WHAT TO CONSIDER
Investing in a development project may reward you with a substantially higher net return. If
everything goes exactly right with an investment – and that almost never happens - an investor
in a development project may achieve a 15 – 25% internal rate of return.
An NNN 1031 DST investment might be 5% (all in cash and hopefully with a 100% return of
capital at the end of 10 years). On a successful repositioning of a tired existing property, IRR
yields can be reached in the 10 – 15% range.
Couple a higher “potential” return with the various tax benefits (e.g. Qualified Opportunity
Zone Fund investing), and development can (potentially) be seen as highly attractive to an
investor sheltering capital gains.
Does your risk escalate significantly with a development project? To quote former Alaska
governor Sarah Palin – “You Betcha!”. Your job is to dig deep to understand the reasons why
the proposed development may fit your investment strategy…and what could go wrong!
FOCUS FIRST ON CAPITAL
The best vehicle does not run without energy. The best development project will fail without
sufficient capital with the right terms at the right time.
1. Does the developer make money even if the project fails (e.g. flipping the land from
their inventory to the development partnership at a significant profit)?
2. From where do funds to cover a “short fall” if costs exceed projections or the offering
itself does not raise all the equity projected? In a QOZF, the developer is prohibited from
owning more than 20% of the project (so don’t look to them to make us a shortfall).
3. How are you as an investor protected with a preferred return, and how much money
does the developer and affiliates pocket, even before you receive your preference?
1. ENTITLEMENTS. How far into the process of obtaining local government approval for the
proposed project are you coming in as an investor? If the developer took a “lift” on
flipping the land into the partnership, most if not all of the approves should be in place.
2. TENANTS. If retail or office, 70% of the space ideally is pre-leased (as that will be a
requirement of the lender). Consider the “outs” the prospective tenants in their
commitment to lease. If apartments or hotel or self-storage, focus on what similar
property has been proposed for development in the area (e.g. have they filed something
with the local government).
3. LOCAL ECONOMY. It seems that every local government, when you read their website
for economic development, are on the verge of unprecedented growth, improved
schools and roads, and lower tax rates. Dig a little deeper, at least focusing on what is
currently occurring near the proposed development.
4. EXPERIENCE. Does the sponsor have hands on experience with developing the proposed
asset class, of the scope suggested, in this specific market? Some skills are transferable,
but why do you want to pay for a sponsor to learn this business on your nickel?
5. ENVIRONMENTAL. Many contaminates are similar to STD, in that containment after the
fact does not eliminate the problem or isolate the investor from the sins of prior
owners. NEVER accept as absolute fact a statement “there is no reason to test” or “the
prior owner did sufficient testing” or “the local government does not consider it a
problem”. When in doubt, walk away.
BOTTOM LINE. Development has become the rage in light of unprecedented tax benefits (e.g.
from investing capital gains into qualified opportunity zone funds). If the development /
repositioning does not make clear sense WITHOUT the tax benefits, look for another
opportunity. Put the project to the test before writing that check!