When a Developer goes to build a new commercial building, the construction lender will require that the Developer contribute 20% to 40% of the Total Cost of the Project. That contribution takes the form of equity in the land; prepaid costs, such as architectural and engineering fees; and cash added at the close of the loan.
Important notes:
- Almost all construction loans are made by commercial banks.
- Total Cost consists of the Land Cost, the Hard Costs, the Soft Costs, and the Contingency Reserve.
- The Contingency Reserve is around 5% of Hard Costs and Soft Costs. The Land Cost is NOT included in the computation of the Contingency Reserve because the land cost is already known. The Developer has either already purchased the land or at least has it in contract. It is highly unlikely that there is going to be a cost overrun in connection with the land.
- The construction lender will require that the Developer spend down his entire equity contribution before the bank advances its first penny out of the construction loan.
- Loan dollars have an interest rate and loan payments. In contrast, equity dollars have no interest rate or loan payments. The equity providers get paid from the success of the project. They are the owners.
- Equity is the first loss piece; i.e., it is the equity providers who get clipped first if the project is unsuccessful.
In the old days, Developers only had to contribute 20% of the Total Cost of the project. Since the Great Recession, however, more and more banks are requiring that the owner-Developer contribute 30% to 40% of the Total Cost. That is a TON of equity, also known as skin in the game. Many owner-Developers simply don't have that much equity.
The solution for small to mid-sized development companies is to raise their required equity dollars from accredited investors using the JOBS Act. It's really not that hard.
If the Total Cost is on the order of $70 million or greater, however, it is infeasible to raise $20 million to $30 million in equity from private, accredited investors. Developers will therefore search out an institutional Joint Venture partner.
Joint Ventures are structured as Limited Partnerships, where the owner- Developer is the General Partner and the Institutional Fund (think Blackstone) is the limited partner. The Institutional Fund wants the owner- Developer to guaranty the construction loan so that the owner-Developer is not tempted to simply walk away from the project.
A huge commercial mortgage banker recently published in their newsletter that they have a Co-GP equity provider for multifamily, student housing, senior independent-living, hospitality, industrial, office, medical office, self storage and mixed-use sectors. The Co-GP is looking to invest between $1 million to $10 million per deal, with an investment period of 2 to 10 years.
Gee, that sounded great, but what on earth is a "Co-GP equity provider?"
My buddy, Bryan Shaffer, at George Smith Partners was kind enough to explain it to me.
"When you do Joint Ventures, the owner-Developer is the GP (general partner) and the Institutional Fund (i.e., Blackstone) is the LP (limited partner). So if they do a 90/10 Joint Venture (the bank is demanding that the owner-Developer contribute $30 million and Institutional Fund is providing $27 million of that equity contribution), the owner-Developer needs to do bring in 10% of the equity."
"If a $30M equity check (is being required by the bank), the owner-Developer may not have $3M, so there are co-GP groups that will invest on the owner-Developer (GP) side and provide part of that $3M. They get part of the promote and are in a deal with a big institutional partner, so it a good spot for some groups. Overall institutional capital is reserved for the strongest owner-Developers, and usually the co-GP groups want the institutional deals."
I suspect that if you do not know if you are one of the strongest owner-Developers, you probably are not. In plain English, these Joint Ventures are not for mere mortals.
Another name for a co-GP equity provider is a venture equity provider.
