Takeaways
- Highest and best use impacts the market value of a development site.
- When there’s a dislocation in current use and market demand, seize the opportunity.
- Selecting the right sponsors and investments mitigates risk and provides outsized returns.
In December 2021, Beyond International partnered with Relevant Group to facilitate the acquisition and entitlement of a redevelopment site in downtown Los Angeles. It was a tremendous opportunity to create value, recognizing that the existing improvement, an older industrial building, no longer represented the property’s highest and best use. We provided Relevant Group, the developer, with the capital it needed to both acquire the property and complete all the predevelopment activities that were needed to fully entitle it with approvals to build a 16-story, mixed-use building with apartment units over street-level retail.
Summary of Investment Returns
By the end of 2023, our capital had been repaid as agreed, allowing us to provide our investors with an annualized internal rate of return (IRR) of 30.4% and an equity multiple of 1.7x over a relatively short-term holding period of 24 months. These very favorable results were possible due to the power of highest and best use. More to the point, they were possible because Relevant Group recognized the untapped potential of the site and we recognized their potential to successfully take the project from the predevelopment stage to the construction stage. Our capital was repaid through construction financing, which was only obtainable once the site was fully entitled.
Investing Basics
Let’s break it down a little bit more. In this case, an equity multiple of 1.7x equates to your investment appreciating by 70% over the holding period. Here’s an example based on the actual returns. If you had invested $100,000 with us in December 2021, we would have returned $170,000 to you in December 2023. In other words, you would have earned a total of 70% on that investment over the 24-month holding period. $170,000 divided by $100,000 equals an equity multiple of 1.7x.
What are Land Use Entitlements?
For those of you who might not be familiar with the entitlement process, it’s the process of obtaining all the necessary approvals, or entitlements, from the appropriate governmental authorities to develop a site for a specific use, density, or building type, just to name a few possibilities. It can be an extremely complicated process, one that’s typically time consuming and expensive because approvals may be required from authorities at the city, county, state, and even federal level. Construction of a new project cannot start until the applicable entitlements are obtained. For this reason, the expectation is that a fully entitled development site, which is sometimes described as shovel ready, will always be worth more than the same property without entitlements.
Specifically, as it relates to our case study, a site that can be redeveloped with a high-rise apartment building is worth a lot more than a site that was previously only approved for the development of a one-story industrial building. That’s why this investment was so successful. Obtaining the entitlements made all the difference. The multi-family component of the project is now entitled for 398 units, which actually includes a density bonus for setting aside a small number of the units for low-income households.
Partnering with the Right Sponsor
Located in the heart of one of the strongest multi-family sub-markets in Los Angeles, the redevelopment site is within walking distance of Crypto.com Arena, which was formerly known as the Staples Center, as well as the Los Angeles Convention Center, L.A. Live, the central business district, a light rail station, and a plethora of neighborhood retail, dining, and entertainment options. The existing industrial building on the subject site, which was built in 1922, by the way, no longer represented the property’s highest and best use. It was out of character with the surrounding land uses. In urban markets like Los Angeles, locating redevelopment opportunities like this, ones that are created from a dislocation in current use and market demand, is essential to success as a developer.
That’s always top of mind as we seek out developers in need of capital. We only partner with a sponsor after doing enough due diligence to fully understand their expertise and capabilities. Relevant Group has an excellent track record of successfully developing both multi-family and hotel projects in Los Angeles. Through these successes, they’ve earned a reputation for developing place-making destinations that enliven urban neighborhoods. That was encouraging, but we gave more weight to their expertise in entitlements. After all, our exit strategy in the investment coincided with the repayment of our capital from construction financing, which could only be obtained once the site was fully entitled. Relevant Group has an in-house team of development and entitlement experts. It’s one of the reasons why each of their last 11 projects made it through the entitlement process, and that gave us confidence in a certainty of execution.
Always Be Selective
As an alternative investment management firm, we pride ourselves on having the patience to be selective. It’s highly motivating to know that our investors entrust us, not only with their capital, but more importantly with their confidence. This case study has been only one such example of how selecting the right sponsors and investments serves to both mitigate risk and provide outsized returns. These are reasons why many of our investors have repeatedly participated in our opportunities. If you would like to learn more about our firm or any upcoming investment opportunities, please contact us.
