Real Estate Development

Introduction
When Does Development Occur?

 Economic Feasibility
o Property Specific Market Analysis
Regional
Neighborhood
o Site Selection

 Design Feasibility
o Site
o Building
 Real Estate Development
Introduction
When Does Development Occur?

 Financial Feasibility
o Investment returns on the
Property
Equity
Debt
 Construction period
 Permanent loan

 Regulatory/Legal Feasibility

 Timing
 Real Estate Development
Economic Feasibility

A. Market Analysis

1. Purpose

a. to identify needs in the real property market

b. to help estimate the market value of the completed property

c. to provide documentation for the financing decision

i. to support loan application
ii. to attract equity investors
 Real Estate Development
Economic Feasibility
A. Market Analysis

2. Steps

a. Define the relevant (sub-)market boundaries

i. primary market
ii. secondary market

b. Market characteristics
i. size of market
ii. market share
iii. absorption rates

c. Characteristics of demanders
i. income
ii. preferences
 Real Estate Development
Economic Feasibility
A. Market Analysis
2. Steps

d. Product supply

i. Existing supply
 Occupancy/vacancy rates

ii. The pipeline

 New construction
 Conversions from alternative uses
 Planned/no permit issued

e. Barriers to entry
 Real Estate Development
Economic Feasibility

A. Market Analysis

2. Steps

f. Location of competing products

g. Current market conditions

i. rent levels
ii. vacancy rates
 by product type
 by amenity package
 Real Estate Development
Economic Feasibility

2. Steps

h. Market projections
i. future demand
ii. future supply
iii. identify development opportunities
 product type
 amenity package
 consumer profile
iv. estimate absorption
v. estimate capture rates
 Real Estate Development
Economic Feasibility

A. Market Analysis
2. Steps
i. Real estate cycles
 Market rents do not justify new construction
o Excess supply
High vacancy rates
Rents and values declining
 No new construction
 Economic growth increases demand
o Vacancy rates decline
o Rents and then values increase
 New construction occurs when expected
benefits exceed (all) expected development
costs
 Real Estate Development
Economic Feasibility

A. Market Analysis
2. Steps
i. Real estate cycles
 Market equilibrium
o Market rents and vacancy rates stable
 Economic growth slower than expected
o Pipeline adds to existing supply
o Vacancy rates increase
o Rents then values decline
 Cycle repeats
o Cycle time varies with property type
 MF: 18 months
 Large Class A Office: 3 years
 Real Estate Development
Economic Feasibility

Equilibrium
Supply/Demand
Inflection Point
High Rent
Rents Rise Growth in Rent Growth
Rapidly Tight Market Positive But
Toward New Declining
Construction
Levels Cost Feasible New
Construction Rents
Long Term Vacancy Average
- Below
Inflation &
Negative
Below
Rent
Inflation Physical Growth
Rental
Negative Growth Market Cycle
Rental
Growth Characteristics
 Real Estate Development
Economic Feasibility
B. Site Selection
1. Highest and Best Use
2. Location and Neighborhood Amenities
a. Proximity
b. Accessibility
c. Visibility
3. Environmental Issues
a. soil contamination
b. groundwater contamination
c. potential liability
Real Estate Development
Economic Feasibility

B. Site Selection

4. Size and Shape

5. Site conditions

a. slope & topography

b. geology/drainage/soil conditions

c. vegetation

6. Easements and covenants

Real Estate Development
Economic Feasibility

B. Site Selection

7. Utilities
a. electric
b. water
c. gas
d. telephone
e. cable

8. Traffic patterns

9. Neighboring uses
Real Estate Development
Economic Feasibility

C. Maps and Surveys

1. Topographic survey
a. property contours
b. springs/marshes/wetlands
c. soil types
d. vegetation

2. Site map

3. Boundary survey

4.Utilities map
Real Estate Development
Design Feasibility

D. Design Feasibility

1. Site

a. Footprint

b. Parking

c. Landscaping

d. Other amenities
Real Estate Development
Design Feasibility

D. Design Feasibility

2. Building configuration

a. External Design Features

i. Structure
ii. Shell components
iii. Roof systems
iv. Signage
 Real Estate Development
Design Feasibility

