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A mortgage broker friend of mine just brought me a land deal in a town about 45 minutes away from me. A developer needs an investor to purchase a piece of land that he wants to build a hotel on. The hotel is a small chain hotel and there is another one from the chain in the town I live in. My parents stay in it when they come to visit me. The hotel is very nice and seems to do pretty well. It has been in business for at least 5 years.
The deal would be for me to put 25% down on a $450K piece of land. Then the hotel owner would seek financing to buy me out in 6 month to a year for $525K. I would not have to do anything except make payments on the loan until it was taken out.
My risk is the developer doesn’t perform and I don’t get the company to refinance and buy me out.
I have asked for pro-forma and the research they have done. They have sent it over to me. I will look over it this weekend. I have also asked for some references for the developer to see if he has a track record.
Does anyone else have some ideas for due diligence with this? Does it sound like a potential deal? What would be a plan B to investigate if the builder doesn’t perform?
Thanks.
So many times buyers think the only way to do a deal is with CASH. They don’t even consider asking the seller if they will do financing. The seller of this land deal may consider financing.. did anyone propose an offer to them?
The developer is taking on a lot of risk to build on land they do not even own. What kind of track record does the builder have? They should know that they could lose all their investment in the construction if a payment were missed on the land purchase.
Why is the hotel owner not buying the land or putting up the money for the land purchase? Or is this a speculation play hoping to sell the hotel to someone after it is finished?
There is absolutely no guarantee that the builder could refi the land purchase. This is a risky investment in just the land with way too many unknowns. If you do this deal, it should be written in to the agreement and DEED that you are a 50% owner in entire project. Or you should have a recorded deed of trust to secure an option for 50% ownership. If the developer can refi within 6-12 months and you get $xxxxx, then you will release your ownership interest in the entire project. Doing it this way gives the developer incentive to take you out of the deal. But it protects your interest.
What’s the worst that could happen if you are a 50% owner? Think things through.
If the developer gets 1/2 way through construction then runs out of money and the project is not complete, you could be forced to come up with extra money to finish the deal. If that happens, you need to have it written in to the agreement in advance that for every $1 you have to invest you get $4 back… or something like that.
What if the developer dies in the middle of the project? Or if he/she gets sick and cannot work? What if the project goes in to a stall.. with no progress for a prolonged period of time?
You never want to be in a position to need to renegotiate AFTER the fact so think through all the things that can go wrong before you enter in to any partnership or joint venture agreement.
I’m speaking from experience here.
One time I bought a house for $25,000 that was 1 1/2 hours away from where I lived. I should have flipped the house for a fast profit. But I decided to do a complete rehab instead. The retail value was $145,000. I teamed up with a rehabber who lived near the house. I had known him for a long time and knew he would do a quality rehab. He was to over see the project, get supplies, etc. He would put up half the rehab cost and I would put up half. He was suppose to get the house all rehabbedand sold then we would split the profit. But about 2 weeks in to the project his wife got real sick then she died. Needless to say, he was devastated and could not finish the project. So I had to make the trip to the house several times a week to finish the project. I had to put up all the cash for the rehab. But come closing time, he still wanted his half of the profit (minus expenses) even though he did not do anything that he agreed to do. My mistake was that I did not write in to our joint venture agreement what would happen if he, or I, did not perform.
Fantastic information Jackie. Thanks so much. I will meet with the people this week and will definitely bring up your terms. I’m a little confused by what you mean by “for every $1 you invest, you receive $4 back if he doesn’t perform.”
Do you mean if he doesn’t perform, and I finish it, I get 4x my investment before the developer receives any money?
Thanks again. I’m not really interested in this project unless I feel very secure in the outcome. But I thought it would be good practice negotiating and learning more about commercial RE. I thought it might be a good topic for discussion for others to learn from.
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First, I mean no disrespect to the OP (original poster) in any way with my remarks.I saw no indication that the OP has much awareness of the world of commercial lending (vastly different from residential lending), and that the banking world for such lending is in the process of locking up again. The short term commercial private lender I know would not touch a hotel development deal right now with a ten foot pole — and that’s without even knowing the local economics and financial outlook of the unnamed city location. The chances of a developer getting a banking re-fi for the next few years are about zilch. Private money “might” be available, but at a whale of a premium because of that desperation.
I also didn’t see any indication that the OP knows what the five basic data points are — that any experienced private commercial lender would require to even look at the deal.
I also didn’t see any indication that the OP (or the developer) knows, or knows how to find, the private commercial lenders who have funded such hotel development projects in the past.
I’m not saying that the deal isn’t possible. It’s just that I’m not seeing the experience here to deal with a highly risky project, with zero experience in judging such projects before, and with no experience in FINDING or VETTING the few private commercial lenders who would be the only parties to bail out this developer for the years to come as the banks pull in their horns again as they did, with horrible punishments to such developers, during and after the 2008 crash.
There may be a little pain from my remarks, but that pales in significance to the agony of getting stuck in a deal you can’t get out of.
