With a shortage of available good deals for real estate investors to place significant amounts of capital, we are hearing recent stories about increases in purchases of development projects in the middle of construction and well before any occupancy or pre-leasing has begun.
Traditionally real estate investors either buy into projects upon completion or co-invest in them alongside a developer prospectively. Then when completed, and at least partially leased, the properties are either sold to a new owner or recapitalized as long-term management holdings.
So, what are some important challenges and advantages of this type of investing?
When you buy a completed building, you have something physical to visit and inspect. And if you have been involved as a partner since the planning stage, it is also easier to ensure that both the design and construction are completed to your standards. However, when you buy mid-stream in construction, the lack of involvement and visibility throughout the very complicated processes and relationships makes it much more difficult to determine the extent of design coordination and how well a project was built—ultimately impairing your assessment of risks and discovery of any actual or potential problems.
Investors stepping into the shoes of a prior relationship carries a high probability for unknown issues to arise, despite best diligence at intentions. There are prior communications and issues of the past (skeletons in the closet) that are very likely to require future attention, so investors must be on top of their game with skilled resources at the ready to manage and resolve them in a timely fashion.
Until a project is completed and approved, there’s always the risk that it will be delayed, or worse yet, never get finished. This may be due to lack of materials, natural causes, bankrupt or inept contractors, lack of government approval, lack of funding, or any other number of causes.
Depending on where the developers are in the process at diligence and deal closing, there are several fundamental and important questions that should be asked when buying something still under construction¬—a very dynamic situation. Are you buying based on plans and specifications or some other written description of the project? How do you make sure to obtain the most current and accurate set of documents? Who will review them against your current and future expectations? How will you compare what has actually been built to what those documents represent? How well does the contractor’s (and subcontractors’) agreements, including change orders to date, reflect the same set of documents and expectations? Who has been involved and to what extent for approving materials and observing the installations for quality control? Can you obtain meeting minutes and reports of those findings? Which materials have been substituted (yeah, there is always something) and not reflected in the specifications? Are you taking full assignment of the agreements with which contractors, architect, designers, and all consultants? Are all those vendors ready, without reservation, to continue the project with you? Is the developer/seller hesitant to share anything with you or holding any documents back? What amounts will be held back to hedge against decisions previously made by the developer? What assurances will you have that the local authorities will inspect, approve, and provide all necessary utilities and certificate of occupancy for the intended uses?
Taking over a project that’s underway but not yet done is a risky proposition. With risk, however, there should be meaningful rewards. Here are a few.
Most developers (sellers) are willing to exit earlier for the right price, that may (and should be) less than what the price will be when the project is completed, and later stabilized (usually maximum price). Obtaining property at a discount is almost always favorable.
Investors that become involved in a project mid-stream will most likely buy off-market, with no broker engaged to market the product for sale, and therefore, less to no competition. This allows for a less intensive and more effective use of your resources.
Another advantage of buying-in before construction is completed is applying your expertise in leasing up a new building in a way that may be quicker and/or with higher rents than may be targeted by the developer. This enables the investor to create even greater value.
There are many investors out there with money to spend on construction opportunities. Real estate often offers better returns than most other investment opportunities, though finding deals that make sense is difficult in the current market and they may feature sizable risk. With the way things in the business are today, people are taking greater risks in the hope of greater returns.
If you are looking to leverage investments with your real estate portfolio, Real Projectives® provides the insight and expertise that drives expected results and manages the related risks for successful outcomes.
Please contact us today to start a conversation.