Construction Financing: The Developers Prospective
Developing real estate takes grit, creative problem solving, and an occasional after-work drink at the local bar. And, as banking protocols have evolved over the past decade, developers need to be selective when it comes to choosing a General Contractor (GC) for each project. But what exactly should developers look for in a solid General Contractor? What qualities make a GC or an AEC (Architectural/Engineering/Construction) firm investable in a project?
To find out, we interviewed several prominent Chicago-based developers to learn about their standard criteria for what makes a GC investable. Across the board, we found that developers care most about the GC project team’s personalities as well as their resumes and portfolio of work. This likely comes as no surprise. When hiring for any job, the client wants to be sure the people hired can do the job and play well with everyone on the team.
How to tell if a GC is Investable
We wanted to dive deeper into aspects specific to developer/GC relationships. So, we asked developers for their next most important way to tell if a General Contractor is investable. The answer? The alignment of the size of the asset class in the GC’s portfolio. Put more simply: size matters. It’s important for the developer to see a completed build on the same scale as their open project in the general contractor’s portfolio.
One of our respondents said seeing large projects in a GC’s portfolio is “critical” to developers. “Large” projects were defined as those nine stories and higher, so a large build’s added complexity, longer timeline, and the need to balance a larger budget explain why work samples are so crucial. Of course, smaller projects fall under this same scrutiny. However, the bigger the project, the more selective developers become.
Financially Viable GC’s
Developers need to know a contractor or AEC firm can provide both quality construction and bookkeeping. Therefore, the next aspect our interviewees check is the construction cost proportion of the project size as compared to the contractor’s overall annual gross revenue. To check this, developers ask questions like: Has the general contractor completed a single project that is greater than 25% of their total gross revenue?
Over the last decade, there has been added scrutiny and need for proof of financial viability on development teams. These requirements are then passed down to the general contractors and AEC firms they hire, so according to our interviewees, there’s a significant emphasis on qualifying the GC’s financial viability.
Developers are feeling challenged more than ever to find investable general contractors for larger projects. With smaller projects (eight stories and under), the GC’s resume, budget, and team are the main drivers, with financial viability coming in later. However, financial viability is the tipping point for larger projects, like those nine stories and higher. Developers are placing an ever-higher demand for the GC’s balance sheet health and capabilities for providing a Completion Guarantee (which is often less expensive than bonding).
The global pandemic has also had an effect on the search for investable contractors. The equity-to-debt ratios have changed dramatically from the pre-COVID era to now. Since the onset of COVID, there has been an increase in these ratios, thus the demand to raise higher equity on the capital stack is another barrier.
The developers we talked to came to the consensus that new relationships cost a lot of time, money, and extra due diligence. That’s why it takes an extortionary effort to hire a new AEC firm.
“That’s why it’s often easier to just work with a past relationship because you know what you’re buying,” said one of our interviewees. For GC’s, understanding the capital stack demands and challenges developers face is as important as completing a construction project on time and within budget.
We’re so thankful to the developers who shared their insights with us. At Summit Design + Build, we place an emphasis on our portfolio’s wide range and our financial viability to become the kind of investable general contractor developers need.
Summit Design + Build has a well-positioned balance sheet, and financial capabilities to make it easier on developers when they’re trying to close with their equity and debt partners. From project concept, through pre-construction, Summit helps developers close their deals.