The Fox and the Henhouse: When Your Development Partner in a Real Estate Project is Also your General Contractor

John Mallinson, Managing Director and Deputy General Counsel, American International Group Inc.

Private investment in real estate may be broadly divided into two general categories: 1) acquisition of land with buildings that are already built, and 2) the planning and building of new projects. The latter category is commonly referred to as real estate “development.” Large and important real estate development projects throughout the world, whether they be for office towers, shopping centers, apartment buildings, hotels, mixed-use complexes and the like, require two things, generally speaking, to be successful: 1) considerable real estate expertise and organizational infrastructure in such areas as site selection, land acquisition, design, permitting, construction and construction management, marketing and leasing, and 2) an often significant amount of equity risk capital. In some instances, the party performing the day-to-day planning and execution of the project (i.e., the “Developer”) also has the wherewithal and desire to provide the risk capital. More typically, however, the role of Developer and principal financial sponsor are bifurcated and performed by separate parties. A Developer, after locating and conceiving the idea for a project, will seek out a financial partner (“Financial Partner”) to provide a significant percentage of the required equity capital for the project, oftentimes up to as much as 90%-95% of such required capital. The Developer will typically contribute the remaining and comparatively smaller portion of the equity capital and the balance of the funds needed to complete the project will be supplied by a third party construction lender.