Many investors know that while residential real estate can offer incredible returns, it can also expose them to risks involving everything from land acquisition to market demand. Choosing the right development partner can make all the difference between success and failure. In fact, it can be just as important as choosing the property itself.
A capable residential development partner should bring more to the table than just an appealing concept. Investors need to be on the lookout for partners who have the right combination of development and landowner experience, financial discipline, communication skills, local market knowledge, and risk management acumen.
Christopher Duffy, a real estate developer, investor, and founder of Hummingbird Development, says investors need to evaluate the entire development process before entering a partnership.
“The potential partner should be able to explain how value will be created,” Duffy says. “They should be aware of what could go wrong and how the project team would respond. The conversation cannot focus solely on the upside of the deal.”
Look for a demonstrated track record of property development success
In any industry, past performance won’t necessarily predict future results. But when evaluating a potential development partner, past performance can show whether that partner has experience executing projects that are similar to the one being proposed. Investors should look for information from potential partners such as the size and scope of their past projects, the specific responsibilities the partner had in those projects, any major delays or disputes connected to the projects, and whether the projects were ultimately successful for property owners.
There’s a stark difference between a person who has participated in one aspect of a project and a person who has managed its critical stages. Experience with acquisitions, financing, entitlements, and construction management can be particularly helpful.
Using a realistic financial model and partnership structure
Any residential development joint venture proposal should include a detailed financial model with a realistic agreement attached to it. Investors should understand how projections were calculated and which assumptions will have the greatest impact on the eventual outcome. A well-prepared financial model typically includes land or acquisition costs, design and engineering fees, permit fees, utility expenses, construction costs, interest rate estimates, insurance and tax costs, legal expenses, marketing costs, closing costs, expected sale price or rental income, and operating costs.
Investors should also ask potential partners for multiple scenarios, including base-case projections and stress-case scenarios, because whether they’re looking to get into affordable housing development or luxury condos, risks still exist. While it can be difficult to think about the risks and possible downsides of development partnerships, investors should consider what happens to the deal if construction costs rise, schedules fall behind, or the final sale price ends up lower than anticipated.
A realistic agreement should include each party’s responsibilities and financial contributions, decision-making authority, and expectations for the project, with an eye on equity, collaboration, and feasibility.
“Every development is built around assumptions,” says Duffy. “It’s the job of the investors to determine which assumptions are supported by evidence and which ones are dependent on favorable conditions.”
Tackling risk management and exit strategies
No one likes going into a partnership thinking about what happens if the relationship sours or the project goes south, but it’s still crucial for investors to protect themselves with a solid exit strategy. Investors should look for protections such as adequate construction and operating contingencies, insurance coverage, backup financing options, strategies in case sales are slower than anticipated, realistic schedules, and a process for resolving disputes.
An exit strategy cannot be an afterthought. The partnership documents need to outline how the development will be sold or divided if a partner needs or wants to exit, who makes the decisions, and how proceeds are distributed.
“The best exit strategy is one that gives the partnership practical options if the market, financing environment, or the schedules change,” says Duffy.
Due diligence makes for solid partnerships
Choosing the right residential development partner requires more than just reviewing projected returns or responding to an appealing project description. Whether one is looking to build a mixed-use space, apartment, or new neighborhood full of luxury homes, due diligence is required for investors to gain a clear understanding of a potential partner’s track record, capabilities, local market knowledge, and approach to risk management.
The goal for investors who wish to get into the residential development space should not be eliminating all risk, but identifying risk early, evaluating whether the risk is manageable, and choosing a partner with experience, transparency, and the discipline to navigate risks as they come.