How does real estate development make sense?
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[{"id": "fpghsxx", "text": "The condo development will almost definitely not take 5 years to complete, meaning his annual rate of return will be much better than your index fund example. Obviously there is risk involved, but as we've seen in the stock market this year, you are certainly not guaranteed a 6% annual return there either.", "replies": [], "depth": 1}, {"id": "fpgi4f9", "text": "Value creation", "replies": [], "depth": 1}, {"id": "fpgiqdm", "text": "Because depreciation of assets offset tax liability and save you a lot of money in addition to the profit generated.", "replies": [{"id": "fpgl187", "text": "Condo developments don't take depreciation since the units are for sale not long term hold.", "replies": [{"id": "fpgl5rz", "text": "I was answering more generally about property ownership over owning stock but you\u2019re right. Unless this person was also going to reserve units himself or also handle sales or manage the units after. Actually, those are all better reasons than the one I previously stated.", "replies": [], "depth": 3}], "depth": 2}], "depth": 1}, {"id": "fpgjjq6", "text": "On a headache adjusted return. You\u2019re right.", "replies": [], "depth": 1}, {"id": "fpgjue4", "text": "Most real estate investors want a project that supports his vision. Likewise most money managers shuns the RE returns stating stocks are way easier to manage and do not want to be bothered with real estate which is not liquid.", "replies": [], "depth": 1}, {"id": "fpgjvgr", "text": "Condos are the worst. One problem in one unit means a class action in all the units. There is a reason why so few developers touch this, you need really good insurance as it is risky development.", "replies": [], "depth": 1}, {"id": "fpgkyiv", "text": "&gt; According to some sites, condo developments return 12-20%. My boss isn\u2019t a highly experienced developer so he\u2019s probably making 15% on his initial money in the project \n\nYou are using a generalization multiplied by an assumption. In other words, if you don't know the exact numbers there is no way to make this conclusion.\n\n&gt; Wouldn\u2019t developers make more money through passive investing than development when you include the taxes and risks and headaches? Can someone help me understand what makes development attractive? \n\nBecause you can use leverage to your advantage to increase your ROI. Can't really do that with the stock market to the same extent.", "replies": [{"id": "fpgpbwn", "text": "You can buy stocks on margin to increase your ROI, just like real estate.  The spreads are different though, but I can tell you leveraging accretive debt to increase investment returns is not something special to real estate.  Also not special to real estate is getting your returns pantsed because you can't cover debt service without calling equity, which decreases your returns vs playing all-cash or at a lower leverage", "replies": [], "depth": 2}], "depth": 1}, {"id": "fpgltyl", "text": "Are there tax credits involved? Do they get development grants? The government loves to give bonsuses to certain kinds of development deals which can be applied across the rest of his portfolio? Is he scraping development credits from the other properties to increase the size/value of this development?  \n\nThe math and levers in development are many, and to simplify it down is not going to give you a proper comparison. The proper different asset comparison tool is an IRR, and you can't boil an IRR down to simple assumptions.", "replies": [], "depth": 1}, {"id": "fpgn0ip", "text": "I can almost guarantee he\u2019s solving to higher returns. Is he the entire equity stack? Does he hit a pref above a certain point? I\u2019d be pretty surprised if he\u2019s not anticipating at least 1.5x his money on this. Why not ask him for his anticipated returns? He\u2019s likely stressing because a condo developer in a recession is not a good place to be. \n\nIf your return assumption is right, then an index fund would likely make more sense on a risk adjusted basis.", "replies": [], "depth": 1}, {"id": "fpgqdcu", "text": "Your math is wrong.  \n\nIf the project costs $10m and he's leveraging so he only has to put down $4m (say an SBA loan) then at 15% he's going to earn $1.5m on $10m with only $4m out of his pocket.  He's earning 1.5/4 = 37.5%.\n\nWebsites can't take into account financing because they don't know what kind of financing you can get.  6%, 4%, 10% down, 25% down?  It makes a huge difference so all they can do is give you a return on total development costs.\n\nYou can leverage in the stock market also by going into margin but that's got the risk of margin calls... ask anyone who's leveraged heavily at the beginning of this year... or last.  You don't get that 6%.  Instead you lose 15% in January... it'll come back and average 6% so just sit there?  No, margin call... forced to sell when its down 15%.  Also, you can usually only margin at 50% of worth not like this condo project where he's leveraging at 150%.", "replies": [], "depth": 1}, {"id": "fpgrpla", "text": "Depending on the index fund, there's real estate included, usually in the form of public REITs.  However, securitized real estate, like buying a piece of CMBS or buying REIT shares, doesn't have the exact same risk component as the underlying real estate. (They're related, but it's not 1:1, there's a few other factors that matter). You're getting into the world of financial services though, but basically, you pay an expense ratio on your index fund for having someone hold the stocks that compromise the index and packaging them into index funds.  The index funds hold REITs, who take in fees by the people managing the REIT.  If the REIT is an LP investor, they are also paying the GP a premium for their \"sweat equity\" through uneven waterfall structures. Some GP's run their own property management too. Underneath that is the actual piece of real estate.  You can cut down the fees paid/convert \"sweat equity\" into actual equity at any point in the chain. Also the actual real estate is less liquid than index funds, but also less risky-the liquidity premium is priced in.  If they started pre-COVID, they might not make the 20% return, but unless they built hotel or non-grocery anchored retail (which the return expectation was already much higher), they're not going to lose as much as people who started pre-COVID in an index fund.  It also matters which index fund, but any major market index took a hit so far.", "replies": [], "depth": 1}]