GreyBrook logotype
Investor Login Contact Us

Investing in the Manufacturing of Housing – 5 Things You Need to Know Before You Do

Date:
June 8, 2020
Share:

What is an investment in the manufacturing of housing? On a small scale its an individual or a small builder purchasing a lot, building a new home and selling it to generate a profit. On a much larger scale this refers to the acquisition of land, and the development and sale of hundreds of new homes (condominium towers, multifamily buildings, master-planned communities) brought to market by top tier real estate developers.  The latter is a capital-intensive business in which developers typically rely on a universe of investment partners that include large institutional investors, pension funds, ultra high net-worth families, and more a growing number of qualified individual investors able to make smaller investments in projects.

Investments in this segment of the real estate market can offer compelling investment returns, and as such, has attracted the attention and investment of thousands of people eager to participate in an asset class to grow their investment capital and diversify their investment holdings.

While these types of investment opportunities are very compelling, if you are considering an investment in this real estate segment, it is important to understand the following five aspects of the deal before making an investment.

1. Understand the investment thesis and development plan

The first thing you need to have a clear understanding of are the specifics of the proposed development and the key assumptions that are being made by the organization or team offering the investment. At a high level, it can be useful to divide your assessment of the opportunity into two categories; consideration of the macroeconomic investment thesis, and an understanding of the project-specific development plan.

Macroeconomic Investment Thesis

You should understand the type of development being proposed and take the time to think through the key factors that can determine its success or failure.

  • Does the proposed development consist of residential housing within a community, or is it a secondary development such as a vacation property or resort?
  • Is the development site located in an urban, or a suburban setting and do its proposed characteristics “fit” the present and future needs of the community?
  • Is the community / sub-market where the proposal is being made growing or shrinking?
  • Is there stable demand for the types of homes being proposed and is the current supply sufficient or in short supply?

At the most basic level, investors should assess if the market has a stable or growing demand for the housing type being proposed. Ideally, preference should be given towards markets that demonstrate strong long-term fundamentals such as consistent population growth (through migration or other factors), a well-diversified economic and employment base, and a shortage of housing that is driven by persistent factors such as industry capacity constraints, planning restrictions, or other structural factors rather than short-term dislocations in supply that can be easily resolved.

Project-Specific Plan and Assumptions

Simply looking at the expected return (whether high or low) without understanding if the key assumptions being made are conservative, reasonable, or aggressive does not provide a sufficient basis to determine if the investment is worthwhile or not. Ask questions to understand the underlying project assumptions and to determine whether or not they are reasonable.

  • What are the current or future entitlements for the development site? Has the municipality designated the land for residential use, or another use such as industrial, agricultural, commercial, employment, etc.? If not, will the developer attempt to convert to a residential designation and what steps may be required?
  • What are the municipal planning assumptions – for example, is the proposed plan aggressive or likely to be supported by the municipality that must approve the plan?
  • Are the pricing and revenue assumptions reasonable?
  • Consider the timeline being proposed. Ask questions to determine if it is too aggressive (e.g., how long will it take to sell 500 homes)?
  • Finally, understand what future financing needs the project may require. At the time of your investment, does the project have all of the capital it needs to proceed to through to construction, or will the GP/Sponsor need to secure additional capital in the future on potentially different terms?
2. Understand the Capital Structure

The capital used to fund large-scale development can take many forms. Developers (sometimes referred to as Sponsors) often use a combination of equity, preferred equity or mezzanine debt, and senior debt to fund their projects. Understanding the differences between each type—as well as the structure of the investment vehicle being used—will help you to properly assess the risk/reward trade-off being offered by the investment under consideration. The level of return you should expect is fundamentally related to the degree of risk involved, and properly understanding the investment structure will allow you to better assess if the risk/reward for the investment is appropriate for you, given your individual objectives/preferences.

