There is an expression that land development is a wealthy man’s game.
Indeed, in our recent meeting with a very seasoned developer (over 30,000 lots before the Recession, now, licking his wounds, down to only 900), he pointed out to the young entrepreneur in attendance that most projects fail because the developer runs out of capital before he gets traction.
This is one reason that successful developers so often need to be visionaries and consummate salespeople. They not only have to convince stakeholders that the vacant land or the unproven mine or the undeveloped port really could be something more, but they have to motivate those stakeholders to act as if it already IS ‘more’.
To the extent that a developer can do that, the more successful the development will be, whether in terms of cheaper cost of capital, project velocity or net returns.
In fact, the more the developer can do this, the less traditional debt or equity he will need, or the better at least his terms will be.
Below is an introduction to 15 creative ways that large real estate and infrastructure developers leverage their projects to generate momentum, raise nontraditional cash, qualify for traditional financing, and turn their vision into reality. The list is interspersed with transactions typically used in infrastructure and other common for real estate development. However, we believe that several of them are underutilized and could be creatively employed more often and in different applications.
How impactful are these strategies? We know one developer who invested only $10,000 by utilizing just two of these strategies and made $35,000,000 by selling to a national homebuilder, and saving substantial within a tax preferred vehicle that his attorney helped him devise.
Forward Sale Funding
Overriding Royalty Interests
Pay upon Completion Contracting
Corporate Bond Funding
Private Transfer Fees
Sales / Leaseback
3rd Party Subordination & Cross-collateralizations
1. Forward Sale Funding
A forward sale is perhaps the quickest and least expensive method of financing in ground assets or commodities.
This strategy consists in a developer entering into a sales agreement with an investment grade purchaser of its assets. A bank then discounts the agreement and funds the developer immediately. The developer remains obligated to deliver the product over the term of the contract for and the buyer guarantees repayment to the bank at the end of the contract term.
The benefit to the buyer is that it begins to receive the product at the beginning of the contract and does not have to pay anything until a date certain at the end – in effect an interest free line of credit. (The buyer can protect itself by taking a security interest or lien position in the client's company).
Because the lending bank relies entirely on the credit strength of the buyer, there is minimal due diligence done on the client and the transaction by the bank.
2. Overriding Royalty Interest (ORRI)
An overriding royalty interest is the right to receive revenue from the production of oil and gas from a well. The overriding royalty is carved out of the lessee’s (operator’s) working interest and entitles its owner to a fraction of production. It is limited in duration to the terms of an existing lease, but is not subject to any of the expenses of development, operation or maintenance.
ORRI’s typically do not own a perpetual interest in the mineral rights. Typically they are structured to have rights to royalties for the term of the lease period. Royalty interests, on the other hand, generally have mineral ownership into perpetuity, even after a lease expires. Thus the main difference between royalty interests and ORRI’s is that royalty interests are tied to the ownership of the mineral rights below the surface, and ORRI’s are tied to the lease agreement and ceases to exist once the lease expires.
For example, the popular publicly traded Permian Basin Royalty Trust (PBT) only owns ORRI’s, not royalties, in various oil and gas properties in the United States. PBT owns a 75% net ORRI in the Waddell Ranch properties comprising Dune, Judkins, McKnight, Tubb, University-Waddell, and Waddell fields located in Crane County, Texas. As of December 31, 2016, its Waddell Ranch properties contained 349 net productive oil wells, 64 net productive gas wells, and 102 net injection wells.
3. Sponsorships, Co-branding and Naming Rights
Large public venues such as stadiums and arts venues typically sell off the naming rights and other sponsorship opportunities to brands. This is a substantial business (Global sponsorship spending for 2016 exceeded $60 billion) which can be extended to many other niche.
For a developer the value of sponsorships can be considerable. For example, the naming rights for Citi Field (opened in 2009) and Barclays Center (opened in 2012), both located in New York City, US. garnered deals of $20 million per year for at least 20 years. According to the Spurs report and online blog other notable sponsorships have included:
Similarly, developers can co-partner, license, co-brand or sell sponsorships to different elements of their development to leverage the participation of others and/or to maximize the value of the project. Just like the gym shoe of the 1950s (canvas, mono color black or white) has evolved to branded, hyper stylized and specialized athletic shoes for every activity), one can imagine how real estate projects could be susceptible to additional branding, segmentation and utilization.
