UNIT 5.

REAL ESTATE FINANCE AND INVESTMENT

1. READING
Project Development Financing- An Overview
The developer may use equity or combine equity with debt financing to acquire the land,
perhaps after taking an option to purchase the land. The developer may provide the equity
capital, or it may come from a partnership between the developer and the landowner or
other investors. Should the developer expect to move forward on the project immediately
after land acquisition, he may negotiate a loan for the cost of constructing improvements,
providing his equity requirements from one or a combination of the sources just described.
Generally, the loan used for funds to construct the building and other site improvements is
referred to as a construction, of interim, loan. This loan usually comes from a commercial
bank, a mortgage banking company, or in some cases, a savings and loan association. It
generally is used to fund all the hard costs of construction such as materials and labor for
site improvements. However, it may also cover some soft costs, such as leasing costs,
planning costs, and management. It may also include some of the costs of finishing the
interior space for tenants through the lease- up stage. If the developer owns the land free
and clear of debt, it may also be possible to obtain additional financing using the value of
the land as security. Lenders prefer to make loans only for the cost of site improvements.
However, in a rapidly expanding market, competition among lenders may result in more
flexible lending policies. Also, in most cases when interim financing is sought, the
developer is personally liable for the note. When construction is complete and the project
is leased, the lender may fully or partially release the developer from personal liability. At
this point the note becomes nonrecourse against the borrower/developer.
There are three general loan structures that are used to finance development. Generally, the
structure chosen will depend on what the developer expects to do with the property after
construction and leasing are completed. In most cases developers expect to do one of three
things:
1. The property may be sold upon completion and lease-up to investors who want to
own real estate but who do not want to bear the risk of development and initial
leasing. In this case, the difference between the developer’s cost and the price
received for the completed property represents profit to the developer. In this case,
the developer will usually consider short-term financing structures.
2. The developer may retain ownership with the expectation that she will continue to
manage, operate, and lease the property as an integral part of her business. Many
developers maintain relationships with tenants and may have opportunities to
 develop and lease to them in future expansion becomes necessary. In this event, a
developer will seek a longer-term financing structure. This may consist of two loans,
a permanent loan and a construction loan.
3. A developer may consider the sale or refinancing of a property upon completion.
This is an option that combined elements of (1) and (2) above. In this case, the
developer may seek short-term construction financing, couple with either an option,
or a commitment, to extend financing for one or two years beyond the construction
period. This allows additional time beyond construction to (1) prepare the property
for sale, or (2) provide actual financial data from operations to lenders. The latter
may provide the opportunity for refinancing at more attractive interest rates as the
project should be less risky to lenders. Many of these loans may have maturities
ranging from five to seven years and are commonly referred to as mini-perm loans.
However, the downside of this strategy is that interest rates may be higher than was
the case when construction began and the developer may be forced to pay a higher
interest rate than may have otherwise been available had a precommitment for a
permanent loan been made at the beginning of the development process. If this
strategy was chosen, a developer should also investigate the possibility of an interest
rate swap or hedge against higher interest rates. After the lease-up stage is completed
and normal occupancy levels are achieved, the interim loan will usually be repaid
by using either proceeds from the sale of the property or funds obtained from a
permanent mortgage loan. Permanent loans usually come from life insurance
companies, pension funds, or in some cases, large commercial banks.
Questions:
1. What is interim loan?
2. What are hard costs, and soft costs?
3. How could the developer obtain an addition financing?
4. When does the developer choose short-term financing structures?
5. When does the developer choose long-term financing structures?
6. When does the developer combine short-term and long-term financing structures?
7. What are advantages and disadvantages of the combination between two kind of
financing structures?
2. EXERCISES
2.1 March words to definitions about Important terms of project development
 1. Height restrictions a. drawing done to scale depicting the placement relative
to right-of-way lines and setbacks of structures,
circulation, parking, buffers, major landscaping, etc., on a
site.
2. Parking ratio b. a map depicting the location of all individual tracts or
lots and streets in a development.
3. Site plans c. one of the more important tools used by city planners to
control size and activity (use) desired within a geographic
area. It is usually calculated as gross building area divided
by square footage of land area.
4. Mixed use development d. used to limit the vertical height of a structure to be
constructed.
5. Plat e. area designated for a public street or alley that is
dedicated for traffic, public use, utilities, etc. Public
entities own this area and the general public have a right to
use it. As a result, no improvements are generally allowed
to be constructed on it.
6. Land - to – value ratio f. may first be conceptual or preliminary, then working,
then final drawings of the improvements (building, etc.) to
be constructed on a site. Will usually accompany the site
plan as a part of presentation material used for permitting,
zoning, and financings.
7. Floor-to-area ratio g. calculated as dollar value of land to total project value
(FAR) (including land) anticipated upon completion of project.
Used as a benchmark to evaluate whether the ratio of land
acquisition price relative to total project value is
comparable to that of other projects in the market.
8. Elevations/Renderings h. required number of parking spaces per sq.ft. of gross
building space or per number of apartment units
9. Right-of-way line i. usually a combination of office, retail, and/or hotel in a
project; may also include recreation, sports facilities, etc.
2.2 Read the text below and find the right word or phrase from the bow to fill each of
the gaps.
 properties rate of interest tax benefits
mortgage interest equity capital portfolio
using debt borrow enough

Why should an investor use debt? One obvious reason is simply that the investor may not
have enough (1)_____________ to buy the property. On the other hand, the investor may
have (2)_________ equity capital but may choose to (3)__________ anyway and use the
excess equity to buy other properties. Because equity funds could be spread over several
(4)___________, the investor could reduce the overall risk of the (5)__________. A
second reason to borrow is to take advantage of the tax deductibility of
(6)_____________, which amplifies (7)____________ to the equity investor. The third
reason usually given for (8)____________ is to realize the potential benefit associated
with financial leverage. Financial leverage is defined as benefits that may result for an
investor who borrows money at a (9)____________ lower than the expected rate of
return on total funds invested in a property. If the return on the total investment invested
in a property is greater than the rate of interest on the debt, the return on equity is
magnified.