For our purposes, we will consider an equity investment in this asset class.  As a common equity holder, you would receive either a direct or indirect ownership interest in the development. Equity investments come with certain entitlements, including most importantly direct and uncapped participation in the profits of the project if it performs well. However, equity bears more risk within a development’s capital structure, as it is usually the first money in and last money out. Thus, the structure used to make an equity investment and the protections and entitlements offered are most critical in assessing whether an equity investment is worth pursuing (i.e. does it offer an attractive risk/reward trade-off). Equity investment returns can vary widely but typically are between 16% to 20% average annualized returns.  To learn more about the various types of capital within a typical real estate capital stack, read our post Understanding the Real Estate Capital Stack.

3. Understand the Investment Structure

Next, as an investor you need to understand the investment structure. The typical private equity real estate investment structure is a limited partnership (LP). In a limited partnership, the General Partner (GP) is responsible for making decisions alongside the day-to-day manager of the development (the Sponsor) and representing the best interests of the LP (the equity investors in the project). The GP has certain legal obligations to perform on behalf of the LP, though the degree of “protection” and “upside” that limited partners are entitled to is determined by the very specific terms of the joint venture that’s established between the LP and the Sponsor.

A good GP is not only focused on generating a profitable outcome for limited partners, but also negotiates several protections within the joint venture agreement that helps protect equity investors and ensures that their risk/reward trade-off is maximized. Investors should ensure that the Limited Partnership contains several key investor protections that a GP can exercise on their behalf. Good investor protections include, but are not limited to:

  • Major decision making – the ability for the GP (on behalf of the LP) to be involved equally in major decision-making rights opposite the Sponsor;
  • Dispute resolution – an agreed upon method for resolving potential disagreement between parties; and
  • Default provisions that allow for the GP to remove/replace the Sponsor in the event of default (insolvency or failure to fulfill their financial obligations).
4. Be aware of the Risks

Regardless of whether you choose to invest in the equity, preferred equity/mezzanine debt, or senior debt (if it’s available), it is critical to review and understand the risk factors. The GP (or Sponsor) should be adequately identifying and addressing these risks in the form of a comprehensive information memorandum, investor presentation, as well as through discussions with qualified representatives of the GP/Sponsor.

Investing in development is about understanding not only the upside potential, but also the potential risks that exist and getting comfortable with the GP/Sponsor’s experience and ability to mitigate them successfully. While each development project is different, we will touch on a few potential risks.

  • Timeline risk – Experienced GPs and Sponsors have the in-market experience to make well informed assessments of the overall project timeline from acquisition through to completion. However, it is not uncommon for the timeline to change as the project progresses and the management team works to seize new opportunities to maximize returns, or to mitigate potential risk. Taken as a whole, these changes can increase or shorten the overall timeline of the development.
  • Use of leverage in the land acquisition – Development projects can be capitalized using a combination of debt and equity (preferred and common). How the GP/ Sponsor uses each within the overall capital structure and their overall proportion is a primary determinant of the project’s risk profile. In a simple example, if a project is highly leveraged, and the development plan includes aggressive timeline assumptions that do not materialize, the project could be burdened with large interest for a longer than planned period of time, that could put the project at risk.
  • Risk to the plan’s feasibility (Entitlements) – In many cases, developers will require a period of time to complete the project’s planning and obtain the necessary permissions to go ahead with a development plan. It is important to evaluate the planning assumptions and legal entitlements that a developer/Sponsor is relying on to determine whether it’s reasonable to assume their plan will be successful within the municipality’s planning framework. If the project is unable to obtain required legal entitlements, the risk is construction of the development may not proceed.
5. Ensure you are comfortable with the Execution Team

Last, but certainly not least, the strength and quality of the team that is responsible for executing the development plan is of paramount importance.

  • Who are they and what are their qualifications?
  • Do they have a proven track record?
  • Does the Sponsor have “skin in the game”?

Regardless of the investment thesis, plan, or assumptions made, the on-the-ground execution and the decisions being made by the GP and Sponsor are the primary determinants of a project’s success or failure. It’s important to be comfortable with the quality of the team, and to make sure that within the investment structure, your incentives as an investor are aligned with those of the execution team. 

