of the project. This fee is paid out to my company with the construction draws from the bank. This fee covers my company’s overhead in the deal but not my general contractor profit, which I defer to the end so that my investors and I are better aligned.
The back-end profits I’m expecting to receive should be enough to account for both my role as general contractor and separately as developer. If the projected profits aren’t sufficient in that sense, I either restructure the deal or pass on it.
Beyond that, there are a lot of other factors that determine what a fair return is for your investor. If you are a brand new builder, you represent more risk than someone with decades of experience. You need to be offering a little higher return. Or vice versa.
I structure my deals with investors like this: first, I offer an 8% simple annual preferred return on their investment to account for the opportunity cost of capital. Then, I split profits with them, usually 50/50. This profit split bucket represents their return for the extra risks I mentioned above.
If you notice both with my fee I charge the project and the preferred return I offer investors, I’m structuring the deals such that we try to value and cover our respective costs first, and then profits we split on top of those costs should be a more accurate representation of profitability.
If I see newbies make one mistake, they fail to account for the true cost of their overhead in the deal and they end up having to pay for it with their supposed profit split at the end. I made this mistake for my first several years.
I ask all our partners to guarantee the loans we obtain, including myself. This way we spread the risk. I compensate my investors for this additional risk they assume via higher targeted returns. In other words, most of the projects I sponsor target IRR’s in the low 20% or higher. If I wasn’t asking for loan guarantee support from my investors, I believe the high teens would be a fair return to target for them. And I would accomplish that by shifting the profit splits whatever amount necessary to keep the target returns in that range.
Conclusion
Those are the typical value buckets as I see them. They are just a general framework and can always be amended as necessary. Seeing the individual components of a deal, the assets and liabilities as I mentioned in the beginning, helps create a much clearer baseline from which to structure and negotiate.
What you decide is fair is between you and your investor, but having these value buckets and general reference points of fair market value for each one will take you 90% of the way.
106 פרקים
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