D. Design Feasibility

2. Building configuration

b. Interior Design Characteristics

i. tenant space
ii. structural flexibility
iii. ceiling height
iv. floor covering
v. utilities
vi. mechanical and electrical
 Real Estate Development
Financial Feasibility

E. Financial Feasibility
1. Measure investment returns
a. Project amount and timing of benefits
b. Project amount and timing of costs
c. Required returns
i. Yield on property
ii. Yield on equity
iii. Yield on cost: spread over cap rates and loan
constants
 Real Estate Development
Financial Feasibility

E. Financial Feasibility
2. Capital Structure
a. Debt
b. Equity
3. Types of loans
a. Construction
b. Permanent
c. Miniperm—construction loan w/option
to extend for a short period
d. Standby commitment
 Real Estate Development
Financial Feasibility

E. Financial Feasibility
4. Completed Project NPV
a. rental revenues: leases
b. non-rental income
c. expenses
i. vacancy/collection/loss to leases
ii. fixed expenses
iii. variable expenses
iv. reserves for replacements
v. tenant improvements and leasing commissions
vi. taxes
 Real Estate Development
Financial Feasibility

E. Financial Feasibility
5. Construction Period NPV
a. land costs
b. site development costs
i. grading
ii. storm/water drainage
iii. sanitary sewer
iv. streets/curbs/walks
v. utilities
Real Estate Development
Financial Feasibility

E. Financial Feasibility
5. Construction Period NPV
c. Building costs
i. hard costs
 shell structure
 HVAC
 Electrical
 Plumbing
 Project management fees
 Finish out
 Signage
 Real Estate Development
Financial Feasibility

E. Financial Feasibility
5. Construction Period NPV
c. Building costs
ii. soft costs
 Architect
 Fees and permits
 Legal
 Construction period interest
 Construction loan fees
 Permanent loan fees
 Leasing commissions
 Direct overhead
 Indirect overhead
 Real Estate Development
Financial Feasibility

Construction Period or Interim Loan

 Variable Rate: prime + 300 basis points

 Developer obtains line of credit and draws funds as work is

completed

 Draws must be approved by lender

 Construction period interest and loan fees accrue during

the construction period and are paid with the proceeds of
the sale of the property or with the permanent financing
 Real Estate Development
Financial Feasibility
Construction Period Loan Example

You want a construction loan to develop a $1.75M garden

apartment complex. The property will take 12 months to build. The
expected non-loan development costs appear in the first column of
the table on the following slide. The construction loan has a 2%
fee. The fee is computed on the total amount borrowed. Interest is
quoted as an annual rate at prime plus 300 basis points. The prime
rate is expected to be:
6% over the first three months of the construction period;
7% over months 4-6 of the construction period;
8% over months 7-9 of the construction period; and
9% over months 10-12 of the construction period.
The interest on the construction loan and the loan fee are not paid
but accrue interest over the development period. Compute monthly
interest, total draws, the loan fee, and the effective borrowing cost.
 Real Estate Development
Financial Feasibility