The Bottom Line

Private investments in residential real estate development can offer attractive investment returns. However, it’s important to understand the benefits and the risks associated with each development and to ensure that these investments fit with your investment goals. If you are considering an investment in large-scale residential development, it is highly recommended that you also engage in a discussion with an expert who can help you further assess the merits of the investment opportunity.

At Greybrook, we provide qualified investors with direct access to institutionally-underwritten and professionally managed, residential real estate investment opportunities. We exclusively participate as an equity partner in large-scale residential developments and have partnered with some of North America’s largest developers (Sponsors) on the development of over $15 billion worth of residential real estate in our chosen markets. Our team of Capital Markets professionals support over 7,000 individual investors, and are equipped to help you better understand and assess whether investment opportunities in this asset class are right for you.


Contact us to learn more or to speak with one of our investment representatives.

Latest Insights

The Elser Hotel & Residences Miami Successfully Closes on $80M in Sales in Less Than 60 Days

January 20, 2023

Greybrook and PMG are pleased to announce The Elser Hotel & Residences Miami, a 49-story new construction luxury condominium located at 398 NE 5th St., has successfully closed on $80 million in sales in less than 60 days. This immense…

Emerald Crossing Welcomes First Wave of Homeowners

January 20, 2023

Homes in the first phase of the development will continue to close throughout 2023. This development is divided into two phases, 138 homes in Phase 1 and 119 homes in Phase 2, including 70 premium lots that back onto protected…

Waterside Villas in Whitby Nears Completion

Portfolio Updates
January 15, 2023

Construction has progressed on the remaining blocks of townhomes in the development with only one block of townhomes left to be completed. Home closings began in Q2 2022, with the final closings slated for the end of Q1 2023. Located…

Greybrook Invests $41,545,000 in a High-Rise Residential Development Project with Tribute Communities in Whitby, Ontario

Portfolio Updates
January 13, 2023

Greybrook Realty Partners Inc. announced today the successful closing of an equity investment by its managed issuer of $41,545,000 to acquire and oversee the development of a parcel of land located on the west side of Charles Street between Victoria…

Watch Greybrook’s 2022 Sizzle Reel – A Year of Milestones

January 12, 2023

Watch our 2022 Sizzle Reel Over the past year, we invested in our 100th real estate project and surpassed $2 billion of equity capital deployed. Having achieved these major milestones, our portfolio is now valued at over CAD$30 billion of…

The Regional Municipality of Durham – A Region on the Rise

Insights
November 30, 2022

Greybrook has been investing in the growing region since 2017 and is continuing to actively evaluate both low-rise and high-rise investment opportunities to meet the needs of Durham Region’s growing population. Click here to view Greybrook’s portfolio in Durham Region…

An Inside Look at The Elser Hotel & Residences Miami

Multi-Family
November 29, 2022

On November 17th the Development Team celebrated the official launch with a ribbon-cutting ceremony that also marked the launch of the hotel component at The Elser alongside our partner, PMG, and industry leading hospitality management company, Highgate. The hotel welcomed…

Construction Progress Continues at 181 East in Toronto

November 28, 2022

With excavation now complete and the first of two cranes erected, the construction team is now pouring the ground floor on the western portion of the site and expects to have the underground garage fully formed up to grade in…

Greybrook CEO Peter Politis Featured Guest on the CashFlow Pro Podcast

Uncategorized
November 21, 2022

Watch the episode below. In the episode titled “Real Estate Investing in Development”, Peter discusses Greybrook’s Society Living platform to an engaged audience of hands-on real estate investors. He shares the unique selling proposition of this national platform – affordable…

Velo Blu Pedal for Blu Genes Charity Ride Raises Over $430,000

Uncategorized
November 15, 2022

Watch the 2022 Velo Blu Highlight Video What started as a personal mission to find a cure for a rare and fatal genetic disorder called Tay-Sachs disease soon became a larger vision of raising funds and awareness to advance gene…

All Publications

Join our newsletter and keep up to date with our news & insights

Contact us