The sponsor's cost overrun came in ahead of my 25k in the stack

I back these because I know renovation work and I thought that gave me an edge reading the scope. It gave me an edge reading the scope. It gave me nothing on the capital stack, which is where the money actually went.

9 unit walkup, full gut on eight of the units, sponsor's budget was 310k for construction on a 1.9m all-in basis, 18 month plan, 8% preferred return to common equity then a 70/30 split. I looked at the scope line by line and thought 310k was tight but defensible if they held finishes and didn't touch the building envelope. They touched the envelope. Roof deck was rotted under the membrane, two units needed the joists sistered, and the electrical service upgrade the plans assumed was a panel swap turned into a new service drop with utility scheduling. Final construction number was about 470k.

Sponsor funded the 160k overage with a mezzanine piece from a lender they'd worked with before. That piece sits ahead of common equity, 14% current pay plus fees. The operating agreement allowed it without a member vote, which I'd read and understood as a normal flexibility provision, and which I now read as the sponsor holding the right to put someone in front of me on their own cost overrun.

Sale closed at month 22 at 2.42m, which is honestly a fine outcome for the property. After the mezz was paid current pay plus exit fee, my accrued 8% preferred was partially paid and there was nothing above it. I got 25,600 back on 25k, so 1.02x over 22 months. The sponsor's promote was zero, to be fair to them.

What I'd do differently. On any reno deal, ask before funding what happens if construction runs 50% over, specifically whether the fix goes in ahead of common equity or comes as a capital call to existing members. And discount any budget that doesn't carry a contingency I can see, because 310k on eight gut units had roughly nothing in it for the things a 1920s building always has.

4 replies

-1priya_n21PO1C

So you did the work, you read the scope, you were right that the budget was tight, and you still ended up at 1.02x. That's the part that unsettles me about deal-level participation. The skill you brought wasn't the skill the outcome depended on.

1ehernandez74PO2BPRO5

Two questions. Did the offering show a contingency line at all, or was 310k presented as the whole construction budget with no cushion? And did the quarterly updates flag the roof before the mezz closed, or did you learn about both at the same time? I'm trying to understand whether there was a point where an investor could have seen this coming.

1devon_pierce Get yoursPRO5

@harrow the 8% preferred being only partially paid is the detail I'd have gotten wrong. I assumed preferred meant it gets paid before anyone splits profits, and I hadn't understood that a new piece of debt above it just eats the whole thing. Adding a column to my list for whether the sponsor can bring in senior capital without a vote.

1aaron_fitz10 Get yoursPRO6

Different cause in my reading. The envelope items you listed are the kind of thing a pre-purchase inspection with a roof cut and a couple of floor probes usually finds. That's a diligence failure at acquisition, before the budget was ever written, and the mezz was just the consequence. Whether an investor could catch that from the offering materials I don't know, maybe by asking what physical inspections were done and by whom.

The sponsor's cost overrun came in ahead of my 25k in the stack

4 replies