Co n s t r u c t i o n Lo a n An a l y s i s : | |
Bo r r o wi n g Co s t 13. 351% | |
Fe e 2. 000% | |
====== ============= ======== ========== ========== ============= | |
No n - I n t e r e s t An n u a l I nt e r e s t Cu mu l a t i v e Ca s h | |
Mo n t h Co s t s Ra t e & Fe e s Dr a w Lo a n Fl o w | |
------ ------------- -------- ---------- ---------- ------------- ------------- | |
0 36, 000 # N/ A 26, 943 62, 943 62, 943 36, 000 | |
1 25, 000 9. 00% 472 25, 472 88, 415 25, 000 | |
2 71, 000 9. 00% 663 71, 663 160, 078 71, 000 | |
3 125, 000 9. 00% 1, 201 126, 201 286, 279 125, 000 | |
4 174, 600 10. 00% 2, 386 176, 986 463, 265 174, 600 | |
5 200, 000 10. 00% 3, 861 203, 861 667, 125 200, 000 | |
6 160, 000 10. 00% 5, 559 165, 559 832, 684 160, 000 | |
7 175, 000 11. 00% 7, 633 182, 633 1, 015, 317 175, 000 | |
8 95, 000 11. 00% 9, 307 104, 307 1, 119, 625 95, 000 | |
9 93, 000 11. 00% 10, 263 103, 263 1, 222, 888 93, 000 | |
10 50, 000 12. 00% 12, 229 62, 229 1, 285, 117 50, 000 | |
11 21, 000 12. 00% 12, 851 33, 851 1, 318, 968 21, 000 | |
12 15, 000 12. 00% 13, 190 28, 190 1, 347, 157 15, 000 | |
------ ------------- -------- ---------- ---------- ------------- ( 1, 347, 157) | |
To t a l s 1, 240, 600 106, 557 1, 347, 157 1, 347, 157 | |
 Real Estate Development
Financial Feasibility
E. Financial Feasibility
6. Property NPV: Amortization/ Depreciation Periods

Cost Depreciation/Amortization Period

Capital Improvements 27.5 years for residential
39.0 years for commercial

Tenant Improvements 7 years

Construction Loan Fees Construction period (1 year)

Permanent Loan Fees Loan Term

Leasing Commissions Typical lease term (7 years)

 Real Estate Development
Financial Feasibility
Interim Lender Closing Requirements

1. Project information: final drawings, cost estimates, site plan

2. Property market and borrower financial information
3. Government and regulator information
4. Legal documentation
a. approval for permanent loan
b. all documentation for general contractors, architects,
planners, subcontractors; evidence of bonding; contractor
agreements to perform for construction lender; closing
documents
c. inventory of personal property that secures interim loan
d. executed leases
e. default provisions
Source: Brueggeman and Fisher, 11th Ed., page 440-441.
 Real Estate Development
Financial Feasibility
Permanent Lender Closing Requirements

1. Market and financial data

a. Financial status of borrower
b. List of tenants, lease contracts, estoppel certificates
c. Residual construction cost obligations
2. Project information
a. Estimate of market value
b. Building survey
3. Government and regulatory information
a. Property taxes
b. Certificate of occupancy
c. Other permits (e.g. fire, safety, health).
 Real Estate Development
Financial Feasibility
Permanent Lender Closing Requirements

4. Legal documentation
a. delivery of construction loan mortgage
b. architect’s certificate of completion
c. insurance policy endorsements (casualty, hazard)
d. title insurance policy
e. status of ground rents (if applicable)
f. an exculpation agreement that relieves the borrower
of personal liability (if applicable)
g. lien releases from construction subcontractors

Source: Brueggeman and Fisher, 11th Ed., p. 441

 Real Estate Development
Regulatory Feasibility

F. Regulatory Issues
1. Zoning
a. permitted uses
b. density
c. floor/area ratio (FAR)
d. height restrictions
e. size requirements
 Real Estate Development
Regulatory Feasibility

D. Regulatory Issues
2. Platting
a. street width
b. lot size
c. setbacks
d. turning radius
3. Public Approvals
4. Building Codes
5. Fire Codes
 Real Estate Development
Timing

Go/No go decision points

Land option (option to purchase land)

Government approvals

o Site plan approvals

o Building plan approvals

Lender commitments

Equity investor commitments

 Real Estate Development
References

a. Professional Real Estate Development: The ULI Guide to

the Business, by Richard B. Peiser with Dean Schwanke.
The Urban Land Institute. 1992.

b. Value by Design: Landscape, Site Planning, and

Amenities, by Lloyd W. Bookout with Michael D. Beyard
and Steven W. Fader. The Urban Land Institute. 1994

c. ABC of Architecure, by James F. O’Gorman with

drawings by Dennis E. McGrath. University of
Pennsylvania Press. 1998.