Too good to be true-right?

[laurence]

So my neighbor-nice lady, mover/shaker business development type-has a friend in the real estate development business. Her fiance is going to go to work for him as his managing general contractor on a 300 home build in southeast California (he's done smaller projects, this is his first big break to truly be in charge). They are excited, we are happy for them, we crack open a bottle of good wine, and then they mention something else: they are going to invest in the development as well.

Now I don't have all the details, but I know that it will be a traditional phase developement with 8 models, and as each phase gets sold out, investors get their return. Minimum investment is 12,000 and it's supposed to return 25% in six months. Oh yeah, if I want to invest they'll put in a word for me.

Now o.k., 50% annual return for just handing your money over instantly makes my hackles rise. I'm supposed to recieve details on this, and if my friend is actually the one building the houses, does this sound like it has a chance of being real? Because, I'm not a millionaire, but I could scrape up 12 grand. Anyone heard of this kind of thing? Ask questions if there are any details you'd like.

 

[yakers]

Heard about things like this and if you are early enough in the cycle it can work out. If you are in a real estate growth area it is possible a reasonable proposition. But if the market tanks you get hit. I would not do this as I am risk adverse and I expect the market to decline. But I have friends and relatives who do business like this quite sucessfully. But occasionally deals fall out and there are some losses. They take the losses in stride, I couldn't. Damn cousin of mine made some serious money this way.

 

[wabmester]

The only question I would ask is why would they pay you 25% for a 6-month loan when a commercial lender will give them the money for, say prime+1%?

 

[brewer12345]

Laurence, you don't really have enough info to make a decision. Get more info, do your due diligence and see what the deal is. I'd pat particular attention to the risks involved. It could be a good opportunity or it could be a donut. If it looks good to you, try it, but only with play money amounts.

I participated in the IPO of a small (tiny) community bank in 2000. This was an unregistered sale of stock in a tiny company that had a limited operating history and to this day is not an SEC filer. Sounds risky, right? I did my due diligence, knew some of the directors, and I was able to look at several years of bank regulatory filings for info. It looked like a good opportunity, so I threw a little money at it. My investment roughly tripled in 5 years. They came back to shareholders to raise more money for futher expansion. I think their plan is a very good one, so I bought more stock. We'll see how it ultimately works out, but so far, so good.

I am also strongly considering buying a few tax liens in December, once again to see if I can find another nice investment. You never know until you try.

 

[retire@40]

Minimum investment is 12,000 and it's supposed to return 25% in six months.  Oh yeah, if I want to invest they'll put in a word for me.

The key word is "supposed."

Let me see if I can predict the future (and maybe you can return and tell us if I was right or wrong): After you fork over your "investment" and construction starts, there will be some unexpected expense or an increased adjustment to the original budget. They may come back to you and the other investors asking for additional investments to cover the shortfall. At the end of the project chances are that construction costs will be greater than anticipated and the investors will be lucky to get back their original investment.

 

[wildcat]

L -

Get the details. Remember this may not be a liquid investment and the time factor could add to the risk (i.e. the longer it sits on the market). If you know the area well then you should be able to make a pretty solid risk/reward decision. I am all for calculated risk. Gotta take 'em every now and then. If you do invest and it does not work out, will things get weird between you and your neighbor?

 

[cube_rat]

I've been on the finance side of RE development before crossing over into IT (long story  ).  There's a significant burn rate with RE development projects.  If not managed properly, and I mean managed by someone who knows what the heck they're doing, you could stand to lose your investment and then some.  Also, the real estate market moves generally in slow cycles.  We are starting to see a cooling off in certain areas of california.  Up here in the bay area, inventory is moving at a slower rate.  Prices are being reduced in certain pockets of the bay area.  

A developer may go into partnership with the land owner or pool together a group of investment capital from private investors.  We sometimes carried notes and paid the investor interest the borrowed money or paid them back their capital plus profit based on their pro-rata share.  I won't go into the legal entity crap that a developer has to do minimize tax impacts for it's investors(some of you are aware of the 1986 tax reform act).

I with Wab on his thought.  Developers go out and secure construction loans with a lender.  Money is drawn down in increments as houses are built (foundation gets XX dollars then framing then....).  I frankly would be leary if someone wanted my money to construct homes.  Land investment would be a different story.

 

[TromboneAl]

Investment-wise, here's the scary phrase:

"...this is his first big break to truly be in charge..."

 

[peggy]

The only question I would ask is why would they pay you 25% for a 6-month loan when a commercial lender will give them the money for, say prime+1%?

As I understand it, commercial lenders can generally only allocate a certain amount or percentage of their available funds for real estate development loans. In a fast-growing market, there may not be funding available from commercial lenders. Thus, the turn to private lenders (investors).

 

[cube_rat]

As I understand it, commercial lenders can generally only allocate a certain amount or percentage of their available funds for real estate development loans.  In a fast-growing market, there may not be funding available from commercial lenders.  Thus, the turn to private lenders (investors).

Good point, Peggy. However, this is why money is released in increments as the construction is built out over time rather then funding the project at 100% up front. Construction loans are very short term and the developer will have hopefully sold upon completion or he/she will need to obtain interim financing. I really don't think construction loans are drying up any time soon even in a fast market.

 

[justin]

Do due diligence. Get a personal guarantee from the principals involved. 300 units puts this project in the $100,000,000 range I'm assuming given CA's real estate prices. These developers may need start up capital to get the ball rolling - legal work, engineer work - site survey, geotech reports, traffic analysis, architects, all stuff the bank needs before they'll issue construction loans. The developer has to pay his people before he can get commercial financing. It's a risky business, since the CA market could collapse and you might never get your money back.

