During the last five years, real estate developers have benefited from an aggressive lending market coupled with falling capitalization rates. This has increased interest and competition in build-to-suit and speculative development.
As cap rates continue to reach all-time lows, developers are often forced to front their own capital as they price build-to-suit projects. However, there are alternatives. They can partner with an experienced capital provider and successfully seek and execute new development business without having to risk more of their capital.
Partnering with a capital provider that has solid experience in both debt and equity real estate capital markets allows developers to pursue more deals and create fee income. Strong capital firms will also demonstrate creativity when solving complex financial problems.
Ideal capital partners will rely on the developer's expertise in development matters. Firms that try to be both developer and financial partner can sometimes create conflict and tension with developers, which is counterproductive to a project's success.
The best capital providers will understand their development partners' needs and have the flexibility to structure a partnership that works well for all parties. Those who employ a one-size-fits-all approach can sometimes create a situation in which one party is left feeling short-changed.
The partnership may be as simple as having the developer work on a fee basis while the capital provider brings the entire capital stack, including debt and equity, as well as providing any guarantees required by lenders. This structure allows the developer to preserve capital and lock in their economics while avoiding market risk. Others may be willing to accept more risk in order to participate in the upside potential of a project. Sometimes this involves the contribution of the land or a portion of the development fee in exchange for an equity allocation.
Whatever the case, it is important to work with a capital provider that understands the developer's needs and has the creativity and experience to structure a partnership that works for all involved. This can lead to follow-on deals that are more efficient once a mutually beneficial partnership structure has been worked out.
Today, tenants and tenant reps are selecting developers and pairing them with all-inclusive capital sources. By forming this type of partnership on the front end, developers can likely avoid a forced “marriage” of capital. Developers should see their capital provider as a long-term partner instead of as a quick capital source for one-off deals.
Keeping this in mind, developers should watch out for capital sources that lack balance sheets. Typically, these firms are waiting to win the developer's business and then go out and find the capital, leaving the developer without the certainty of execution that they expected. These firms can also risk the developer's reputation.
When searching for a capital provider, developers should look for partners that have a strong track record of success and experience in complex financial transactions. They should ask to see the potential partner's portfolio and discuss the most recent deals the firm has closed.
By partnering with an experienced capital provider, developers can focus on managing the cost and execution side of new projects and allow the capital provider to use its expertise in pricing. This transfers the risk of future cap rate changes to the capital provider. Whether this transfer of risk is structured as a forward-takeout or full funding from closing, the capital markets burden is removed from the developer.
Capital sources spend 100 percent of their time focused on the economic drivers of real estate pricing. Developers can leverage this expertise by bifurcating the development process and allowing the capital source to focus on its strengths while the developer focuses on the actual real estate. This approach allows for the most competitive all-in proposal.
One of the greatest benefits of selecting the right capital partner is the ability to pursue more potential opportunities. Leveraging the financial strength of a capital partner allows the developer to increase deal flow. By not having equity or debt capacity constraints, the developer is able to pursue more deals that generate fee income without putting capital at risk. A strong capital partner will also provide any lender-required financial guarantees, which protects developers from taking on this additional liability as well.
Along with an increase in deal flow, experienced capital providers can expand developers' networks by making introductions to top firms in the industry. These connections can include general contractors, property managers, and other resources.
Today developers who are still relying on their own internal capital and potentially stale market knowledge are at a disadvantage to competitors who are forming alliances with capital sources. However, developers who are looking to take advantage of strategic capital partnerships need to take the time to find the right capital source for their specific projects.