Lenders typically require developers to presale or pre-lease a certain percentage (e.g. 50%) of their project before providing construction financing.
This requires that developers have the considerable skills and resources to generate presales. While a typical sales and marketing budget may represent 5% of sales, the ability to achieve these presales makes the difference between getting funding and not.
As presales represent a significant risk to the success of a project, developers have developed several creative strategies. These include staged pricing with pricing increases as the project gets traction, alliances with strong marketing partners as well as bulk, or wholesale presales (a la Groupon model) where developers offer discounted pricing, preferred amenities, additional dealer incentives, and preferred exit, maintenance fees, usage, or other exclusives. In times of bull markets, where buyers are optimistic of real estate markets, these bulk arrangements have been particularly attractive for less established developers in need of significant traction in the short term.
Real estate crowdfunding continues to be a dynamic and ever-evolving industry, growing to an estimated $3.5 billion in 2016. By 2025, the crowdfunding industry as a whole is anticipated to be valued at more than $300 billion and online real estate marketplaces are primed to capitalize on that explosive growth.
Real Estate Crowdfunding
Crowdfunding platforms currently exist for debt, equity, and secondary markets and are expected to continue to help increase liquidity and access to institutional quality real estate.
6. Options Contracts
An “option agreement” is a contract used in real estate investing that gives you the right to purchase a property for an agreed upon price up to a certain time frame. A straight option purchase agreement contract is frequently used by developers and buyers of commercial property and high end luxury homes. A builder does not want to purchase raw ground only to find it cannot be built on or that approvals to change zoning or to subdivide the property won’t go through.
By the same token, the builder does not want to pay a lot of money doing feasibility tests only to find out the seller sold the property to someone else. So the builder uses a straight option contract to lock down the property, an important element of which is consideration. The builder gives the seller consideration (usually money) that is frequently non-refundable for the right to tie up the property and lock in a purchase price for a future sale/transfer.
7. Pay Upon Completion Contracting
Well established developers are frequently able to negotiate favorable terms with suppliers and vendors. In some cases, the value of these services can substantially enhance the overall value and marketability of the project. While this arrangement is traditionally employed on real estate sales where the agents are paid on commission with each sale, many developers have been able to extract similar concessions with property owners, professional services firms and other vendors. Sometimes these concessions come with additional upside for the counterparty, and sometimes are merely a result of the developer’s strong reputation, or superior skill or experience in negotiating in these situations.
One notable example of this is referenced above where our developer friend optioned vacant land and was able to negotiated a $500,000 engineering bill to be paid upon successful completion of the engineering work. In the meantime, the developer was able to attract a national homebuilder in search for entitled lots and was able to sell them for a multiple of his optioned purchase price, all on the strength of the engineering firms’ efforts.
8. Corporate Bond Funding
For clients with substantial assets that are available to be used as collateral, funding by the creation of corporate bonds can be a very attractive option. This works particularly well for clients with valuable in ground assets such as oil and gas, gold, silver, iron ore, copper, and granite.
For in ground assets, geology reports which are NI 43-101 or JORC compliant prepared by recognized geological firms and demonstrating proven or measured reserves are required. In the case of power generation projects, a Power Purchase Agreement from purchasers with strong credit ratings are necessary.
Bonds collateralized by the developer’s assets which then obtain a credit rating (S&P, Moodys or Fitch), making them marketable to be sold to the investment community. A bank serves as the trustee and creates a sinking fund from the business profits to pay the interest and retire the bonds. There are pre-issuance costs such as the rating agency fees, legal expenses and trustee fees which the client must pay which can exceed $400,000. The overall fees at closing typically run from 5% to 8%. The underwriter sells the bonds to institutional investors. The time required to complete a bond financing is generally about three to four months.
[to be continued]
Contact: Mike Bishop, JD, and Russ Robinson focus on project finance at Slim Ventures; they can be reached at email@example.com and firstname.lastname@example.org
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