What is a Merchant Builder?
Merchant builders, also referred to as merchant developers, are those developers that build properties and sell them, rather than holding onto them for longer periods of time. In many cases, merchant builders trend toward the construction of single-tenant commercial buildings. This can often be explained by the fact that, much of the time, merchant builders don’t build on spec; instead, they develop a building with a specific tenant in mind, typically a national brand such as a Wendy’s or a CVS.
After developing the property and leasing it to the tenant, a merchant builder will generally sell the property to one or more investors. Generally, the tenant will have signed a long-term, double or triple net lease, increasing the profitability of the property and thus making it easier to sell to potential investors.
Investor/Developer Partnerships for Merchant Builders
Much of the time, merchant builders partner with investors, who will often contribute the majority of the capital required for the deal. In some cases, they will sell the finished building to a third party, while in others, the merchant builder/developer will sell their share of the building to the investor(s), giving them full ownership.
For instance, if a merchant builder wants to build a $5 million single-tenant property for a drug store, and can get commercial financing up to 75% LTV, they will need a down payment of about $1.25 million. Developers often contribute about 10-20% to such deals, so, with a 15% contribution, the developer will put down $187,500, the investors will contribute about $1.06 million, and the developer will have a construction loan of approximately $3.75 million.
If, at the end of the building period, the building is sold for $6 million, this would leave the developer and the investors with about $1 million in pre-tax profit after the repayment of their construction loan. In most cases, both parties will agree on preferred return for the initial equity they have invested in the project, which can be implemented in a variety of different ways. For instance, if the preferred return is 15%, the developer/merchant builder would receive $28,125, while the investors would get around $159,000. The remaining $850,000 or profit is likely to be divided more equally between the developer and the investors, with a 50/50 arrangement being somewhat common. This would provide about $425,000 in returns for both parties.