Undercapitalization may be an issue - if the developers need more money to carry the project, can they get it.

 

[laurence]

You all touched on things I wondered. My first question to my friends was, "so have you seen the environmental impact report? The EPA isn't going to say this is the last habitat of the three-toed hopping desert mouse, right?" and I was met by blank stares. This morning my car pool buddy said, "If that's the area I'm thinking, I ride my dune buggy out there, often over land graded for housing tracks that never got built"

I'm going to get more details. Wab, Cube_rat, that was my thinking, why can't he secure the money with a construction loan? Thanks all, just making sure nobody could tell me, "Oh! That's like IPO's and you have first right to buy! You can't lose <insert believable technical jargon here>. Go for it, Laurence!" ....I want to believe.

 

[Sheryl]

Investment-wise, here's the scary phrase:

"...this is his first big break to truly be in charge..."

Danger Will Robinson!

Being in the construction industry, this one set off alarm bells with me too. What is the largest project this guy previously succeeded at?

 

[laurence]

Well, he and his Dad are a small business (we will call them Smith and son) that have done commercial as well as residential work. He's been subcontracted out to a lot, been about ten years in the business, his Dad 30. But yeah, I don't know if I want him learning on my dime.

 

[cube_rat]

L - With their combined years of experience they can build or remodel houses or commerical properties. However, a large scale residential development project is a whole other ball of wax. There are so many gotcha's that a project that size needs to be run by folks with hard core experience.

I worked for a high end developer in San Francisco. When I say high end, his condos sold for 2mil+ in 1997. He would turn out 2-4 units a year. He made a lot of money for himself and his investors, but not without a lot angst. He's seasoned, well connected, has a GC & RE Broker license, AND is a real estate attorney and he still had the gotchas he had to oevercome.

 

[Nords]

You all touched on things I wondered.  My first question to my friends was, "so have you seen the environmental impact report?  The EPA isn't going to say this is the last habitat of the three-toed hopping desert mouse, right?" and I was met by blank stares.  This morning my car pool buddy said, "If that's the area I'm thinking, I ride my dune buggy out there, often over land graded for housing tracks that never got built" 

This housing project wouldn't happen to be near an old military base with a groundwater contamination problem, would it?

The smart money has to be all over this by the guys who can spit out $12K as .0001% of their diversified investment portfolios. By the time they come around to us suckers almost-accredited investors there's a reason.

 

[Martha]

Sounds like potential security violations to me. The "offering" of the opportunity to make loans or put in equityin a project is a securities offering. You probably have to be an accredited invester for them to make such an offering to you without violating securities laws. If they aren't following the securities laws, I would stay away.

 

[wabmester]

Good point, Martha. I was going to mention that but I wasn't sure if real estate investments were "special."

I'm constantly amazed about two things:

1) Investment scams are widespread. I live in a relatively small town (20,000), and one of our local boys bilked $90M from investors using a network of people who solicited mostly from church members.

2) The SEC has got to be the weakest regulatory agency on the planet. Don't count on them for saving you from (or investigating) even the most blatant cases of security fraud.

 

[laurence]

O.K., so you guys have convinced me to shy away, but do I say anything to my friends? He's going to be putting his career and his money in this!

 

[wabmester]

Unless you have hard evidence that it'll hurt them, you shouldn't try to talk them out of it. The best you can do is say that it sounds a little too risky for you, ask them some probing questions (like, can I see the prospectus? is this regulated by the SEC? what are my downside risks? etc). If they can't answer, then at least the questions might seed doubt in their minds.

 

[saluki9]

2) The SEC has got to be the weakest regulatory agency on the planet. Don't count on them for saving you from (or investigating) even the most blatant cases of security fraud.

HA! I take it you've never been through an SEC audit. They can be impossible to deal with and very strictly enforce their rules. However, the SEC is a picnic compared to the NASD.

You can't expect them to be listening in to people's houses whenver a friend or neighbor offers you to invest in something.

 

[saluki9]

Good point, Peggy. However, this is why money is released in increments as the construction is built out over time rather then funding the project at 100% up front. Construction loans are very short term and the developer will have hopefully sold upon completion or he/she will need to obtain interim financing. I really don't think construction loans are drying up any time soon even in a fast market.

I've invested in some of these with an established builder and they have returned the promised 12% carry + 1/3 share of the profits. What they tell us is that the reason they need our seed money on projects is that the banks will not give loans until 1/3 of their units are sold which is why they need investors.

 

[CybrMike]

are u in indiana?

Good point, Martha. I was going to mention that but I wasn't sure if real estate investments were "special."

I'm constantly amazed about two things:

1) Investment scams are widespread. I live in a relatively small town (20,000), and one of our local boys bilked $90M from investors using a network of people who solicited mostly from church members.

2) The SEC has got to be the weakest regulatory agency on the planet. Don't count on them for saving you from (or investigating) even the most blatant cases of security fraud.

 

[ats5g]

Good point, Martha. I was going to mention that but I wasn't sure if real estate investments were "special."

I'm constantly amazed about two things:

1) Investment scams are widespread. I live in a relatively small town (20,000), and one of our local boys bilked $90M from investors using a network of people who solicited mostly from church members.

2) The SEC has got to be the weakest regulatory agency on the planet. Don't count on them for saving you from (or investigating) even the most blatant cases of security fraud.

Then don't go to Europe where they don't care about insider trading. Or South America where they have fake stock exchanges.

- Alec