Real Estate Development Introduction

Real Estate Development Introduction

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. g. Location of competing products 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 Growth in Rent Growth Rents Rise Tight Market Positive But Rapidly Declining Toward New

Construction Levels Cost Feasible New Long Term Vacancy Average Construction Rents - Below Inflation Rental Growth Negative Rental Growth Below Inflation & Negative Rent

Growth Physical Market Cycle 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. ii. iii. iv. Structure

Shell components Roof systems 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. Minipermconstruction 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 Construction Loan Analysis: Borrowing Cost Fee ====== ============= ======== ========== Non-Interest Annual Interest

Month Costs Rate & Fees ------ ------------- -------- ---------0 36,000 #N/A 26,943 1 25,000 9.00% 472 2 71,000 9.00% 663 3 125,000 9.00% 1,201 4

174,600 10.00% 2,386 5 200,000 10.00% 3,861 6 160,000 10.00% 5,559 7 175,000 11.00% 7,633 8 95,000 11.00% 9,307 9 93,000

11.00% 10,263 10 50,000 12.00% 12,229 11 21,000 12.00% 12,851 12 15,000 12.00% 13,190 ------ ------------- -------- ---------Totals 1,240,600 106,557 ========== Draw ---------62,943

25,472 71,663 126,201 176,986 203,861 165,559 182,633 104,307 103,263 62,229 33,851 28,190 ---------1,347,157 13.351% 2.000% ============= Cumulative Cash Loan Flow

------------- ------------62,943 36,000 88,415 25,000 160,078 71,000 286,279 125,000 463,265 174,600 667,125 200,000 832,684 160,000 1,015,317 175,000 1,119,625 95,000 1,222,888 93,000 1,285,117

50,000 1,318,968 21,000 1,347,157 15,000 ------------(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. 2. 3. 4. Project information: final drawings, cost estimates, site plan Property market and borrower financial information Government and regulator information 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. architects 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. OGorman with drawings by Dennis E. McGrath. University of Pennsylvania Press. 1998.

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