Have been doing some thinking about ground up development of small-to-medium size apartment buildings lately.
We’ve not built ground-up before, but we’re getting closer and closer and I believe ground-up is likely to be a big part of our business mix in the coming years.
Here’s how I think about it: Assuming reasonable planning (eg the right product in the right neighborhood) and execution (eg not screwing up the construction), the returns are mostly dependent on the business cycle.
If you buy and build when times are bad, you’re likely to do quite well. And if you buy and build when times are good, you’re likely to do ok but not great.
But, if you take the long-term view that people will always want to live in LA and that it will always be hard to build here, you know that rents are likely to grow faster than inflation.
That means your margins are likely to improve over time. And that means that even OK deals will end up being pretty good ones over a sufficiently long time horizon.
So, I think there’s a strong argument for building a few buildings / year, pretty much every year (with the possible exception of the 1-2 years in each cycle where land prices are really, truly crazy). If you do this consistently for, say, 25 years, you will end up with something like 50 high-quality buildings in good locations.
Some deals will end up better than others, mostly due to extrinsic factors. But, viewed as a portfolio and managed appropriately, you’d have a cashflow monster which ought to spit out increasing amounts of free cash, even accounting for the occasional new roof, etc.