Have you been offered a great property investment opportunity – great location, exciting development potential, attractive returns? What about the development team itself – have you done enough due diligence (DD)? This part of your DD should come before analysing the deal itself. Here are those essential questions …
1. Show me the track record
Why is this important? Development is about identifying the opportunity and executing it. Executing matters because a good developer will squeeze more profits out of the opportunity and minimise risks. The track record will show this.
Questions to ask about track record:
- How many projects have you undertaken?
- Were those projects similar to the current offering? Eg if they are proposing a 120 unit mixed-use scheme, have they done this before? Look at type as well as scale of projects they have done
- Ask to see metrics on completed past projects: Return on investor capital (ROI), overall project timeframes, cost management (build cost/sqm), planning timeframes (from instruction to approval), efficiency of exit process for investors
- At completion, how close were these metrics vs initial projections? What was the degree of variance?
2. What’s special about your process?
Why is this important? To identify what makes the developer effective. Do they focus on one specialty (eg. blocks of flats in a particular city) or are they more opportunistic in considering numerous strategies in various locations? In property, both approaches work – as long as the developer possesses an “edge”, or competitive advantage, that makes them successful.
Components of the developers’s edge?
- A knack of finding great off-market opportunities?
- Having in-depth knowledge of the planning system?
- Specialist expertise in a particular niche – eg focusing on serviced flats.
- Ask to see specific deal history and if this confirms their favoured strategy
- Ask what would make them look at different strategies. Have they tried doing things differently before ? What was the result? Why does their favoured strategy produce better results ?
3. How good is the overall team?
Why do we need to know? A developer is only as good as the whole team. An effective developer needs to assemble a quality team around it.
This includes a planning consultant or architect to succeed in the planning process; a good QS for accurate costing; a good team of lawyers to efficiently structure the transaction and execute with minimal risks; and a great construction team and a project manager.
Make sure your developer doesn’t skimp on any of these important “team members”. Check credentials of each one.
As for the main developer him/herself. Check their reputation online: social media can be helpful to get an overall impression. Google them and see if they have been associated with any adverse stories/events historically.
Check out their historical business track record at Companies House. Note: having failed companies is not necessarily a sign of personal failure. It could be a great education in how to do things successfully. What is worrying is any evidence of malpractice, fraud etc.
4. Where is your “skin in the game” ?
It’s always a good sign if the developer has invested into the project. It aligns the interests of the investor to that of the developer.
Ideally this would consist of a financial investment by way of cash investment, a personal guarantee or a charge on assets. A material investment of time and other non-financial resources might also be taken into account.
Check if the developer is contributing any of this to the deal.
5. Are you answering my questions ?
A good developer will be open to lots of questions – it’s called good investor relations.
As a prospective investor, you need to perform detailed due diligence – so take this opportunity to ask lots of questions. The level of responsiveness will provide clues as to how helpful the developer will be after you have invested.
6. Show me the shareholder agreement
You must always read through the terms of engagement and the shareholder agreement. This contains critical terms which determine how the developer and investor(s) will work together. Not reading these documents is like buying a property in auction without reading the legal pack!
Amongst other things, focus on:
- What is the vehicle that legalises the arrangement? SPV, partnership agreement, LLP ?
- Does the SPV (assuming it is) have an accountant and solicitor that are independent of the developer? – highly recommended
- How are profit shares determined – eg does the developer take equity or are they paid as a “consultant” to the investor(s)
- Which costs borne by the developer are reasonably permitted to be expensed to the SPV?
- Under what circumstances can the investor relieve the developer of its duties ?
- What is the wind-up procedure of the SPV? Voluntary liquidation? Tax advantages of Entrepreneurs Relief?
- At which point does the developer get paid their profit share? Will it be before investors get paid ?
- How would disagreements be resolved? majority vote, 75% majority ?
- Is the developer a director of the SPV? If so, are they a voting member of the board ? This is not advisable
7. And … don’t be swayed by the marketing!
Social media provides an opportunity for anyone to raise their profile, regardless of ability. Don’t be sucked in by a glossy image that’s been designed to sell deals to investors. Serious investors should cut through the marketing to focus on proper analysis and DD.
All of this might well be time consuming, but is vitally important to assess how a developer will execute with your capital.
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Manish Kataria CFA is a professional investor with 18 years’ experience in UK real estate and equity portfolio management. He has managed money for JPMorgan and other blue chip investment houses. Within real estate, he invests in and owns a range of UK property including developments, HMOs, serviced accommodation and BTLs.