Respectfully,
Dee
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I used the ?horrible punishments? phrase above to describe what commercial lending banks often do to developers whenever a Federal Reserve-generated financial bubble collapses, as happens about every 7-8 years. Let me describe one example.A few years ago sometime after the 2008 crash, I was trying to find replacement funding (around $4.5 million) for an Arlington, Texas restaurant developer. He had a long and successful history under his belt of about 25 years. He had NEVER missed a payment to the Texas bank which had actively courted his business. When the crash came, the regulators changed the rules on that bank, forcing an almost total replacement of their staff, and insisted that bank increase their cash reserves. That resulted in their filing four separate foreclosure lawsuits against the developer, which cost him $100,000 in legal fees to successfully defend against in court. He told me that he never again wanted to be stuck with bank loans as long as he lived, and was seeking private money for a re-fi.
What he could not know was that the bank, if it had been successful in any of those foreclosure attempts, would have made up any losses from an insurance arrangement, and that Wall Street vulture funds had been created just for that crash aftermath to scoop up such REO?d properties for a song and quick flip profits, because the banks (which are lousy REO marketers) didn?t need to get the highest price when they unloaded such REOs, with insurance making up the difference. That same looting racket will again be played as developers get burned in the crunch years ahead of us.
Private commercial lenders are not subject to federal banking regulations. The world of commercial lending has its own vocabulary, its own experience demands, and its own community — very different from residential lending. Those with the experience to handle hotel development (including the ability to vet developers, to judge the local economics of the deal, and to structure the financials and legals of the deal to keep from getting hurt, etc) are a tiny fraction of that community. And those are skills and experience that commission-driven mortgage brokers do not have, nor have the ability to judge.
I would expect that a developer with substantial experience would have offered his deal to some long established private lenders first (if he had not already tried the banks first). I would also guess that he had been turned down repeatedly, which might explain why his deal was being presented to inexperienced investors — without the experience to properly vet the deal. Do you see a likely red flag in such history?
FYI.
–Dee
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Mr. Graber (Dee),
I don’t take any offense at all. When it comes to money (and most other stuff), I am much more interested in the truth than I am in my feelings. You obviously spent a lot of time composing your responses, and for that I am very grateful.
The more I look into it, the less interested I am. I will pull the plug. But I hope all these words of wisdom are helpful to keep others out of bad deals. Thanks again!
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A few more random thoughts:It?s generally not part of most real estate investors? education to understand how we evolved over the centuries from competing precious metal-backed (and therefore counterfeit proof, mostly) money to government monopoly debt-based digital money from which the purchasing power can be easily stolen from defenseless money holders by rampant and near-instant duplication and dilution. It?s also not part of that elusive education to understand how the Federal money creator, in the process of expanding and diluting the purchasing power of the money supply, causes financial bubble after bubble, boom and bust, on a nearly regular basis.
I think that lack of understanding of monetary history was partly behind the foreclosure of a large highrise project in Las Vegas just after the 2008 crash. At a conference in Oklahoma City, I had an opportunity to talk with the lady who was part of a family who had used a section of land they owned in Arizona as collateral for the construction loan — which they lost completely in that foreclosure. She was presented to the audience by the conference sponsor as a to-be-admired ?action taker,? despite the terrible failure and losses from their project. I asked her later if anyone in her project group (my polite way of referring to her family) had some awareness of the Federal Reserve?s history of creating and puncturing financial bubbles, and the tragic damage that can create for anyone trying to build — going into a crash. She presented me with a ?deer in the headlights? look, and remarked that if they had bothered to spend all the time to look at such history, ?nobody would ever get anything done,? never mind that they would still have their original section of land today. Her state of denial, even in the face of a tragic loss, left me stunned.
My point is that commercial development and commercial loans in general today are tremendously vulnerable to that artificially (think dishonestly) created boom and bust cycle. Lack of awareness of that hazard results in the tragedy I described above.
Other observations about commercial deals:
Many private commercial lenders will not even consider a deal with a mortgage broker in the middle, who they claim often insists on a too-large chunk of a too-thin deal, and who often gets in the way of doing sufficient quality due diligence.
Commercial deals found on LoopNet have often been previously shopped around to death, turned down for many reasons, and have gone to LoopNet (like the proverbial elephant?s graveyard) to die.
Knowing how to do sufficient due diligence AND how to structure away the risk in such deals is key to the return OF one?s capital — as well as the return ON one?s capital. That takes considerable experience in the relevant commercial niche.
I think there is sound reasoning behind one?s reluctance to invest in asset classes outside of one?s area of experience and expertise.
I also have a firm rule about not trying to tell more than I know.
?Preaching to the choir? is easy, but especially if anyone who doesn?t yet feel they?re ?part of the choir? finds one or more useful gems in this discussion, my long rant is not wasted.
–Dee
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Dee,
I am wholly in agreement with everything you said. I have been reading people like Ludwig Von Mises, Murray Rothbard and other Austrian economists for about 16 years now. I completely understand the destruction the Federal Reserve has wrought.
I listened to a podcast several weeks ago. The person being interviewed was a successful business person. His philosophy on deals is ‘Heck Yeah or No’. Either you have done your due diligence, completely feel good about the deal and understand it, or it’s a ‘No’. No halfway measures. I think it is a good policy to adopt.
I emailed the person who brought me the deal last night and told them ‘No’. Thanks for all the help with this.
Hal
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Hal, I started to give you a thumbs-up every time I wanted to applaud your thinking, but quickly ran out of thumbs. You will understand why I treasure my copy of “Human Action” and my early introduction to that world of perspective a very long time ago. I’m glad to hear that you’ve arrived at probably the best choice to facilitate many good nights of sleep — a too often neglected corner-block of healthy decision making.–Dee
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